Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

1 | P a g e Income Tax Fundamentals The NZ business owner’s guide to mastering income tax

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

2 | P a g e Income Tax Fundamentals A guide for New Zealand Business Owners About This Guide . . 3 Introduction . . 4 What is Taxable Income . . 6 Business Income . . 8 Capital Gains Versus Income . . 18 Tax Losses . . 20 Calculating Income Tax . . 23 Income Splitting . . 31 Paying Tax . . 33 IRD and Tax Administration . . 44 Tax Planning . . 50 Conclusion . . 54

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

3 | P a g e About This Guide This guide is written primarily for small business owner-operators in New Zealand.

Its aim is to explain, as painlessly as possible, how income tax affects them and how they can be tax-efficient and compliant. The guide covers different commercial entities, such as sole-traders, companies and trusts, and their tax implications. It addresses the most frequent questions I get from my clients who are a mix of service providers including healthcare professionals, architects and engineers, IT and business consultants, who are in business for themselves either as solo-operators or with a small team.

This guide need not be read from start to finish. Each section is self-contained so read any sections relevant to you. Tax is a vast, complex area and a guide of this size cannot cover complex or specific situations. If you have further questions, please feel free to contact us. Robb MacKinlay Legal Notices This guide is intended to provide general advice, and not intended as specific legal or tax advice. While every attempt has been made to provide helpful, accurate information, we do not accept any responsibility or liability for results of action taken in reliance on information in this guide.

All readers should seek independent professional advice.

Copyright 2018 M2 Limited, t/a MacKinlays Ver 1.0

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

4 | P a g e Introduction Nobody goes into business to file returns and pay tax. But they do go into business hoping to make money and tax has a big say on that. While we can’t always foresee the financial result of our decisions, we can know what the tax impact will be. So, there is no excuse for not taking charge of this major part of our business. If you don’t take control of your tax, your tax will take control of you. Penalties for getting it wrong are severe. At the low end, late payment penalties can cost you 5% of the missed payment after a week, and 1% per month thereafter.

Along with IRD’s interest charges, this can quickly cause your tax liability to balloon. At the top end, penalties for failing to account for taxable income can hit 150% of the tax shortfall plus criminal conviction.

And this is before considering the cost, time and stress of dealing with tax audits and investigations. Only tax solicitors and IRD investigators enjoy a good tax audit. But the government gets such a high return on tax enforcement – over $5 for every dollar spent – that they are committing more and more resources to it. IRD are also investing $2,61 billion upgrading their technology, empowering them to be smarter and more targeted about tracking down under-payers. If you are not meeting your obligations, the odds are catching up with you.

While the costs of not managing their tax are so high, many business owners make little effort to understand it.

Even a basic understanding of the tax consequences of their decisions can save them from expensive mistakes. Take the IT professional with a fast-growing company who is worried about an inevitable big tax bill as he nears the end of a good year. After a discussion with a friend, he decides he can justify spending $50,000 on a new car – that he doesn’t really need – to slash his taxable profit before 31 March. But will it really help?

$50,000 spent on a business vehicle in the last month of the year, doesn’t cut his tax by $50,000, or even the tax percentage of $50,000, like he might expect. It entitles him to claim one month’s depreciation on the vehicle, or $1,250, which will reduce his company’s tax bill by $350.

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

5 | P a g e Yes, he will get a full year’s depreciation the following year, but the point is, if you understand the basic principles of how taxation works, you will make better business decisions and get better results. This guide aims to give you that understanding. The smart business operators I know don’t try to trick the tax system.

They just have: • A basic understanding of their tax obligations, and ask for help when needed • A tax-efficient commercial structure • Systems in place so their returns get filed, their tax gets put aside, and tax payments get made

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

6 | P a g e What is Taxable Income Money you make from work or investments is generally taxable income. Your total taxable income received in a tax year, from all sources combined, is multiplied by the appropriate tax rate(s) to calculate your Income tax. This income tax is collected by the Inland Revenue Department (IRD) on behalf of the government to fund their expenditure. Taxable Income Our tax laws determine whether the money you make is classed as taxable income, and therefore subject to income tax. Generally, money received regularly in return for our personal efforts or investments is taxable income.

Taxable income can be categorised as active income or passive income. Active Income Active income is income you earn through our personal efforts. This includes salaries or wages and profits from business activities. Passive Income

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

7 | P a g e While active income is paid for your personal efforts, passive income is paid for the use of your money. When you invest your money in a bank account or income earning assets, your money earns a return on that investment. Examples of Passive Income Interest. When you deposit money in a bank account, the bank will pay you interest for the use of your money.

When you lend money to a company (aka investing in bonds), the company will pay you interest. Rents. When you invest in a rental property, your tenant will pay you rent for the use of the property. Dividends. When you buy a part ownership of a company (i.e., buy shares), the company may pay you a share of its profits as a dividend.

Royalties. If you own an intangible asset such as a patent, trade mark, artwork, book or piece of music, and you allow others the rights to use that intangible asset, they will pay you royalties for its use. All the above is subject to income tax. However, many of these investments can increase in value as well as returning you the passive income. This increase in value is a capital gain and, as discussed later, generally not taxable.

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

8 | P a g e Business Income In most cases, the amount of our income is clear cut. When you are paid a salary, interest, dividends etc, you are paid a determined amount.

Business income is not so straight forward. What is a Business First, we need to know what our tax law deems to be a business and what it doesn’t. In most cases it will be obvious. If you make your living by consulting fulltime to various companies, then you have a consulting business. However, if you spend a few hours a week buying old bicycles off Trademe, doing them up and selling them, you might have a hobby.

Profit Motive The main criteria to determine whether you have a business or a hobby is the intention of making a profit. A business is an activity carried on for profit. Whether or not you actually make a profit is another matter. But if you intend to make a profit and carry on your affairs in a business-like manner trying to make a profit, then you are in business. If your main purpose of an activity is to have fun or to follow a passion, then you probably have a hobby. Let’s take the bike-do-up example. Say you love bikes and enjoy fixing them up. So, you search Trademe listings, buy run down bikes and spend a few hours in your garage, and a bit of money, getting them up to scratch.

But you don’t have room to keep them all in your garage, so you resell them on Trademe. As you are selling them in good order, you tend to get a good price for them and make a bit of a gain. However, you do it because you enjoy it and if you didn’t make any money it wouldn’t really matter. You have a hobby.

Now let’s say an entrepreneurial friend sees what you are doing and gets excited about the business potential. So, with her help and encouragement, you write out a simple business plan and figure that you could make a decent second income from this. You move your car out of the garage to make room for more bikes. You stock up on parts for repairs. You start recording which brands sell for decent

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

9 | P a g e prices and tracking your costs. Your sales increase from one or two bikes a month to two or three bikes a week. At some stage in the above process, your hobby has turned into a business.

The distinction is important because a hobby is not taxable, but a business is. If you believe you have a hobby, but IRD pick up that you’re listing a lot of bikes on Trademe and decide that you’re running a business, they will tax you on your profits. The onus will be on you to prove your activity is a hobby. Alternatively, you may believe you are running a business while IRD see it as a hobby. Once you have deducted your “business” costs including the bike purchases, electricity, tools, and Trademe selling costs, you might be making a loss. Including that loss in your tax return will reduce your total taxable income and therefore your tax.

If IRD decide you in fact have a hobby, the onus is on you to prove it is a genuine business.

When assessing a business versus hobby situation, IRD will look at the level of your sales, how regularly you work on it, whether you keep business records, have a business plan and are generally carrying on like a professional – i.e., in it to make money. Or are you in fact just doing it for the love of it. Calculating Taxable Profit With a business comes income tax obligations. The amount remaining after deducting your tax- deductible expenses from your sales is taxable profit. Profit is worked out on a Profit and Loss Statement. Here is a simple example. Real Simple Consulting Business Profit and Loss Statement for the Year Ended 31 March 2017 $ $ Income Fees 120,000 Less Expenses Office & Administration 22,000 Travel & Entertainment 16,500 Interest 3,000 Professional Development 5,000 Sundry Expenses 3,500 Total Expenses 50,000 Profit 70,000 The $70,000 is subject to income tax.

Income Tax Fundamentals - The NZ business owner's guide to mastering income tax

10 | P a g e Accruals Versus Cash Basis You don’t need a deep accounting knowledge to successfully run a business, but you should understand a few basic principles. One of these is accrual accounting. Taxable profit is generally calculated using an accrual accounting basis. Under accrual accounting, income is recognised when it is earned, not when it is paid for. Generally, income is earned when you have provided the goods or services and you are entitled to invoice your client. If you complete a consulting project for a client during March, and invoice them on 31 March, the income will be taxable in the year ending 31 March.

This is regardless that the client may not pay you until April or later.

Likewise, expenses are recognised when incurred, which can generally be taken as the date of the supplier’s invoice. Under a cash accounting system, income and expenses are recognised when paid. Under most circumstances, we must calculate business income on an accruals basis. Business Expenses As explained above, our taxable business profit equals sales – expenses. The expenses deducted are called tax-deductible expenses because we deduct them from our income before calculating tax. Expenses can be claimed if they are incurred by the business: • to derive taxable income, or • to carry on a business to derive taxable income When a computer business buys computers to resell, the cost of those computers is directly incurred to derive taxable income and is therefore tax-deductible.

When the same computer business rents a shop to display and sell those computers, the rent cost is incurred to run the business and is also tax-deductible. A reasonably common misconception is that “business” expenses are effectively free because we get them back on our tax. People often justify spending with “It’s OK. I can put that through my business” like they will get it back when they file their tax return. What really happens is the expenses reduce their taxable profit, so their tax savings is the tax that would have been paid on the extra profit had the expense not occurred. This tax savings will be anything from 10.5% to 33% of the expense, depending on your marginal tax rate, as discussed later.

