business advisers
Auckland, New Zealand
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Accountants & business advisers |
PKF Ross Melville Auckland, New Zealand |
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PLEASE NOTE: The articles that follow are for general information of clients and are not to be taken as a substitute for specific advice. Consequently we accept no responsibility to any person who acts on information herein without consultation with Ross Melville PKF. Depreciation on Second Hand Goods Employee or Self Employed Contractor Entertainment Expenses Checklist Interest Deductibility for Private Investors Lump Sum Payments - Capital or Revenue Maintenance Costs - Revenue or Capital Personal Services Income - The Attribution Rule Revolving Credit - Hidden Costs A taxpayer may deduct the remaining adjusted tax value of depreciable property if: * The asset is no longer used by the taxpayer in business or to produce taxable income; and
Barter deals are quite common, particularly with small businesses. Barter trading is a perfectly valid way of doing business, but you need to be aware that it has full income tax and GST implications. The person providing the goods or supplying the service derives income which normally constitutes a ‘taxable supply’ for GST purposes and gross income for income tax purposes. On the other hand, the recipient of the goods or services incurs an expense, which can be claimed as a tax deduction and will normally be included as ‘input tax’ for GST (unless any part of the barter transaction is a private expense). However, difficulties can arise in recording and accounting for these transactions. This is further exacerbated when one is unable to distinguish between a barter deal (with full revenue implications) and a kindly act (no tax implications). A barter deal exists where a deal is struck between the parties before the event takes place, e.g. A offers services to B in return for goods. But if A offers services to B (out of the goodness of their heart) then no revenue arises. Likewise, at a later date if B thanks A for his services with some goods, no revenue is involved. One interesting point to note is that B may still be able to claim both GST input tax and income tax deductions on the goods given to A on the grounds that the expenditure was incurred in the course of carrying on their business. If you are involved in barter transactions, your recording system may need to be reviewed. Please contact us if any assistance is required. There must be a genuine intention to set up and operate a trust. Actions should support this intention. While defective administration will not necessarily result in a trust being set aside as a sham, it can result in other unintended consequences. Risk elements include the following. 1. Poor documentation. A trust deed, overall investment plan appropriate to the trust and its objectives, transfer documents, debt acknowledgements, separate bank accounts, and minutes of trustees will help to support the bona fides of a trust. 2. Lack of consultation. Settlors cannot have their cake and eat it as well. They must consult. In making settlements on a trust, the assets become those of the trust and all trustees are responsible for them. It is not acceptable for settlors to continue to deal with those assets as though they are their own. They’re not. All trustees must be consulted in relation to matters of any significance including investments and distributions. Decisions are usually required to be unanimous and should be recorded in the minute book. 3. Lack of independence. All trustees must exercise all the care and skill their circumstances require. This may result in concurrence with the settlor, but not necessarily so. Trustees who act purely as nominees of the settlor and in accordance with their instructions may endanger themselves and the trust. 4. Retaining complete control. Some arms length involvement is important. Someone truly independent should be active in a capacity such as trustee, protector (requiring consent for particular transactions such as distributions to beneficiaries), or appointor (having the power to hire and fire trustees). Maximum protection would be achieved by having all these functions vest in unrelated parties, but this would be unusual and is not critical. The other extreme is to have all these vest in the settlor. There is adequate scope between these extremes to meet most needs between relinquishing control and maintaining a reasonable level of involvement. While these requirements may seem onerous, they lead to sound business practices. Good records are important anyway. And if you appoint an independent person whom you believe able to contribute to your decision processes, consultation should come naturally and with benefit. Generally, it should not be time consuming or onerous. Existing, as well as new trusts are likely to receive increased scrutiny in years to come. Perhaps now would be a good time to review how well your trust would withstand scrutiny.
