What Business Structure Is Best For Small Business In NZ?
Starting a new business? Then one of the first things you need to decide on is what sort of structure you’ll use. Here are your main options arranged according to the degree of asset protection and tax flexibility that each provides:
If it’s a one person startup or a part time business, then a sole trader structure may appeal. The main advantage is that it’s really simple and inexpensive to set up and maintain. The only initial registrations you need are with Inland Revenue for GST purposes if you expect your turnover to be more than $60,000, or as soon as you decide to hire an employee.
The main disadvantage is that your liability is unlimited even though insurance and sound operational processes can help to mitigate this risk. In addition, it is the least flexible structure, taxwise, that you can have. For these reasons many sole traders will later convert their business to a company as their business grows.
Some mum and dad businesses start off as partnerships. Their significant advantage is that the initial and ongoing time and cost of complying with the necessary legal formalities are less than for companies. Registration requirements are the same as for sole traders and, although there is no legal requirement for a written partnership agreement, it is certainly desirable to have one.
The biggest disadvantage though, is that each partner is liable for the debts of the other. So, for a mum and dad partnership, this is a road that risks total financial ruin as all privately held assets owned by each spouse are not protected from business creditors’ claims. In recent years however, it has become possible to overcome this by using a limited partnership structure that offers limited liability whilst imposing additional legal compliance requirements.
From a tax point of view, this structure can lack flexibility as each partner is taxed on a fixed share of profits (or receive the benefit of losses) at their personal tax rates
Although it’s well known that the main advantage of using a company structure is that you can limit your liability, there are many examples of where you, if you are a director of your company, may still have personal liability. For example, if you:
- have given a personal guarantee to a supplier or to your company’s bank, or:
- cause your company to trade recklessly, or:
- have entered into an arrangement that is considered to be a tax avoidance arrangement, or:
- have not complied with health and safety at work obligations
These are often good reasons why both you and your spouse should not be directors of your company.
A company also offers more flexibility taxwise, to split income between shareholders, especially if your company has a well developed business structure that includes several employees.
Furthermore, a company structure is often desirable from an image point of view as it's generally well understood by financial institutions, suppliers and customers – and that information relating to it is readily accessible online at the Companies Office.
Conversely, a company’s main disadvantage is the extent of its legal compliance needs, due to it being a separate legal “person”. Although the online formation process is often relatively straightforward, the ongoing requirements are significant, irrespective of your company’s size. Those requirements include financial, taxation and Companies Office reporting, dealing with company specific tax issues with fishhooks such as imputation, capital gains, loss carry forward and Look Through Companies, as well as the maintenance of minutes and company statutory registers.
Trusts offer a greater range of advantages than companies ie:
- more complete asset protection
- greater tax benefits due to their flexibility in distributing profits and capital gains
Conversely their disadvantages are that they:
- are considerably more expensive to set up
- can involve significant ongoing administration costs in order to comply with trust and taxation law
- are not especially practical as a trading entity
Trusts are often used in tandem with a trading company as a way of providing greater protection for your private lifestyle and passive investment assets. This often results in incidental tax benefits provided the scale of your company warrants it. Your company undertakes its trading activities with the benefit of limited liability. Your trust on the other hand is shielded from those liabilities as your company’s majority shareholder. It receives dividends from your trading company which the trustees may in turn distribute to trust beneficiaries as they see fit.
What business structure is best for a small business in NZ is generally a decision with long term effects. It will depend on your situation and the weighting that you give to issues of the type that I’ve covered here. I recommend therefore, that you don’t take action unless you have first taken appropriate professional advice related to your particular circumstances.
AJS Advisory provides on call support that includes assessing the effectiveness of your business structures alongside the use of proven methodologies aimed at improving your business results. Contact us now for more information.