It is generally clear whether an expense is tax-deductible or not as most expenses are either incurred for business or personal purposes. However, when your business and you personally both benefit from expenses, it gets a little more complicated. Expenses incurred entirely for your business are fully tax-deductible meaning that the whole cost is deducted from taxable profit. Expenses incurred partly for business but also provide a private benefit, such as a trip to Australia to visit some potential clients and spend a couple of days looking around town

11 | P a g e with friends, must be apportioned between business and private use.

Yet other expenses are considered totally private, even where you may believe they benefit your business, such as a gym membership to keep you fit and productive. Typical business expenses include: • Buying products to resell • Renting business premises • Business travel and accommodation • Telephone and internet • Professional development costs such as courses and seminars • Interest paid on money borrowed for the business • Lease of business assets • Depreciation (the reduction in value over time) of long-term business assets • Entertaining customers and/or staff Let’s look at these in more detail.

Cost of Sales The cost of buying goods for resale is tax-deductible as they are directly purchased to derive taxable income.

There is an added complication with the timing of cost of sales. While most business expenses are deductible when they are incurred, the cost of goods sold must be aligned with the sale of those goods. So, in calculating profit for a tax year, we must calculate the cost of the goods sold in that year. E.g., a model shop buys inventory (aka stock), displays it on its shelves and waits for customers to buy it. If a model is still sitting on the shelf at year end, its cost is not claimed in that year. To calculate cost of sales, we require three amounts: • Opening inventory: inventory on hand at the start of the year • Purchases: inventory purchased during the year • Closing inventory: inventory on hand at the end of the year Opening inventory was purchased in a previous year but has not yet been claimed as the inventory had not been sold.

We add it to the cost this year under the assumption that it will be sold this year. If it is still on hand at the end of this year, it will be added to closing inventory again this year and thus taken out of the cost of sales.

Here is an example of a cost of goods calculation. Cost of Goods Sold Calculation $ Opening Inventory 18,000 + Purchases 82,000

12 | P a g e - Closing Inventory (24,000) = Cost of Goods Sold 76,000 $76,000 is deducted when calculating this year’s taxable profit. If you sell services and not products, you do not have costs of goods sold. There may be a cost of delivering your services, such as paying for staff or contractors to deliver services. However, these costs are normally expensed as they are incurred and not added to an inventory balance in the way that purchases of goods for resale are.

If you work on a project basis, there is an argument for building up Work-In-Progress. In this case, costs of a project that has not yet been invoiced may be carried forward in the same way as closing goods inventory.

Rent Renting business premises such as a shop, factory or office, is a tax-deductible cost. Home Office If you use an area of your home for business, such as using a spare bedroom as an office, you can claim the costs of occupancy of that area. Any expenses specifically relating to the business area is a 100% business cost. This can include repainting the office or putting up shelves. However, many household costs relate to the whole property and therefore provide a personal benefit (for your home) and a business benefit (for your office). These costs must be proportioned between private and business with the business portion claimed.

These costs typically include: • electricity • gas • water • contents insurance – presuming it covers your personal and business assets in the house • gardening contractors • cleaning • Interest charged on the home loan (mortgage). • Rates • Building insurance • Rent To claim the business portion of these expenses you must first determine the business percentage. The default calculation method is by floor area. If you have a 100m2 house and use a 10m2 room as an office, you claim 10% of the shared expenses (10 / 100 x 100)%.

13 | P a g e If you also work fulltime at home, and use the kitchen and bathroom during the work day, you can include a portion of those areas in the calculation.

You might decide that 1/3 of the bathroom and kitchen use is for business purposes, so add 1/3 of those areas to the 10m2 of business area above. Sometimes, the floor area method underestimates the business use of a shared cost. E.g., A mechanic using power tools in a home garage, might use 50% of his electricity to run the workshop. A separate power meter for the garage would provide the correct business cost to claim. If this isn’t practical, some sample readings taken on non-work days and full-work days may provide a good estimate of the business usage.

To claim more than the floor area percentage of shared costs, make sure you have a sound basis for your calculation and keep records of the calculation in case of an IRD enquiry. Telecommunications Business telephones and internet usage are fully deductible. In a home office situation (see above), a dedicated business line will be fully deductible, but a shared household phone line or internet should be apportioned. 50% of a home line rental can be claimed by a home-based business and 100% of business call costs.

Travel Out of town business travel is fully deductible. This can include vehicle running costs, public transport, accommodation and meals.

Note that wining and dining business contacts turns the expenditure into entertainment, subject to the entertainment expenditure rules mentioned below. Professional Development Costs of continuing learning and upskilling is deductible. This can include courses, seminars, books and other resources. Qualifications such as a degree or diploma will generally not be deductible. When we study for a degree, we are improving our skills so that we can become a professional in a certain field. The general interpretation is that these costs are incurred in developing us to become qualified to practice a vocation, not incurred to assist the carrying on of an existing vocation.

The business benefit will come later once the individual can fulfil a higher skilled role.

Interest and Finance Costs When money is borrowed to fund a business, the costs of that borrowing such as interest and loan fees, are tax-deductible. It is the purpose the money is used for that determines whether the finance cost is deductible or not. If the money is used to buy business equipment, the costs are tax-deductible. If money is borrowed, even by a business, and used to purchase a private boat, the interest is not deductible.

14 | P a g e Note, however, that there is a rule allowing a company to deduct interest regardless of what the money is used for.

Refinancing Businesses are funded from two primary sources: Owner’s equity and debt. Owner’s equity is the owners’ investment in the business and the business pays for the use of these funds by entitling the investor to a share of the business profits and gains. Distributions of profits to owners is not tax deductible. Debt is finance from external parties in the form of loans and the business pays for the use of these funds in interest and financing fees. These costs are tax-deductible.

If a business raises debt finance to repay other funding, such as owners’ investments, it is restructuring its financing. Therefore, the debt finance raised is being used for business purposes and is tax- deductible. If you are a business or investment property owner and are borrowing money for any purpose, it often presents a tax planning opportunity. I strongly recommend getting professional advice before refinancing or you could easily end up with non-deductible debt that, with a more efficient structuring, could be tax deductible. This can make a huge difference to your overall tax-efficiency.

Loan Structure Loan repayments must be separated into principal and interest. Principal payments are repayment of the borrowed funds, while interest is a payment for the use of those funds. Only the interest is a cost of using the money and therefore tax-deductible.

Most loan repayments include interest and principal. In a table loan, the repayments remain the same throughout the loan term so, as the loan balance reduces, the interest portion of the payments decrease while the principal portion increases. A loan schedule is needed to calculate the tax-deductible interest portion of each repayment. Leasing Leasing, or renting, assets provides some advantages over buying including a lower financial commitment and more flexibility to upgrade or swap the asset. Short-term leasing also usually means paying for the asset only when needed without the maintenance costs of long-term ownership.

Tax laws for leases are complex. For income tax purposes, leases are split into two categories: operating leases and finance leases.

Operating leases are simpler and akin to renting. The lessee pays to use the asset and the risks and benefits of ownership remains with the lessor. The lessee’s cost is fully tax deductible.

15 | P a g e Finance leases are more complex. A finance lease occurs when the lease term covers most of the asset’s useful life. The lessee is considered to take on the financial risks and rewards of ownership regardless of whether legal ownership transfers or not. A car lease exceeding four years is a finance lease. Under a finance lease, the lessee is treated as having purchased the asset and financed the purchase with a loan from the lessor, or financing company.

The lessee business brings the asset into the accounts and depreciates it (see below). The lease payments are treated as loan repayments and the interest, or finance cost, portion of the repayments are tax-deductible. Whether a lease is treated as a finance lease or an operating lease for tax purposes will depend on the terms of the lease arrangement and other lease terms. It is important to get advice when entering a lease to ensure you take the correct tax position.

Fixed Assets and Depreciation The benefit resulting from most business expenses is used up immediately or at least within a year. These expenses are claimed as they’re incurred. The cost of an asset that will provide benefits over multiple years has to be spread over the useful life of the asset. The value of the asset is written down each year at an IRD prescribed percentage, and the amount written down (depreciation) claimed as an expense in that year. Depreciation is an attempt to match the cost of the asset to the periods in which it helps generate income. The rate we can depreciate an asset at, for tax purposes, is set by IRD and depends on the expected useful life of the category of asset.

For example, computers become obsolete quickly and can be depreciated at 40% of the cost price each year until fully written off. An office desk is expected to last longer and can only be depreciated at 8.5% per year.

Motor Vehicles Small business owners typically use vehicles for both business and privately. As with other shared costs, the cost of owning and running a vehicle can be claimed by the business to the extent it is used for business. There are multiple ways to handle this however and, as vehicle costs and the resulting tax consequences are significant, it is worth getting advice before committing to a new purchase. Below are three common methods. 1. Business Percentage Calculation Using a Log Book The business usage portion can be claimed by keeping a log book of business kilometres travelled and then calculating its percentage of total kilometres travelled.

You can then claim that business percentage of all vehicle expenses including fuel, servicing, depreciation on the vehicle’s cost price and interest on vehicle finance.