There is much confusion about the rules applying to the depreciation on second-hand assets. The CIR will normally allow depreciation to be claimed on the purchase price where: * There is an arm's length sale; This is straight-forward when there is a genuine arm's length sale between unrelated parties. However, it is slightly complicated when associated parties are involved. The claiming of depreciation on second-hand assets purchased from a related party was tested in the High Court case: CIR v Lys 10 NZTC 5,107 (1988). In the Lys case there was a transfer of a property to a family trust. The High Court stated that this transfer should be considered in relation to normal commercial and conveyancing practices, and allowed the family trust to depreciate their property at the new market value but at the same depreciation rate as used by the vendor. Notwithstanding the Lys decision, it is recommended that written application be made to the CIR confirming they allow depreciation based on the purchase price. Many applications have been rejected by the CIR – probably because they were not based on sound commercial reasons. Usually in an associated party transaction the purchaser’s claim for depreciation will be limited to the lower of the original cost price to the vendor and the purchase price. Employee or Self Employed Contractor An Important Distinction The difference is crucial. It raises taxation and employment issues. On the tax side it affects who should deduct tax from whom, and at what rate; who is liable for ACC levies; what deductions are available in arriving at assessable income; and who should be registered for GST. Employment issues include the jurisdiction of the employment courts, the basis on which the contract may be terminated, the procedures required, and the damages, which could result. For example, you are in business and engage what you believe to be a self-employed contract driver, fencer, or handyman. You are dissatisfied with the work and terminate the contract. Immensely offended, humiliated and otherwise aggrieved, he sues for wrongful dismissal and a variety of compensation. Should it turn out that this person was indeed technically an employee, then loss of profit may be only a relatively small item amongst the package of claims. Not only that, but tax deductions that should have been made could be recovered from you by the IRD and ACC levies as well. The employee could lose the benefit of any expense deductions he may have been entitled to as a self-employed contractor. Some Difficulties Despite its extreme importance, the distinction is difficult to define. IRD, taxpayers and advisers have wrestled with the issues and differed in their conclusions. The Courts have arbitrated and some ground rules have been established. A recent interpretation guideline from the Commissioner establishes his position. While not legally binding, employers ignore it at their peril. In view of its importance we summarise the essential elements. Firstly, names do not count. You cannot change a spade into a fork just by changing its name. Neither can an employee become self-employed merely by changing their title. Documentation is not critical to the distinction – either contract may or may not have it. Written contracts are useful, however, in analysing the terms of the contract and the nature of the relationship intended by the parties. The Courts have held that, provided it is not a sham, the written documentation should form the basis from which the nature of the contract should be analysed. Ultimately, however, it is the nature of the contract between the parties that determines status. The distinction is drawn between a "contract of service" (employee) and a "contract for services" (self employed). Employees work under a master-servant relationship. They are generally required to be available to work to a set timetable and under the control of the employer. The emphasis for an independent contractor is on the service provided, rather than the control by the employer. While many tests have been considered, there is no exhaustive list, none is conclusive and each should be considered in conjunction with the other. Tests to Apply Five have been identified. Control Once the deciding factor, the degree of control is now only one of the issues. The Courts have held that: "A man does not cease to run a business on his own account because he agrees to run it efficiently or to accept another's superintendence." Nevertheless, close control over the hours of work and the manner in which the work is done, will tend to suggest an employer/employee relationship. Independence Conversely, a high degree of independence will help to indicate self-employed status. Such independence may be inferred from a number of factors: * working for a number of clients; Please note that a requirement restricting a contractor from working for others will not necessarily upset their self employed status. Indeed it may emphasise an entitlement to work for others. Organisation or Integration Factors considered here include whether the work is: * integral to the organisation; Intention The intention of the parties is important. Evidence of such intention may be supported by the description in a written contract. However, this is not conclusive and if actual circumstances conflict with the description, the substance of the relationship will prevail. Nevertheless, given the uncertainties, a written record of the intention of the parties should be a priority. Fundamentals Is the worker in business on his own account, or part and parcel of the employing enterprise? Factors for consideration include: * The apparent justification for using an independent contractor; Conclusion The interpretation guidelines provide no clear answers. The "tests" are really in the nature of factors to be considered. They overlap and may conflict. None is exclusive or conclusive. Where they all point in the same direction, the answer will be clear. In other circumstances, an indeterminate balancing exercise will be needed. As with all tax matters, given the consequences of "getting it wrong", this issue should not be taken lightly. As always, we are here to help.
