Business Structures - Which One Should I Use?

Business structures- which one should I use?

Deciding the most appropriate structure for your business can be difficult. Each type of business entity has its own unique advantages and disadvantages. The following outlines some of these and can help when deciding which structure best suits your needs.

Sole trader

Advantages

Simple and does not involve any costs relating to establishment or administration of a separate entity.

The income is subject to progressive rates of individual tax.

Disadvantages

Does not easily permit equalising of income with other family members.

Does not provide limited liability.

Income is subject to provisional tax.

Summary

This form is most satisfactory for small businesses, where other family members have other income or where there are no family members to share income with.

Partnerships

Advantages

Simple and not expensive to establish or administer.

Can provide for income to be shared in desired (fixed) proportions.

Tax is paid at personal rates.

Losses are deductible against other income, subject to certain loss offset limits.

Disadvantages

No limited liability.

Income distributions may be inflexible.

Income is subject to provisional tax.

Summary

Best used for husband and wife businesses where simplicity and equalising of income achieves maximum effectiveness.

Company

Advantages

It is generally well understood by financial institutions and customers.

Provides limited liability, although most lending institutions will require personal guarantees.

Permits splitting of dividend income to family members through shareholdings.

Dividends may have imputation credits attached which will reduce or eliminate the individualís tax liability

If the company is a ëqualifying companyí, dividends will either carry imputation credits or be tax-exempt, and tax losses can be attributed to shareholders (if the company is also a ëloss attributing qualifying companyí.

The Companies Act 1993 allows the registration of a ëone personí company.

Disadvantages

Income is taxed at a flat rate of 33%.

Costs of establishment and administration.

Splitting of income by way of shareholding is inflexible and cumbersome.

The company tax rate may be higher than that applicable to individuals with relatively low levels of income.

Except in the case of a ëloss attributing qualifying companyí, losses can be utilised only in the company (or within a group of companies) and are available for carry forward only where there has been continuity of ownership.

Summary

Where the company ëprofití is distributed by way of salary, the salary is deductible and taxed at the individual marginal rates. Alternatively, profits distributed by way of dividend may have imputation credits attached, eliminating the double taxing of company income. The ëqualifying companyí tax regime can also permit beneficial treatments of dividends and losses.

Trusts

Advantages

Provides maximum flexibility and distribution of income or capital gains to family members.

Income vested in beneficiaries (beneficiary income) during the year or within 6 months thereafter is taxed at personal tax rates.

Income not vested in beneficiaries, ie trustee income, is taxed at a flat rate of 33%.

Disadvantages

Not always understood by financial institutions and creates problems when borrowing.

Is relatively expensive to administer where a corporate trustee is used.

Losses can be recouped only against future trust income.

Trustees are required to comply with New Zealand trust laws.

For the 2001-02 and subsequent income years, distributions of beneficiary income from trusts to children under 16 years will generally be taxed at a flat rate of 33%.

Summary:

The profits may be distributed as beneficiary income and are taxed at the beneficiariesí individual marginal tax rates.

Finally

Talk to us before deciding on any business structure. There may be tax implications depending on your particular cirumstances that may need to be considered.

See Us First

Before making any financial decisions.

To assist you in meeting the necessary legal or financial requirements.

If you consider that any of the issues contained in this fact sheet may affect you.

Disclaimer

Important: This is not advice. Clients should not act solely on the basis of the material contained in this fact sheet Items herein are general comments only and do not constitute or convey advice per se. Changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of the areas. We believe the contents to be true and accurate as at the date of writing but can give no assurances or warranty regarding the accuracy, currency or applicability of any of the contents. This fact sheet is made available to our clients as a helpful guide for their private information. Therefore it should be regarded as confidential and should not be made available to any person without our prior approval.

Copyright: No unauthorised copying permitted

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Last updated August 2004