16 | P a g e A percentage calculated from a log book over a three-month period of typical business / private use can be used for the following three years unless the business use percentage changes significantly. After three years, another three-month log book period is required. 2. Company Car and Fringe Benefit Tax If you trade through a company and your company purchases a vehicle, it can claim 100% of the vehicle costs. If the vehicle is available for personal use, Fringe Benefit Tax (FBT) is payable. FBT calculations are based on the value of the benefit provided to the employee, usually taken as 20% of the GST inclusive cost price of the vehicle, per year.

The company then calculates and pays FBT on this benefit. The FBT rules include exemptions for days that the vehicle is unavailable for private use and some limited exemptions for business purpose vehicles.

The FBT rules are complex and often subject to IRD scrutiny so take care. 3. Claiming a Standard Rate per Kilometre If you use your private vehicle for business, it may be easier to claim for the business usage without collating actual costs. IRD provide a standard mileage rate for this, currently 72 cents per kilometre. The business reimburses the vehicle owner 72 cents for every business kilometre. The reimbursement is tax-deductible to the business. To calculate business kilometres, you will need to record business trips. Mobile app logbooks can make this easier, and if you have regular business trips, knowing the distance of specific trips helps to keep track even if you forget to record the initial mileage when setting off.

The rate claimed does not have any GST content and is just claimed as a deduction in the annual income tax return. You can also use vehicle costs published by other industry bodies such as the Automobile Association (AA). The AA publish rates for different sized vehicles and the rates are often higher than the IRD rate. These reimbursement rates are limited to 5,000 kilometres per year so, if you do a lot of business driving, may not be a good option. Entertainment Tax In relationship-based businesses like professional services and consulting it is normal to invest in those relationships with staff, clients and other business contacts.

This can involve holding functions, buying meals or giving gifts.

This type of expenditure is prone to abuse and hard to police. Lunch with your spouse, who also helps with your business, can easily become a “business” discussion. For this reason, entertainment tax rules limit what can be claimed.

17 | P a g e Deductions for certain types of entertainment expenditure is limited to 50% of the expense. This includes costs of: • Events and functions • Holiday accommodation • Pleasure craft • Food or drink There are exceptions to the 50% limitation. Under certain circumstance, 100% of the following can be claimed: ✓ Business travel costs, as above ✓ Food and drink at conferences or training courses ✓ Meals allowances when working overtime ✓ Tea and coffee while working and snacks at morning and afternoon tea ✓ Overseas entertainment There are limitations to these exceptions.

E.g., a training course must be over four hours long to be able to fully claim a meal. So before planning an event, know what you’re entitled to. Expenses we Cannot Claim Some expenses that may have a business benefit cannot be claimed. Generally, this is where IRD see them as primarily providing a private benefit. Examples are: • Health related costs such as gym memberships, massages, glasses and hearing aids • Clothes, even if used only for work, unless classified as protective clothing or uniforms • Life insurance, although income protection insurance can be claimed in your personal tax return Grey areas exist when an expense, that is normally considered private, is primarily incurred for business.

E.g., sponsorships may be deductible if you run a business in the industry you are sponsoring and can demonstrate a connection between the expenditure and generating business. Again, it is worth getting some advice to get the appropriate tax deductions.

18 | P a g e Capital Gains Versus Income Assume you purchase a residential property with the primary purpose of renting it out. The rental returns are taxable income, but any increase in the property’s value is a capital gain and not taxable. This is because we do not have a capital gains tax in New Zealand. Now let’s assume that you hear about plans for a high-speed commuter train service between the city centre and a small town 35km away. This will greatly ease the commute from the town to the city centre and you anticipate house values in the town will shoot up. Wanting to capitalise on this, you buy a section near the town’s planned railway station with the intention of reselling later once the prices have increased.

Presuming the section price does rise, your gain on sale becomes taxable as your intention at the time of purchase was to profit from the price gain. This is one example of a gain, that would otherwise be non-taxable, being caught by our income tax laws and treated as income rather than a capital gain. So, while we do not have a comprehensive capital gains tax, certain gains under certain situations are treated as taxable income. Some of the provisions that capture gains as income relate specifically to land sales (including buildings and improvements attached to the land) and some relate to any type of asset.

While this guide does not go into detail of when “capital” gains become taxable, the following is a list of situations where an income tax liability can be triggered, and advice should be sought. Sale of any assets including land, shares and precious metals • Asset purchased with the intention of reselling • The sale forms part of a business activity or profit-making undertaking or scheme • Taxpayer forms a pattern of regular purchases and sales Specific to Land Sales • Sales within two years of purchase under the bright line test • Taxpayer is in a land-related business such as a: o Land dealer o Developer

19 | P a g e o Builder • Taxpayer is associated to someone one of the above business types • The land is subdivided • A rezoning has substantially increased the land value Exceptions in the Land Tax Rules If a land sale is caught by one of the above provisions, exemptions may provide relief where the property is used for the taxpayer’s residence, business premises or farm. There are also time limits to some of the rules such as some land sales sometimes only being taxable if sold within ten years of purchase.

It is also worth noting that, should a sale be caught as taxable income, deductions are generally allowed for costs.

I.e., it is just the “profit” made that is taxable, not the full sale price. If you are concerned about the tax status of an investment, make sure you keep records of all related costs. Professional Advice These rules are complex and individual circumstances vary. There is no substitute for specific professional advice, before making a buying decision.

20 | P a g e Tax Losses What is a Tax Loss? To calculate the taxable income of a business, we take the total sales and deduct total expenses, leaving the remaining taxable profit, or taxable income. When costs exceed sales, the taxable profit becomes a negative, or a tax loss. Tax losses can occur on any type of income where costs can be deducted. This includes business, rental and other investment income. Offsetting Tax Losses Against Income A person is taxed on their total taxable income for a tax year. If they have a tax loss from one source of income, this is deducted, reducing their total income.

E.g., Bob had two sources of income during the 2017 tax year: a salary of $70,000 and a rental property which made a loss of $14,000. His taxable income is $56,000: $ Salary 70,000 Rental loss (14,000) Taxable Income $ 56,000 If Bob’s rental loss exceeded his salary, he would have an overall tax loss. This excess loss could be carried forward to offset against income in subsequent years: $ Salary 10,000 Rental loss (15,000) Tax loss to be carried forward to following year ($ 5,000) Note that making an overall loss in a year would not entitle Bob to any sort of tax rebate. He will be refunded any tax he has paid during the year, such as PAYE deducted from his salary, but nothing more.

IRD does not subsidise losses.

Offsetting Tax Losses Between Taxpayers Generally, tax losses can only be offset against other income of the same taxpayer, not against income of other taxpayers. This can lead to tax inefficiencies where we have one entity paying tax on income while another entity is losing money but receiving no benefit from them. E.g., you may have a company

21 | P a g e or a family trust that is losing money on a rental property while you are personally paying income tax on your salary. If you are planning to make an investment or start a business, and anticipate making losses initially, careful structuring can help ensure you can offset the losses against your other income.

Tax Losses and Structures When we talk about tax structure, we are referring to the choice of entities to own our business or other investments. Structuring choices are made for commercial reasons with the most important being protection of individuals and assets from commercial and personal risks. For example, most people use a company to own their business as a company limits their personal liability. So, tax is not the only consideration when designing an appropriate structure, but the tax implications have a big impact on the financial results.

Companies and Tax Losses If an ordinary company makes a loss in a tax year, the loss can generally be carried forward and offset against future taxable income of the company. There is no time limit on carrying forward losses. A company can carry them forward for many years until profits are made. However, the losses are forfeited under certain circumstances, the main one being a major shareholding change. Losses are forfeited when a company’s shareholding changes by more than 51%. This rule is to ensure that only the company’s owners at the time the loss was incurred can benefit from the losses.

We cannot sell a company inclusive of tax losses.

Company tax losses are also forfeited if the company becomes a look-through company, as discussed below. Assuming a company maintains its losses, the losses are still generally contained within the company. However, in some circumstances, they can be offset against income of other taxpayers. Loss Offsets Between Commonly Owned Companies When a person, or group of people, own at least 66% of two or more companies, the companies are considered commonly-owned. A tax loss from one commonly-owned companies can be offset against a profit of another. 66% or more common ownership must be in place from the beginning of the year the loss is incurred until the end of the year of offset.

The loss offset cannot exceed the profit in the profit company. I.e., an offset cannot put the profit company into a loss situation. To offset company losses, an election must be made by the time the tax return for the offset year is due to be filed, generally 12 months after year end if an Extension of Time for filing is in place.

22 | P a g e Look-Through Companies (LTCs) A New Zealand company with five or fewer shareholders can apply to IRD to become a Look-through company (LTC). Related people are counted as one shareholder. LTCs are normal companies in all respects other than for income tax where they are transparent, acting like partnerships.

Income and expenditure of an LTC passes through the company and is attributed to its owners in proportion to their shareholding. If an LTC with two equal shareholders makes a profit of $100,000, each shareholder returns $50,000 income to be taxed at their personal tax rates.

If the same LTC made a loss of $50,000, each shareholder would include a $25,000 loss in their tax return which would be offset against their other taxable income. LTC’s can be an effective structure to own an investment or business that is likely to make losses in early years where the owners have other income to offset the losses against.

23 | P a g e Calculating Income Tax Income tax is calculated on taxpayer’s total taxable income from all sources for a tax year. For most people, a tax year runs from 1 April to 31 March. The tax rates applied depend on the type of entity being taxed.

Companies and trusts have flat tax rates so pay tax at a fixed percentage of their income regardless of the level of income. Individuals have progressive tax rates meaning the rate increases as income increases. Current income tax rates are: • Companies 28% • Trusts 33% • Individuals 10.5% - 33% Individuals currently have four tax rates: Income Band Tax Rate 0 - 14,000 10.5% 14,001 - 48,000 17.5% 48,001 - 70,000 30.0% Over $70,000 33.0% These are marginal rates. This means that the rate only applies to the income within the relevant income band.