From 1 April 2009, Personal tax rates decreased and as a result the flat FBT rates of 64% has been reduced to 61%. To prevent the imbalance for affected employees, a tiered FBT system is in place to correspond with each employee’s marginal tax rate. From 1st April 2009 These are: * 14% for employees with income less than $12250; * 61% for employees with income exceeding $53851 to highr. Employers have the option of either paying FBT at 61% on all benefits or using the three-tier system. Quarterly filers of FBT returns have the option of paying FBT at a rate of 49% or 61% for the first 3 quarters of the income year, and then squaring-up in the last quarter based on employees’ individual income tax rates. Taxpayers may claim GST input tax on second-hand goods purchased from unregistered persons, subject to various limitations in the legislation. The following are examples where taxpayers incorrectly claim GST under the second-hand goods provisions: * When goods are purchased from an unregistered associated party. GST is not claimable if the associated party did not pay GST when buying those goods; Travel between home and work is considered of a private nature in relation to a company vehicle and therefore is subject to the FBT regime. Until now, the cost of taking the motor vehicle home was considered a business cost if the house was a place of business. However, in light of recent cases, Inland Revenue has updated its policy on what constitutes a home as a work base. Inland Revenue has listed the following factors as being relevant in determining whether a home is a workplace: * Are there sound business reasons for operating from home? Are these activities closely integrated with the taxpayer's business? Some of the criteria Inland Revenue will look at to satisfy the above factors include: * Nature of the business; Business goods and equipment stored at the home. Factors not likely to be sufficient for a home to be regarded as a place of business are: * Business use of phone or fax at home;
Recently we have been asked a number of questions about interest deductibility and its application to residential property and investment portfolios. The general interest deductibility rules have not changed. As a refresher, this article highlights three key principles: * The right to an interest deduction depends on the purpose of the borrowing. Let us look firstly at the purpose of a taxpayer’s borrowing. It is the purpose rather than the asset used to secure the borrowing that will determine deductibility. For example, an individual might borrow against a private home to invest in the sharemarket to obtain both dividend income and capital gains. The house which is the underlying security for the loan has no connection with the shares and the shares may not pay a dividend each year. But, the taxpayer will still get a full deduction for the interest cost because the predominant purpose of the borrowing was to earn income. The second principle is that interest on borrowings with a mixed purpose must be apportioned. The taxpayer will only be entitled to a deduction on that part of the interest which relates to earning income or carrying on a business. Apportionment effects home owners wanting to buy another property to live in and keep their existing private home to rent out. Home owners often look to step up when their mortgage has reached a manageable level. The scenario at the time of the step up may look something like this: In this scenario the interest deduction on the rental property is limited to the interest on the mortgage remaining ($50,000) before the increase in borrowings to fund the new house. The interest expense on the new loans totalling $210,000 is not deductible because the borrowing was put in place to provide a new home. The borrowing was for private rather than income earning purposes. There may be a better way. Possible solutions include: transferring the original home to a private company and restructuring the loan or repaying the original mortgage and drawing down fresh loans. These restructuring steps require careful planning to maximise your interest deduction. If the taxpayer had started out with a $260,000 home and subsequently obtained a $135,000 mortgage for the purpose of buying a rental property worth $150,000, the answer would be different. The full amount of the interest on the $135,000 mortgage would be deductible as the purpose of the borrowing was to earn rental income. And the third principle: That interest on a mortgage taken out to retain income-earning investments is generally not deductible. An example of this situation occurs when an individual taxpayer with an investment portfolio decides to raise a mortgage rather than liquidate investments to obtain funds for private spending, e.g. a new house or car. The taxpayer asks: Can I offset the mortgage interest against the income earned on the investments? Case law has tested this area and concluded that the immediate and direct purpose of the borrowing was to finance private spending. Although the advance was obtained to preserve income-earning assets, the link between the income-earning activity and the borrowing is insufficient to obtain an interest deduction. A more tax efficient result could have been obtained by selling the investment portfolio, carrying out the private spending and then borrowing to reinstate the investment portfolio. The interest cost of the subsequent mortgage would be fully deductible. These stories demonstrate some of the anomalies and pitfalls taxpayers face. If you would like us to look at your private borrowings and consider options to maximise your tax deductible interest – please call.
