There are number of structures under which a business can be operated. While a Company is the most commonly used, everyday business are run through Trusts, partnerships or operated under a person’s own name (sole trader).
Choosing the right structure will be dependent on a number of factors including:
- Is there more than one person involved in the business?
- What type of business will be operated?
- Is there a potential liability risks?
- Will staff be employed?
- Remuneration considerations
- Tax responsibilities
The below provides some insight into the typical entities New Zealand business owners use for running businesses. However a meeting with the All Accounted For team is recommended prior to deciding on the best solution for your business.
Companies (Companies Act 1993)
Companies are a separate legal entity from the owners (shareholders). This provides the shareholders with limited liability, protecting them personally from any Company debts.
Companies provide flexibility around income distribution, with the Company able to retain profits, distribute as shareholder salary to shareholders or distribute as dividends. The type of income distribution will be dependent on each shareholders income requirements.
Unlike sole traders and partnerships, a business does not need to be re-registered due to a change of ownership. However, the annual compliance costs are higher due to the legislative requirements of the Companies Act. Directors and shareholders are required to meet regularly to approve the activities of the Company and the annual financial results. A summary of resolutions passed at these meetings is required to be filed with the Companies Office annually.
While the income tax rate for Companies is 28%, any profit distributed to shareholders will be taxed at the shareholders marginal tax rates (up to 33%).
Sole traders are the business. The business in relent on the owner, but they can still employ staff to assist with the running of the business.
Sole traders are solely responsible for business’s liabilities and debts. Sole traders however also retain full control of the business assets and its profits.
Many small businesses owners start trading as sole traders because there is less complicity around operating the business. There are also no costs involved with creating a separate legal entity such as a Company.
Sole traders and their businesses are considered to be the same legal entity. Sole traders pay tax through the owners personal IRD number.
Examples include contractors and tradespeople (painter/decorators).
Partnerships (Partnership Act 1908)
A partnership is when two or more people or entities join together to operate a business. The partners combine their assets and share in the profits and liabilities of the business.
A partnership does not have limited liability protection like a Company, meaning the partners are liable personally for any debts incurred by the partnership. If one partner is unable to settle their share of the debts, the remaining partner(s) will be required to settle their share, in addition to their own.
It is generally wise to have partnership agreement that outlines the roles and responsibilities of each partner, along with the profit distribution if not allocated equally.
If a partner leaves the partnership, the entire partnership must be dissolved and a new partnership formed. This can create unintended tax consequences around the disposed of fixed assets.
Partners are taxed individually on their share of the partnership income, meaning each partners will need to account for their own provisional income tax.
Similar to sole traders, partnerships can employee staff to assist with the running of the business.
Trusts (Trustees Act 1956)
Trusts are useful for asset protection and estate planning. A typical family trust will own the family homes and other passive investments. A Trust also provides protection for assets that would have been owned by business owners operating as sole traders and through partnerships
While Trusts are not considered to be a legal entity, Trustees appointed by the Trusts creator (settlor) hold and manage the assets of the Trust on behalf of the beneficiaries. Trusts do provide flexibility with regards to income distributions to beneficiaries, along with the ability to replace the Trustees and beneficiaries without triggering any tax consequences.
All Trusts are expensive to set up and Trading trusts in particular are expensive to administrator on annual, basis due to the complex nature of the Trustees Act.