An individual’s first $14,000 of income is taxed at 10.5%. If they earn more than $14,000, their next $34,000 (taking them up to $48,000 total income) will be taxed at 17.5%. So, while their total income is between $14,000 and $48,000, their marginal rate is 17.5%. I.e., the marginal rate is the rate at which the next dollar of income will be taxed. Once their income reaches $48,000, their marginal rate increases to 30%. Tax Paid at Source Some income is received untaxed, such as rental and business income, while other income has tax deducted from it before you receive it, such as salaries and wages.

Your employer deducts tax, known as Pay as You Earn (PAYE), from your salary. Your bank deducts Resident Withholding Tax (RWT) from your interest. PAYE and RWT are names given to income tax deductions from different types of income. They are all passed onto IRD and credited to your income tax account.

24 | P a g e Source Deduction Tax Rates These source deductions are an estimate of the tax you will have to pay on the income. As the payer does not know what other income you have, they may deduct too much or too little requiring you to pay extra or get a refund after the end of the tax year. Your PAYE rate depends on the tax code you provide your employer with. An “M” tax code means it will be taxed as your main source of income. A secondary tax code presumes you have other income, so are in a higher income band, and deducts tax at a higher rate.

You can advise your bank your rate for RWT deductions with your choices being 10.5%, 17.5%, 30% or 33%.

To advise the right rate, so no further tax need be paid or refunded, you need to know your marginal tax rate which depends on your total taxable income from all sources. If your total income is below $14,000, choose 10.5%. For an income between $14,000 and $48,000, choose 17.5%. Dividends and director’s fees must have 33% tax deducted. All tax paid at source is accounted for when calculating your final tax payable for the year. Taxing Different Business Structures The right commercial structure will protect you and your assets. It will also affect the way your tax is calculated. A basic understanding will help prevent you from paying too much tax.

To follow is an overview of how individuals, partnerships, look-through companies, trusts and standard companies are taxed.

Individual Tax Calculation As we saw above, individuals are taxed on a progressive scale with tax rates increasing as income increases. Let’s look at an example. Tom, a self-employed plumber, earned total taxable income of $52,500 during the year ended 31 March 2017: Taxable Income $ Taxable profit from plumbing business 54,000 Loss from rental property (4,200) Interest earned on savings 2,000 Dividend from power company 700 Taxable Income $ 52,500

25 | P a g e Source Deductions Tom had elected an RWT rate of 17.5% with his bank so they deducted $350 tax from his interest ($2,000 x 17.5%).

His power company must tax the dividend at 33% so a further $231 of tax has been paid ($700 x 33%). Total tax deducted at source is $581 ($350 + 231). Tax Payable To calculate Tom’s tax payable for the year, we split his total taxable income into the relevant individual income bands and calculate tax on each band: Income Band Tom’s Income in Band Tax Rate Tax 0 - 14,000 14,000 10.5% 1,470 14,001 - 48,000 34,000 17.5% 5,950 48,001 - 70,000 4,500 30.0% 1,350 Over $70,000 0 33.0% 0 Total $ 52,500 $ 8,770 As Tom made more than $14,000, we calculate tax on the first $14,000 at the lowest tax rate of 10.5%.

This comes to $1,470.

He also made over $48,000, so the next $34,000 (48,000 – 14,000) is taxed at 17.5%. $5,950 is payable on this. Tom’s income is under $70,000 so his remaining $4,500 fits into the third band and is taxed at 30%. As we can see, Tom’s total tax is $8,770. Tax Payable or Refundable As above, Tom has already had tax deducted, from his interest and dividend, of $581, leaving an end-of- year tax bill of $8,189: Tax calculated 8,770 Less Paid at Source (581) Tax Payable $ 8,189

26 | P a g e If Tom’s source deductions exceeded his tax payable, IRD would refund him the amount overpaid.

This often happens where most the income is taxed at source and has been deducted at a higher rate than necessary. Later we will look at when Tom must pay the $8,189. Partnerships A partnership exists between two or more people when they do business together without creating a separate legal entity such as a company. Partnerships are not separate legal entities. I.e., there is no legal barrier between the partnership and the partners. Each partner has personal liability for all debts of the partnership. A partnership is like a sole-trader, with the individual being the legal business entity, but with more than one individual involved.

Partnerships do not pay income tax. They are transparent for tax purposes, meaning their profits or losses are directly attributed to the partners who are taxed on them. The partnership income split is not necessarily 50:50. If a Partnership Agreement has been drafted, it will determine how the profits are to be split. For a two-partner business, this could be 50:50, 75:25 or any split that the partners agree on, provided it totals 100%. If a two-partner 50:50 partnership makes a $100,000 profit, each partner returns $50,000 of partnership income in their tax returns. They are then each taxed at their individual tax rates as per the previous section.

Look-through Companies (LTC’s) As discussed earlier, a look-through company (LTC) is a normal company other than for income tax purposes. A company with look-through status with Inland Revenue is treated as a partnership for tax purposes with profits and losses directly attributed to the shareholders’ individual income tax returns, in proportion to their shareholding, to be taxed at the shareholders’ individual tax rates. So, an individual owning 20% of the shares will receive 20% of the losses, or profits, of the company. The main tax-advantage of both partnerships and LTCs, when compared to normal companies, is that losses are attributed to the owners who can offset them against other income, thus reducing their overall taxable income and therefore their tax.

An LTC provides the legal benefits of a company, primarily protecting the owners, but the tax benefits of a partnership. LTC’s are often used for investments, such as rental properties, where losses are expected in the first few years. An LTC can pay wages to one or more partners for working in the business, with the remaining profits or losses attributed. So, there is some flexibility in terms of splitting income. Trusts New Zealand trusts all have one of three tax statuses: • complying trusts

27 | P a g e • non-complying trusts • foreign trusts Each has its own set of tax rules. For our purposes, we will consider complying trusts which make up most NZ trusts. If you are a settlor or trustee of a trust, and have lived overseas or are moving overseas, then you may have to consider the other two types. When a complying trust earns taxable income, it can either retain the income and pay tax at the trust rate of 33%, or distribute some or all of the income to one or more beneficiaries. Income distributions from trusts are included in the beneficiaries’ taxable income and taxed at their individual tax rates.

If the trust has paid tax at source on the income distributed, it can also elect to distribute the tax credits, so the beneficiary does not have to wear the full tax burden. A trust can elect to pay the beneficiaries’ tax on their behalf, but if it does so, it is paid at the beneficiaries’ rate, not the trust rate.

The ability of a trust to distribute income is dependent on the rules in the trust’s deed. Most modern family trusts allow the trustees discretion to distribute income to any beneficiary as they see fit. Below is a simple example. The Smith Family Trust The Smith Family Trust has money invested in term deposits and a share portfolio. The trust has made investment income of $30,000 in the year ended 31/3/17. The trustees decide to distribute all the interest income, but not the dividend income, to Bob the beneficiary. The Smith Family Trust’s Tax Calculation $ Dividends 10,000 Interest 20,000 Taxable Income 30,000 Less Interest distributed to Bob (20,000) Trustee Income $ 10,000 Trust Tax Payable @ 33% 3,300 Less Tax Deducted from Dividends 3,300 Trust's Tax to Pay $ 0 $20,000 was distributed to Bob, along with the Resident Withholding Tax (RWT) deducted by the bank from the term deposit interest.

This leaves the dividend income, earned on the share portfolio, as

28 | P a g e trustee income. The trust pays 33% tax on this but, as the dividends have already been taxed at 33%, there is no remaining tax payable. Bob the Beneficiary’s Tax Calculation $ Business Profits 25,000 Interest 20,000 Taxable Income $ 45,000 Tax 6,895 Less RWT deducted from Interest 1,207 Bob's tax to pay $ 5,688 Bob includes the $20,000 interest in his tax calculation which, along with his other income, takes his total taxable income to $45,000. Bob is taxed on the $45,000 ($6,895) but receives a credit for the $1,207 RWT which the trust distributed, leaving Bob with tax to pay of $5,688.

Companies A company is the most popular type of commercial entity for owning and running a business for good reason. Companies also provide some tax planning opportunities.

A company’s taxable income is its profit after deducting all allowable tax-deductible expenses from its revenue. Companies are taxed at a flat rate of 28% of their taxable profit. Here is an example of Hayley’s company. Hayley's Nutrition Services Ltd Profit and Loss Statement For the Year Ended 31 March 2017 $ $ Income Fees 90,000 Less Expenses Salary paid to Shareholder 65,000 Home Office 5,000 Travel 2,500 Professional Development 2,000 Office Expenses 1,200 Sundry 1,000

29 | P a g e Total Expenses 76,700 Taxable Profit 13,300 Tax Expense @ 28% 3,724 Hayley’s Nutrition Services Limited had taxable income was $13,300 after deducting all business expenses, including a $65,000 salary paid to Hayley.

The company pays income tax of $3,724 (13,300 x 28%). Shareholder Employees When a business owner-operator has a company trading structure, the company is a separate legal entity and taxpayer. The individual works for the company. Presuming the business owner-operator owns at least one share in the company in her name, she is both a shareholder and an employee. A small company has some flexibility in terms of how it pays its shareholder-employees. PAYE Deducted Salaries The company can pay a PAYE deducted salary to the employee. The salary is an expense to the company and therefore deducted from its taxable income, reducing company tax payable.

The salary is taxable income to the employee, but the company deducts tax as PAYE and pays this to IRD on behalf of the employee.

