To Corporatise, or not to Corporatise? That is the question

What structures are available to builders that can balance tax efficiencies, offer flexibility for businesses, and ease of compliance?

There are four main structures that are available; Sole Trader, Partnerships, Companies, and Trading Trusts. Each structure has positives and negatives, and it is the balancing of these competing factors that work out what the best structure should be for you. Members who are also Licensed Building Practitioners (LBP) have the additional complication that the structure is “looked” at through to the individual license holder. If this is you, you may need to discuss this further with your advisor to determine a way of undertaking additional asset protection structures with trusts and spouses.

The business risk to a sole trader is that they are liable for all business debts as there is no separation between the individual and the business.

Sole Traders A Sole Trader is the simplest structure and easy to set up because when you are born, you are automatically given an IRD number, which is all you need. From a compliance point of view, all income after expenses are deducted and treated as being taxed in the sole traders’ hands, however this does not always give you the most tax efficient outcome. For example, you are not able to employ your spouse without the IRD’s approval and the deductibility of some expenses are limited. On the counter side, it is very easy to wind up a sole trader as you can make an election with IRD to cease operating.

The business risk to a sole trader is that they are liable for all business debts as there is no separation between the individual and the business. Therefore, all personal assets belonging to the sole trader could be exposed to creditor risk.

Partnerships If two friends decide they want to work together they can form a Partnership. The partnership is separate from the two individual partners, so the nature of expenditure in a partnership is directly related to the business and any personal expense is “charged” to the partners current accounts. Partnerships also have an additional level of complexity for compliance as they are required to complete tax returns, and then any profit (or loss) is attributed to the individual partners. If partners enter

and exit a partnership, this is seen as a restructure and the partnership continues (although there can be some adjustments made for the exiting and entering partners) therefore resulting in nil negative tax consequences for the remaining partners. The partnership can be dissolved if all partners agree and is a similar process to winding up a sole trader.

Partnerships can be risky as all partners are joint and severally liable for each other. It is almost like a business marriage, so when entering into a partnership it is important to have trust in your business partners, or at a minimum, documented accountability. While you may have confidence in your abilities, you also need to have the same faith and confidence in your business partners.

Companies Due to the liability issues of a Partnership, a Company is the preferred structure for business partners. A company has limited liability (represented by the “LTD” at the end of a company name) meaning the shareholders of the company are seen to be separate from the company itself. This also increases the compliance costs as the company needs to account for the inflows and outflows of the resources of the company. The separation of ownership (shareholders) and management of the company (directors) means that expenditure to assist in running the business, (including payments to working shareholders) is treated as a deductible expense to the company and not as private expenses to the shareholders. The company pays tax in its own name which is separate to the tax paid by individual shareholders. Surplus profits are distributed by way of dividends to the shareholders, and this is where the Imputation Credits are used, in effect reducing double taxation on the distribution of surplus profits. Winding up a company can be difficult because of the separation between the shareholders and the company itself. The company needs to go through a formal removal process from the companies register and prove the shareholders have agreed to cease trading. Companies are often removed through “liquidations” which has a negative connotation on the basis that the business was insolvent, but even solvent companies can be liquidated. It is more common to have the company struck off for not filing an annual return, but the correct process is a liquidation process. Trading Trusts The fourth option, which has diminished in popularity over recent years, is the Trading Trust concept. Trusts will be well known to many as part of asset protection for the family home, or other investments that are held in trusts. These are more passive in nature, as they are not taking on business risk by trading. Trading Trusts have the same level of compliance as companies, as there is an accountability to the beneficiaries on the use of the resources of the trust by the Trustees; but trading trusts have the flexibility on the distribution of the profits as these can be taxed in the trusts hands (33%) or in the hands of the beneficiaries (marginal tax rate). Trading trusts are still governed by the trust deed, so it is important that trustees are still familiar with the terms of the Deed.

The Trustees of the trading trust will usually take on the risk of the business, and if trading insolvent, can be held personally liable. It is common, therefore, to have a company as the corporate trustee of the trading trust. It is easier to wind up a trading trust than a company, as it only requires a deed to bring forward the vesting date, vest the assets, and then wind up the trust as it no longer holds any assets. Often the Trustee company will be wound up which means the trust can “fail”

A company has limited liability... meaning the shareholders of the company are seen to be separate from the company itself.

as it no longer has a trustee. The table below summarizes the benefits and weaknesses of the four options:

STRUCTURE

EASE OF COMPLIANCE

TAX EFFICIENCY PERSONAL RISK

Sole Trader

Partnership

Company

Trading Trust

3 3 7 7 7 7 3 3 3 3 7 7

Each business is going to have different needs and it is also expected that business will evolve over time. Pick the best structure that meets your needs, monitor the evolution of your business and adapt as your needs change. For more information or to chat further please call us on 0800 651 900 or visit our website www.tradeworx.co.nz

David Waine is a director of Tradeworx Limited. Tradeworx are NZCB National Partners and a cloud integration company that works with a number of software suppliers to tailor the best IT solutions for you and your business to meet your business goals.