Shareholder Salaries More commonly, the company will wait until the tax year is finished to decide how much to pay the employee. Our tax law allows this flexibility. The advantage is that the company can wait to see how much taxable income there is in the company and then decide how much to pay the shareholder. The company then allocates an appropriate salary. The salary is not usually paid in cash, but credited to the shareholder’s current account which is a balance in the company’s accounts owed to or from the shareholder.

The amount of the salary must make commercial sense. As with most transactions, a salary paid just to minimise total tax, is tax avoidance and maybe overruled by IRD.

During the year, the shareholder will take money out as drawings which are a loan from the company. No tax is payable on drawings as it is not an expense of the company or income to the shareholder. Dividends Another way a company can pay income to a shareholder is by a dividend. Unlike a shareholder salary, dividends are not a payment for services provided to the company but are a share of the company’s profits and a return on the shareholder’s investment in the company. When a dividend is paid, all

30 | P a g e shareholders receive part of the dividends in proportion to their shareholding (presuming all the company’s shares have the same rights to dividends) regardless of whether they work for the company or not. As dividends are a return on investment, they are passive income. This means that ACC Levies are not payable on dividends as ACC only covers earned income such as wages, salaries and self-employed business earnings. Dividends must be taxed at source at 33%. The company deducts Resident Withholding Tax on Dividends (DWT) to ensure 33% tax has been paid on the dividend. So the company deducts of a maximum of 33%, but often less than 33% as explained below.

The company pays tax on its profits at the company rate of 28%. When profits are distributed, this tax already paid on them can be attached to the dividends, so the shareholder gets credit for them, avoiding paying tax again on the same profits. The tax credits attached are known as Imputation Credits and the company keeps an account of how many imputation credits it has accumulated (by paying tax) and how many it has distributed (by attaching to dividends). The balance in a company’s imputation credit account must be at least zero at year end. I.e., the company cannot attach more imputation credits than it has available.

As a company pays income tax at 28%, it will have a maximum of 28% of imputation credits available to attach to dividends. DWT must be deducted to take the total tax on the dividends to 33%. If there are Imputation Credits of 28% available, the company deducts an extra 5% DWT. Sometimes a company will not have 28% imputation credits available, in which case the DWT deducted must be sufficient to take the total tax credits to 33%. i.e., DWT and Imputation Credits must total 33% of the gross taxable dividend.

31 | P a g e Income Splitting As we have seen, income tax rates vary from 10.5%, the lowest rate for individuals, to 33%, the highest individual rate and the trustee rate.

Clearly there are advantages of spreading income out to take advantage of the lower rates. Business income A simple example is a couple with a business but no other income. Let’s say Sheila is a self-employed audiologist making a business profit of $100,000 per year. Her husband, Bruce, is a stay-at-home Dad with no income. If Sheila is a sole-trader, all the $100,000 profit is hers and taxed at her tax rates. That includes $30,000 of income at the over $70,000 rate of 33%. Sheila’s income tax comes to $23,920: Sheila Bruce Total Taxable Income 100,000 0 100,000 Tax Payable 23,920 0 23,920 Sheila and Bruce would be far more tax-efficient if they split the income.

Ultimately, a 50:50 split would give them $50,000 taxable income each and combined tax payable of $16,040, $7,880 lower than the scenario above.

Unfortunately, in NZ, we are not allowed to spread our income with our spouse in this way unless it is a genuine commercial arrangement. Our anti-tax avoidance rules mean that most of the income must be taxed as Sheila’s income as she has primarily generated the income. There is no allowance for the fact that Bruce is supporting the kids, so Sheila can put in the hours at work and make their money. However, we may be able to help Sheila and Bruce. Let’s say they incorporate a company and each of them owing shares. And let’s say Bruce does some work for the company. Maybe he looks after the bookkeeping, credit control and keeps the business’s social media accounts updated and can justify being paid a $20,000 shareholder salary.

32 | P a g e This leaves $80,000 in the company. Most of this will have to be paid to Sheila, but we may be able to leave say $10,000 in the company as retained profits to be taxed at the company rate of 28%. So, we pay Sheila a shareholder salary of $70,000. Now what does the overall tax look like? Sheila Bruce Company Total Taxable Income 70,000 20,000 10,000 100,000 Tax Payable 14,020 2,520 2,800 19,340 With total tax of $19,340, this a $4,580 tax savings on the first scenario. Investment income Other income splitting considerations include looking at how investments are structured. Money in the bank, shares and rental properties can be in individual names, joint names or in Look-through companies with an appropriate share split between partners.

The best outcome is for income to accrue to the partner with the lower marginal tax rate and tax losses to be attributed to the partner with the higher marginal tax rate.

Tax losses To benefit from tax losses, we need to offset them against taxable income. In our previous example, if Sheila and Bruce had a loss-making (negatively geared) investment property, a LTC company with all the shares in Sheila’s name would mean the whole loss would be used to reduce her taxable income. There are numerous factors to consider on top of straight tax-efficiency including staying on the right side of anti-tax avoidance rules, legal ownership issues and asset protection. Legal structuring is a complex area and is well worth getting advice on your specific situation.

33 | P a g e Paying Tax Your income tax payments due dates depend on your balance date (the last day of your financial year).

Your balance date will be New Zealand’s standard balance date of 31 March unless IRD has given you permission to use another one. Non-standard balance dates are usually allowed in specific industries that are seasonal in nature. Year ends will be timed around seasons such as 30 June for dairy farmers during their traditional dry season. Also, NZ entities with overseas owners may apply for a balance date aligned with the owner’s balance date. Many countries have 31 December as their standard year end date.

The examples below presume a 31 March balance date. First Year in Business Unplanned for income tax can be life-threatening to new businesses. When we start a business, we don’t need to do anything about income tax until after our first year of business, and even then, we have up to another year available to procrastinate. But it catches up with us. Facing two years’ worth of tax payments within a month can cripple a fledging business so it is vital to plan your cash flow for it. Let’s take a hypothetical example of Darren Light, an IT Consultant. Darren leaves his fulltime job in April 2015 and launches his own business, “Light IT!”.

Darren decides to trade as a sole-trader initially and see how things go. He is sure is turnover will be over the GST threshold of $60,000 so he registers for GST, but at this stage does nothing about income tax.

Darren has good contacts and some work lined up from the start. In its first year to 31 March 2016, Light IT! has revenue (sales) of $135,000 and, after deducting business expenses, a taxable profit of $88,500. Business is booming and by the second year, Darren is flat out. He knows he must organise getting his tax return filed but is so busy doing real work that he keeps putting it off. When he finally has a couple of weeks’ break in January 2017, he starts worrying about his tax obligations. So, he returns to work a day early and sorts out his records for his accountant.

On the last day of February, his accountant calls Darren and tells him he has tax of $20,125 to pay on his $88,500 profit in the year ended 31 March 2016.

This is due 7 April 2017. That is not all. As Darren’s tax bill is over $2,500, he now becomes a provisional tax payer. His accountant explains that he will pay tax for the following year (the year ending 31 March 2017), which finishes in a month, in three instalments during the year. The instalment dates are 28 August 2016, 15 January 2017 and 7 May 2017.

As it is already the end of February 2017, by the time Darren’s tax return is filed, only the 7 May instalment date will remain. That means that the whole year’s provisional tax will become due on 7 May 2017.

34 | P a g e Darren’s provisional tax will be based on his 2016 tax bill. Under the default calculation method, his provisional tax is his previous year’s tax plus 5%. In this case, that is $21,131 ($20,125 plus 5%). So now Darren faces tax bills of $20,125 on 7 April and $21,131 on 7 May. That is two years’ tax due in the next two months or so. If he hasn’t been providing for this tax he faces a cash flow crisis.

Many businesses fail at this two-year point. Terminal Tax and Provisional Tax Income tax is income tax however it is calculated and paid. Tax paid at source can be called PAYE (deducted from wages), RWT (deducted from interest) or Withholding Tax (deducted from some contract income), etc. But it all goes to the same place – our income tax account. When we receive untaxed income, and pay our own income tax, the tax payments are called either provisional tax or terminal tax.

Due Dates Provisional tax is paid in three instalments: two during the tax year and a final payment just after the tax year end. Terminal tax is a final washup payment, after accounting for the final tax calculation and all other income tax already paid. An extension of time (EOT) means that you have until 31 March, 12 months after your year-end, to file your tax return and an extra two months to pay your terminal tax. When you use a tax agent (accountant registered with IRD for filing tax returns), you automatically receive an EOT. You can lose your EOT if you file a tax return late, and must then file one on time again to be able to apply to have your EOT reinstated.

Without an EOT, tax returns must be filed by 7 July, just over three months after year-end, instead of 31 March, 12 months after year-end. Without an EOT, terminal tax is due 7 February, just over ten months after year-end, instead of 7 April.

35 | P a g e Income Tax Due Dates With Extension of Time No Extension of Time Due Date Days after year-end Due Date Days after year-end Tax return filing 31 Mar 365 7 Jul 98 Terminal tax payment 7 Feb 313 7 Apr 372 For example, a provisional tax payer has the following income tax payment dates for the year ending 31 March 2018: Year Ended 31 Mar 2018 (1 Apr 17 - 31 Mar 18) Tax Payment Due Date Provisional Instalment 1 28-Aug-17 Provisional Instalment 2 15-Jan-18 Provisional Instalment 3 07-May-18 Terminal Tax 07-Apr-19 If you have a balance date other than 31 March, these dates will differ.

Please ask us if you are unsure of your due dates.

First Becoming a Provisional Tax Payer You will become a provisional tax payer on the day you file a tax return showing a tax bill (after accounting for tax deducted at source) of $2,500 or more. Your first provisional tax payment will be due on the next provisional tax instalment date. Therefore, you can delay paying provisional tax, in the first year you become a provisional payer, until the second or third instalment date for the year by delaying filing your return. Calculating Provisional Tax As you pay provisional tax during the applicable tax year, it is necessarily based on an assumption of what the tax will be.

We don’t know the final amount until we have calculated it after year-end. There are four different methods of calculating provisional tax: • Standard • Estimation • Ratio • Accounting Income

36 | P a g e Standard Method The standard method, also known as the standard uplift method, is the default method and applies unless you choose another method. Under this method, provisional tax is last year’s tax plus 5%. If you haven’t yet filed last year’s tax return, it is the previous year’s tax plus 10%. E.g., Johnny filed his 2017 tax return (year ended 31 Mar 2017) on 10 Aug 2017. His 2017 tax is $6,000. It is his first end-of-year tax bill over $2,500, so he now becomes a provisional tax payer for the 2018 year.

Under the standard method, Johnny’s 2018 provisional tax is $6,300 ($6,000 plus 5%).

As there are three provisional instalment dates remaining in the 2018 year, this will be due in three equal instalments: Provisional Instalments 28/08/2017 2100 15/01/2018 2100 07/05/2018 2100 6300 If Johnny filed his tax return between the first and second instalment dates, the provisional tax would become payable over the remaining two instalment dates. E.g. Johnny files his 2017 tax return on 31 Oct 2017: Provisional Instalments 15/01/2018 4200 07/05/2018 2100 6300 As 15 Jan is the second instalment date of the tax year (even though it is Johnny’s first payment), 2/3rds of his tax is due on that date.

If Johnny filed his 2017 return after 15 Jan, all $6,300 would be due on 7 May 2018. His tax return is due by 31 Mar 2018, assuming he has an extension of time, so the full provisional tax will be due by 7 May regardless. Subsequent Years For the 2019 tax year, Johnny’s provisional tax will be based on his most recently filed return. This will be his 2017 return until he files his 2018 return. As the 2017 return is two years prior to 2019, his provisional tax will be the 2017 tax plus 10%.

37 | P a g e Until Johnny file his 2018 return, his 2019 provisional payments will be due as follows: 2019 Provisional Instalments Provisional tax = 2017 plus 10% 6600 28/08/2018 2200 15/01/2019 2200 07/05/2019 2200 6600 When he files his 2018 return, the new provisional calculation of 2018 tax plus 5% will replace the above calculation from the next instalment date.

Estimating Provisional Tax If your income is reducing, you may be unwilling or unable to pay provisional tax based on the previous year. In this case, you can estimate your provisional tax. Once you estimate, you cannot return to the standard method for that year.

You can estimate any amount you want and your provisional instalments for the following instalment dates become based on the estimate. You can re-estimate anytime up until the final (7 May) provisional instalment date should things change during the year. E.g., Johnny cuts back on his self-employed work early in the 2019 tax year and is sure his tax for the year will be around $4,000, not the $6,600 calculated under the standard method. He files an estimate of his 2019 tax with IRD of $4,000 on 10 Aug 2018. His provisional payments are now: 2019 Provisional Instalments Provisional tax = estimated 4,000 28/08/2018 1,333 15/01/2019 1,333 07/05/2019 1,333 4,000

38 | P a g e Estimating may seem like a good option to manage your payments. You could estimate a low amount then a higher amount before the final payment date. However, there are a couple of catches. When you estimate, your tax becomes subject to Use of Money Interest. I.e., IRD will charge you interest if your final tax is higher than your estimate. Say Johnny estimates his 2019 tax to be $4,000 as above, but it turns out to be $9,000. Once he files his 2019 tax return, IRD will retrospectively calculate interest from each of the provisional dates assuming that he should have paid $9,000: Underpayments Cumulative Provisional Dates Payments Paid to Date Actual Tax Underpaid 28/08/2018 1,333 1,333 3,000 1,667 15/01/2019 1,333 2,667 6,000 3,333 07/05/2019 1,333 4,000 9,000 5,000 From 28/08/2018 until 15/01/2019, Johnny is underpaid by $1,667 and incurs interest daily on that balance.

After 15/01/19, he incurs interest on $3,333 and after 7/05/19 on $5,000. Interest is charged until the tax is paid in full which, if Johnny waits until the due date for his 2019 terminal tax, will be 7 Apr 2020. This means interest charges for 20 months from the first provisional instalment. At the time of writing, IRD is charging interest at 8.27%.

If Johnny overestimates his tax and pays too much, IRD will pay him interest. However, the current rate of interest on overpayments is 1.62%, much lower than the 8.27% they’re charging on underpayments. Shortfall penalties when estimating provisional tax The danger with estimating does not end with interest. If it did, Johnny may still choose to under- estimate and pay the 8.27%. Especially if this is lower than other options for borrowing money. But, the bigger danger with estimating is shortfall penalties. If IRD deem that Johnny failed to take due care in calculating his estimate, they can also charge him a “lack of reasonable care” penalty of 20% of the underpaid tax.

Once we start accumulating shortfall penalties [discussed later] and use of money interest, estimating provisional tax can be a dangerous exercise. If you really know your numbers, then estimating can be a good option. However, generally it is safer to stick with one of the other methods. Ratio Method The ratio method was introduced to help GST registered entities align provisional tax payments with their profit and cash flow. Under this method, provisional tax is paid with each GST payment – not on

39 | P a g e the three instalments under the standard method – and is calculated as a percentage of the sales figure in the GST return.

If the business has a high-sales GST period, provisional tax increases. As the profit will generally also be higher, an increased tax payment is appropriate. It is also aligned with the better cash flow. Likewise, in low-sales GST periods, provisional tax decreases, matched by a lower taxable profit and tighter cash flow. Another advantage of the ratio method is that no Use of Money Interest is charged providing all payments are made as assessed and on time, even if the provisional tax calculated turns out to be too low.

Let’s look at a simple example. CBD Medical Ltd is a company running a small inner-city medical centre and is on the ratio method. This is an abbreviated Profit and Loss Statement for the year ended 31/03/2016: CBD Medical Ltd Profit and Loss Statement for the Year Ended 31 March 2016 $ Sales 1,000,000 Less Expenses (852,143) Net Profit before Tax 147,857 Less Tax @ 28% (41,400) Net Profit after Tax 106,457 The company had sales of $1,000,000 ($1M) and tax of $41,400. The Profit and Loss Statement figures exclude GST. The $1M sales would have been returned as $1,150,000 ($1,000,000 plus 15% GST) GST inclusive sales in the GST returns.

The tax liability for the year is $41,400 which works out to 3.6% of the GST inclusive sales (42,000 / 1,150,000 x 100)%. Once IRD assess the 2016 income tax return, the provisional tax ratio will be set to 3.6%. For following GST returns, provisional tax of 3.6% of the GST inclusive sales will be payable. Making provisional tax payments under the ratio method CBD Medical Ltd will make one payment, on the GST due date, that covers both GST and Provisional Tax. They will use tax type “GAP” (GST and Provisional Tax) when making the payment.

40 | P a g e Registering for the ratio method You need to register to use the ratio method. Your registration is effective from the first day of the financial year following registration. To register for the 2019 tax year (1/4/18 – 31/3/19) you must register by 31/3/18. Who can use the ratio method? Only GST registered entities can use the ratio method. Often, a business owner-operator will have a company as the trading entity, and therefore GST registered, but also be a provisional tax payer themselves as they receive a shareholder salary that is not taxed at source. However, as the business owner is not GST registered, they cannot use the ratio method for their provisional tax.

Other requirements for the ratio method The business must: • Have been in business and GST registered for a full year before going onto the ratio method • Have tax for the year prior to using the ratio method of between $2,500 and $150,000 • Be on a GST return period of either one-monthly or two-monthly. i.e. no six-monthly GST periods • Not be a partnership • Have a ratio percentage between 0% and 100% The ratio method is a good option for many businesses, but won’t work for everyone. Accounting Income Method (AIM) The Accounting Income Method (AIM) is a new option available from 1 April 2018.

Under AIM, a business calculates provisional tax on its current year’s profit calculated by its accounting software. Advantages of AIM Like the ratio method, AIM allows a business to pay provisional tax based on its business results. When profit increases, more provisional tax is paid; when profit decreases, provisional tax payments decrease. Unlike the ratio method, payments are based on profit, not sales. As turnover is not always a good indicator of profit, the AIM method should provide a more accurate estimate of the final tax liability. This can be an advantage if the business is growing but requiring a lot of expenditure to grow it, and therefore profit is not growing as fast as sales.

If profits are high early in a tax year, resulting in higher provisional tax payments, followed by lower profits later in the year, tax may have been overpaid for the year. AIM allows for a refund of some or all of the provisional tax without having to wait until the tax return is filed.

41 | P a g e As with the ratio method, interest will not be charged so long as the business makes its payments as calculated. How AIM works To use AIM, a business must have IRD approved accounting software. The business registers for AIM by selecting the method within the software.

IRD will be advised automatically. To be eligible to use AIM for a tax year, IRD must be advised before the first provisional tax date under the AIM method. The business files a “Statement of Account”, from their accounting software, for each period that provisional tax is calculated for. The Statement of Account is a summary of the financial results for the period, calculating a profit figure and the tax payable. The profit calculation considers relevant accounting adjustments such as: • depreciation • debtors and creditors • inventory on hand • provisions for shareholder salaries The accounting software must be capable of these adjustments.

Restrictions on using AIM Not every provisional tax payer can use this method. Maximum turnover – Not available to businesses with a turnover exceeding five million dollars. The method is designed for small businesses.

Businesses only – As the provisional tax is calculated on business profits, it is not available for shareholder employees and others who pay provisional tax on non-business income. No Foreign Investment Fund (FIF) or Controlled Foreign Company (CFC) income – AIM is not available for businesses that receive these types of overseas investment income. Voluntary Provisional Tax Payments You can make provisional tax payments voluntarily, without an assessment under any of the above methods. Voluntary payments can help you avoid potential use of money interest, and take advantage of the self-employed first year discount mentioned below.

Managing Use of Money Interest (UOMI) charges The ratio and AIM methods eliminate interest charges, but these methods are not available or appropriate to all provisional tax payers.

42 | P a g e Let’s look at an example of how UOMI can apply to a taxpayer using the standard uplift method. Sleek Graphic Design Ltd’s income tax for the 2017 year (year ended 31/3/17) was $50,000. Their provisional tax for 2018 was $52,500 ($50,000 plus 5%), calculated under the standard uplift method. Sleek paid the $52,500 which it paid in full by the final provisional payment date of 7/5/18.

Sleek Graphic Design Ltd is growing rapidly. The company’s actual tax bill for 2018 turned out to be $70,000, leaving them short-paid by $17,500 (70,000 – 52,500). This $17,500 is the company’s 2018 terminal tax, due by 7/4/19.

Because Sleek’s tax now exceeds $60,000, it is subject to UOMI on the underpaid amount from the final instalment date. If the company does not pay the terminal tax until 7/4/19, IRD will charge interest daily from 8/5/18 to 7/4/19 on the $17,500. Making voluntary provisional tax payments If Sleek had known its tax bill was going to be $70,000, it could have prevented some of this interest by making a voluntary payment earlier than 7/4/19. Ideally, the company would pay an additional $17,500 on 7/5/18 eliminating the shortfall and interest. Making the voluntary payment prior to 7/5/18 would have meant giving IRD an interest free loan as the UOMI calculations (both on underpayments and overpayments) do not kick in until that final provisional tax payment date.

Of course, Sleek may decide it is happy to delay the payment and pay 8% interest. This could be the case if it has an overdraft with a higher interest rate.

First year self-employed provisional tax Since 1 April 2005, IRD have offered a 6.7% discount to self-employed persons who make early, voluntary provisional tax payments. This is available to sole-traders and partnerships but not to companies or trusts. It is only available to people making business income, not passive income such as interest, dividends or rents. The discount applies to the tax paid by the end of the first year in which tax on business income exceeds $2,500. As discussed earlier, a new business will not have a tax assessment at that stage, so any payment is voluntary.

The discount is limited to the higher of 6.7% of the voluntary payment, or 6.7% of 105% of the actual tax payable for the year.

So, if your tax liability ends up being $10,000, and you voluntarily pay $15,000, you will receive a discount on $10,500 ($10,000 plus 5%). The discount will be $703.50 (10,500 x 6.7%). To be eligible for the discount, you must be a new provisional tax payer (i.e. have not paid provisional tax in the previous four years) and you must elect to receive the discount. The election is made when filing your tax return for the year.

Of course, the alternative is to delay paying the tax until the terminal tax payment date of 7 April the following year. If you feel you can do better with your money than taking the 6.7% discount on it, that maybe the better option.

43 | P a g e Filing Tax Returns and Provisional Tax Tax return due dates Without an Extension of Time, income tax returns are due on 7 July following the year end. The return for the tax year ended 31/03/2017 must be filed by 7/07/2017. You can apply for an extension of time which gives you until the following 31 March to file, a full 12 months.

Your return for the year ended 31/03/2017 is then due by 31/03/2018. If you use an accountant, or tax agent, to file your return, you will automatically receive an extension of time. This is to allow accountants to spread the load of filing income tax returns over the year. Effect of filing on provisional tax As discussed above, the standard method bases provisional tax on the most recent return filed. Provisional tax is either 105% of the previous year’s tax or 110% of tax from two years ago, whichever was the last year filed.

When a tax return is filed, subsequent provisional payments become based on that return. For example, if your last tax return filed was for 2016, and you are currently paying provisional tax for 2018, your payments will be your 2016 tax plus 10%. Once you file your return for 2017, your following provisional payments will become based on your 2017 tax plus 5%. This does allow for some flexibility in the timing of provisional tax payments. If your 2017 tax is higher than your 2016 tax, your 2018 provisional payments will increase once your 2017 return is filed. You can delay this increase by waiting until after the first or second provisional instalment date to file the 2017 return.

By the final provisional date of 7/05/18, your 2017 return will have to have been filed.

44 | P a g e IRD and Tax Administration Tax problems can drain your resources. Penalties and interest will cost you financially while audits and investigations will cost you in money, time and stress. This is one area of your business you must stay on top of. Being on top of your tax requires three things: 1. knowing your tax obligations 2. a system to put aside your tax money 3. someone taking responsibility for filing returns and reminding you to make payments Let’s look at the different types of penalties charged by IRD. Late filing penalties Late filing penalties can be charged when a tax return is filed after the due date.

The penalty for late income tax returns depends on the level of taxable income: Income Late filing penalty < $100,000 $ 50 $100K - $1M $ 250 > $1M $ 500 Late payment penalties Late payment penalties are imposed as follows: • 1% one day after the due date • A further 4% seven days after the due date • A further 1% each month thereafter The penalties are charged on the amount underpaid. If you pay $600 of $1,000 due, by the due date, the remaining $400 will be subject to late payment penalties.

45 | P a g e Note that for tax relating to the 2018 tax year (year ending 31 March 2018) onwards, the 1% ongoing monthly penalty is being abolished. This means the maximum penalty will be 5%, although interest will still be charged on overdue amounts. Shortfall Penalties Shortfall penalties can be imposed when IRD deem you are returning incorrect amounts. We have a self-assessment tax system where we calculate and file our own tax returns, thereby taking a tax position. When IRD disagree with our position, they can impose penalties of up to 150% of any tax shortfall.

Below are the five categories of shortfall penalties, from least to most serious.

1. Not taking reasonable care: 20% shortfall penalty We are required to take reasonable care when calculating our tax. Reasonable care means having adequate record-keeping systems and procedures to accurately calculate our tax. It also means seeking professional advice if we are uncertain of a tax treatment. Systems and procedures can include a manual bookkeeping system, such as a manual cashbook, or electronic software. It must enable us to accurately record and check our figures and show how we came to the tax result.

Seeking professional advice will show that we have taken reasonable care even if IRD disagree with our result. However, seeking professional advice will not protect us if we have not provided our tax advisor with all relevant information. It also will not cover us if we follow advice that we should have known was incorrect. So, professional advice does not abdicate responsibility for doing the right thing. 2. Unacceptable tax position: 20% shortfall penalty It is OK to disagree with IRD so long as you have good grounds to believe you are right. There are legal procedures available to settle disagreements.

However, if you lose without an argument capable of being seriously argued in court, then you have taken an unacceptable tax position. This shortfall penalty can only apply where the shortfall is over $50,000 and 1% of the total tax bill for the year. So, it must be a significant calculation discrepancy.

It will also only be imposed on blatantly incorrect positions such as buying a vehicle and claiming the full cost as a tax-deductible expense when the law clearly requires that you depreciate such assets over their useful life. 3. Gross carelessness: 40% shortfall penalty This applies to actions that create a high risk of a tax shortfall. The test is whether a reasonable person would have foreseen that your actions would miscalculate your tax.

46 | P a g e An example of gross carelessness is not keeping records of your business expenditure then estimating, and overclaiming, expenses.

4. Adopting an abusive tax position: 100% shortfall penalty This applies to an unacceptable tax position with a dominant purpose of avoiding tax. This covers tax avoidance arrangements. When you make a business decision for commercial reasons (it will help you make more money), and it results in reducing your tax, that is OK. If the tax reduction is a dominant reason for the decision, that is tax avoidance.

5. Evasion: 150% shortfall penalty Tax evasion is the most serious category of tax misdemeanours. Evasion means deliberately avoiding paying your tax. Examples include buying some furniture for your home and claiming it as a business asset, or taking a cash payment for a job and not returning the income. Criminal Convictions As well as penalties, breaking the law can bring criminal convictions resulting in fines or imprisonment. Again, there is a range of penalties depending on the seriousness of the crime. Absolute liability offences include failure to adhere to tax laws including maintaining records and filing returns.

Maximum penalties are a fine of $4,000 for a first offence increasing to $12,000 for third or subsequent offences.

Knowledge offences involve knowingly not providing required information or not accounting for taxes withheld such as GST or PAYE. Maximum penalties are fines of $25,000 for the first offence and $50,000 for subsequent offences. Evasion and similar offences can result in fines up to $50,000 and/or imprisonment up to five years. Obstructing IRD in carrying out its duties can result in fines up to $25,000 for the first offence and $50,000 for subsequent offences. Managing Penalties There are ways to mitigate penalties including making voluntary disclosures to reduce shortfall penalties, entering into payment arrangements to eliminate some late payment penalties, and using tax pooling facilities to reduce or eliminate late payment penalties and interest.

47 | P a g e Voluntary disclosures If we have taken a tax position exposing us to shortfall penalties, we can reduce the impact by voluntarily disclosing our error. The earlier in the process we make the disclosure, the larger the penalty reduction. Conversely, if we obstruct IRD from finding out we have taken an incorrect position, we face additional penalties. The disclosure must provide enough information to IRD to enable them to make an accurate assessment of the correct tax amount. The table below shows the various shortfall penalties and the effect on them of voluntary disclosure at various stages.

Shortfall Penalties Standard penalty Reduced by 75% for disclosure before notification of audit Reduced by 40% for disclosure after notification of audit Reduced by 75% for disclosure when filing return Increased by 25% for obstruction Lack of reasonable care 20% 5% 12% n/a * 25% Unacceptable tax position 20% 5% 12% 5% 25% Gross carelessness 40% 10% 24% n/a * 50% Abusive tax position 100% 25% 60% 25% 125% Evasion 150% 37.5% 90% n/a * 187.5% * Not applicable as these penalties apply to the returns that have already been filed so you cannot be disclosed when filing.

Tax instalment arrangements If you are unable to pay your tax in full by the due date, you can apply to IRD to enter an instalment arrangement.

The advantages of an arrangement include eliminating late payment penalties other than the initial 1% penalty for being one day late. Penalties will stop from the date the arrangement starts so long as you meet the agreed payments. An arrangement is not an automatic right but IRD will generally accept arrangements if they pay off the tax within 12 months. They are less lenient when it comes to PAYE and GST than to income tax because they consider PAYE and GST as others’ tax and held in trust for IRD. Generally, IRD will require that all returns are up to date before considering an arrangement.

They will also want you to meet future commitments in full while the arrangement is in place. Therefore, when deciding how much you can commit to pay under an arrangement, make sure you budget for ongoing tax commitments.

48 | P a g e Depending on the amount of overdue tax, and the period you want to spread it over, IRD may request detailed information such as bank statements. A simple payment schedule over say three months, when everything else is up to date, should just require a phone call to set up. As Use of Money Interest (UOMI) will still apply, paying it off quicker is usually better. Tax pooling Another option for managing and financing tax payments is to use a tax pooling service. There are a handful of companies in New Zealand that are authorised to pool tax payments, so taxpayers can trade them.

If you cannot, or do not want to, pay tax on the due date, you can buy a tax credit.

For example, Shoestring Ltd, a fledgling business, is struggling with cash flow and decides to defer paying its provisional tax for the 2018 year. Shoestring’s provisional tax is due in three instalments on 28/8/17, 15/1/18 and 7/5/18. The company can defer paying this tax by buying tax payments later. E.g., on 30/6/18, nearly two months after the final instalment date, it can buy tax that was deposited back on the due dates.

There is a finance charge to pay for the use of the money, but as the payments were made to IRD on the due dates, no late payment penalties or IRD interest charges. The finance charge compensates the seller of the tax who has had their money deposited in the pool since the provisional instalment dates and is considerably cheaper than late payment penalties and UOMI. Tax pooling allows taxpayers who have overpaid tax to share the overpayments with taxpayers who are underpaid or late paid. IRD have a significant difference in their rates charged on underpaid tax (8.27% at time of writing) and their rate paid on overpaid tax (1.62% at time of writing).

This leaves the opportunity for tax poolers to strike a rate somewhere in between, increasing the return to the overpaid taxpayer and decreasing the cost to the underpaid taxpayer, while eliminating late payment penalties. Record Keeping

49 | P a g e All businesses, including self-employed contractors, have record keeping requirements. Their records must show how their taxable income is calculated and evidence receipts, payments, income and expenditure. Below are the general requirements. English language Generally, records must be kept in English, although an application can be made to keep them in Maori. Kept in New Zealand The records should be kept in NZ unless authorisation is obtained to keep them overseas. Examples where records may be kept overseas include a company headquartered overseas but with a business in NZ, and electronic records kept on overseas servers.

If you use a cloud based service, such as Xero accounting software, the records may be kept on an overseas server. If the server provider have authorisation from IRD to keep records overseas, then the end user does not have to apply separately. Both Xero and MYOB have this authorisation. Held for seven years Records must be kept for seven years from the end of the income year they relate to. E.g., records for the year ending 31/3/2010 must be retained until 31/3/2017. Required records include: • An accounting system from which the financial transactions and financial position of the business can be determined.

• Bank statements, invoices, receipts etc. to verify the transactions in the accounting system • Records verifying business assets and liabilities Manual or electronic format Records can be either manual or electronic. Electronic records must: • Be accessible so they can be referred to if required • Be legible and understandable as a manual record would be • Have a sufficient backup system in place If the record keeping software is updated, the records must either be converted to the new system or you must retain the old software, so the old records can be accessed.

50 | P a g e Tax Planning Providing for Tax Planning is the key to stress-free tax management.

A tax plan calculates the portion of your income to put aside for tax, so it can be set aside in a tax savings account and available when the due date arrives. Calculating the tax portion involves: 1. Forecasting your taxable profit 2. Calculating the tax on your forecast taxable profit 3. Calculating the tax as a percentage of your forecast GST inclusive sales Here’s an example. Cal has formed a company for his new cartooning venture and wants to know how much of his income to put aside to cover his tax bills.

1. Forecast taxable profit Cal has forecast business income and expenses for his first year of business as follows: Cal's Cartoons Ltd Forecast Profit and Loss Statement $ Revenue 100,000 Expenses 30,000 Taxable profit 70,000 2. Calculate tax on the forecast taxable profit The company will be taxed at 28% so tax based on the forecast figures comes to $19,600 ($70,000 x 28%). 3. Calculate tax as a percentage of forecast GST inclusive sales

51 | P a g e Cal’s forecast profit and loss figures are GST exclusive. To make life easy, he wants to know how much of each receipt to put aside whenever he gets paid by a client.

As the company is GST registered, the actual receipts will include GST, so we add 15% GST to the $100,000 revenue figure giving us $115,000 of forecast revenue receipts. ($100,000 + 15%). We can now calculate the tax ($19,600) as a percentage of GST inclusive revenue ($115,000). The result is approximately 17%. (19,600 / 115,000 x 100)%.

If Cal puts aside 17% of each receipt, he should have his income tax covered when the due dates arrive. This is obviously a simplified example. Other factors to consider are: • Actual profit margin may vary from 70%. If revenue exceeds the forecast, the profit margin will probably increase as some of Cal’s expenses will be fixed regardless of the level of sales. If revenue falls short of expectations, the profit margin may reduce. The net profit should be reviewed when management accounts are prepared and the tax percentage adjusted accordingly.

• Putting aside GST. A portion of revenue received will be GST, and passed onto IRD.

There will also be GST to claim on expenses so a separate forecast for GST will enable Cal to add this portion to the amount put aside. • ACC and other commitments. ACC levies, and any other ongoing commitments that vary with sales, can be calculated and added to the amount put aside. As described earlier, a new business is not required to make income tax payments for some time. However, income tax liabilities start to accrue as soon as the business is profitable. Tax is a major cost and must be budgeted for. A large tax bill after two years of business can be a killer for a fledgling business.

A business financial plan should include a cash flow forecast. The forecast will incorporate tax payment dates and amounts due, based on the income and expenditure assumptions in the forecast. The cash flow forecast is the primary tool for planning for these obligations.

52 | P a g e Marginal Tax Rates and Business Decisions As discussed previously, a taxpayer’s marginal tax rate is the rate they will pay tax on their next dollar of income. E.g., an individual with an income of $56,800 is in the 30% tax rate band for income between $48,000 and $70,000.

If they earn another dollar, they will pay 30c in tax. This means that their marginal tax rate is 30%. Should their income reach $70,000, their marginal tax rate will become 33%. Most business decisions affect income or expenditure and the relevant after-tax result depends on the marginal tax rate.

Let’s take an example of Lucy, a self-employed graphic designer who has been in business for about a year and is currently making a taxable profit of $25,000. Assuming this is Lucy’s only income, she has a marginal tax rate of 17.5% as her income sits in the $14,000 - $48,000 income band. Lucy is considering a targeted Google AdWords campaign to try to increase traffic to their website. She is budgeting to spend $1,000. To see the effect on her forecast cash flow, she needs to find the after-tax cost of the expenditure.

The advertising is a tax-deductible cost so will decrease her profit by $1,000, reducing her tax by $175 ($1,000 x 17.5%), so the after-tax effect of the advertising spend is $825.

Lucy hopes the advertising will bring her more business, so she will build this into her forecasts. If she estimates an additional $5,000 of income, this will be taxed at her marginal rate of 17.5%, increasing her tax by $875 ($5,000 x 17.5%). Her additional after-tax income is $4,125 ($5,000 – $875 tax). Overall, Lucy’s advertising campaign is forecast to increase her net, after-tax profit by $3,300. Lucy's Google AdWords Campaign Forecast Cash Flow Forecast $ Increased sales 5,000 Less cost of advertising (1,000) Overall increase in profit 4,000 Less tax payable on increased profit @ 17.5% (700) After tax increase in cash flow 3,300

53 | P a g e If Lucy’s current profit exceeded $70,000 per year, her forecast after-tax return from the advertising campaign would be only $2,800, 15% lower than above. So marginal tax rates make a difference.

54 | P a g e Conclusion Like it or not, tax has a big impact on our businesses. Hopefully, this guide has given you a better understanding of how to manage your tax requirements. If you would like help with your specific situation, we are here to help. MacKinlays is a boutique accounting firm based in Auckland, helping service providers throughout New Zealand.

We provide business development and tax compliance services. Want help? Contact us for a free, no obligation chat about your business or tax challenges: Want to learn more? Browse our free resources on where you can also sign up to receive our quarterly newsletter with valuable information on building a more successful business. Robb MacKinlay Director 0275 407859 MacKinlays