The IRD has recently issued statements about the tax treatment of lump sum payments - lease surrender payments and restraint of trade and exit inducement payments. Landlords frequently ask for a lease surrender payment when a tenant elects to vacate a property before the lease period expires. Usually the level of the surrender payment is determined by the amount of the lease, time to expiry and other factors. Occasionally it is agreed between the parties. The surrender payment is compensation for loss of future rental income and the cost and hassles associated with finding a new tenant. Landlords with significant portfolios of leased property are ‘in the business of leasing’. In most situations lease surrender payments received by these landlords will be regarded as income. However, if the payment is large relative to the landlord’s leasing business, it may be regarded as compensating for the loss of a structural asset. Structural assets are part of the capital of the business. Payments related to the structure of the business are usually not taxable. Whether a payment is going to be capital or revenue depends on the size of the payment and the significance of the lease surrendered, relative to the landlord’s situation. Landlords need to seek advice before the method and amount of the payment is struck. Restraints and exit inducement payments are also big dollar sums. Restraint of trade payments are made to individuals in exchange for an agreement to limit the person’s right to perform employment, contracting or office holder services. Exit inducement payments are compensation for giving up a position or a career option. In the past, careful structuring of restraint or golden handshake payments meant some of these payments were not taxed. New laws will now make restraint and exit inducement payments taxable to the recipient and deductible to the payer. There is an exception to this. Restraint of trade payments may be treated as capital when the payment is part of a business sale and purchase agreement. Buyers and sellers – please talk to us about the components of your business sale and purchase before you finalise the agreement. We can help you to get the best tax outcome. Maintenance Costs - Revenue or Capital The Privy Council was unkind to another substantial taxpayer recently, entailing some $5.8 million in disputed tax. Again there are lessons to be derived by lesser mortals. Their Lordships were required to consider whether certain expenditure amounted to repairs and maintenance of a revenue nature. If not, the expenditure should be capitalised and presumably, depreciated. The Auckland Gas Company Ltd (AGCL) had many kilometres of old gas lines, much of it leaking through fractures, corrosion, or faulty joints. After many years of repairing piecemeal, AGCL decided on a better solution for much of the problem. This was to insert polyethylene piping into the existing gas lines. Such piping was not subject to corrosion or joint leakage and could cope with vibrations much better than the old cast iron and stainless steel structures. The cost of doing this was actually lower than the traditional repairs option. The High Court was sympathetic to the taxpayer. It held that, although the method of repair "differed from what might ordinarily be regarded as repair," in its essence the insertion programme was a repair and should be charged to revenue. The Court of Appeal disagreed. It held that the old pipeline was effectively abandoned other than as a housing for a new pipeline. This decision overturned the High Court result and meant that the polyethylene insertions were regarded as capital. The Privy Council agreed with the Court of Appeal. The scale of effective pipe replacement and the improvements effected by the new materials were consistent with capital expenditure. Some longstanding principles in assessing the nature of expenditure in relation to fixed assts were affirmed: * It is of critical importance to determine the asset on which the work is being carried out; Perhaps however, this quote from their Lordships judgement is the most telling: "Judicial dicta applicable to one set of circumstances may be unhelpful or misleading when applied in different circumstances." In other words, each case stands on its own! New Zealand's tax system is based on two broad notions: * Residents of New Zealand are taxable here on their worldwide income. If you are going on an OE or perhaps you are temporarily based here, it will be important to work out whether you meet the definition of a tax resident. Note that residency status for immigration purposes is quite different to being a tax resident. If you are already a New Zealand tax resident and are away from New Zealand for more than 325 days in any 12-month period, you become a non-tax resident provided you do not have a "permanent place of abode" in New Zealand. You will have a "permanent place of abode" here if you have an enduring relationship with New Zealand. An enduring relationship is established by considering: * Presence in New Zealand (It will usually take more than one of the above to form an enduring relationship.) If you do have an enduring relationship, you will continue to be a resident for tax purposes even though you may be away for more than 325 days. On the other side, if a person who is not already a New Zealand tax resident is present in New Zealand for more than 183 days in a 12 month period, then the individual is deemed a tax resident. New Zealand also has tax treaties with a number of countries. The tax treaties can alter an individual's tax obligations in each country. If you know of people who are considering leaving New Zealand or entering the country for an extended period of time, encourage them to check out the tax issues. Careful planning can help minimise their total global tax payable. Trusts and companies have their own specific rules about residency. If you are planning to leave or enter the country, there is definite merit in seeking our professional advice before you move.
Anti Avoidance Provisions The Government enacted legislation to give effect from 1 April 2000 rules aimed at preventing individuals circumventing the top personal tax rate by using an interposed entity to redirect personal services income. The new rules attribute the personal services income of the interposed entity to the individual service provider when four key criteria are met: * 80% of more of the interposed entity’s service income comes from one recipient (or associates of that recipient); The four key criteria represent, for taxation purposes, a narrowing of the definition of an independent contractor, and is likely to result in some genuine one-man independent contractor operations being caught. Powers of attorney A ‘power of attorney’ refers to a legal document by which person grants another individual (called an attorney) the authority to sign documents and act on their behalf. This power is often given by the elderly and travellers. Although ordinary powers of attorney are in common use, they can become useless and of shorter duration than originally intended if revoked. Revocation of power can occur if the person who granted it becomes mentally incapable. This can make it difficult not only for the appointed attorney, but also for the family involved, as they are unable to act or handle the person’s affairs in an efficient manner. To overcome this problem, an ‘enduring power of attorney’ can be created and granted. Enduring powers of attorney can be used in relation to property, and/or personal care and welfare. The advantages of enduring powers of attorney are: * Restrictions can be imposed on what can be done with, and how to deal with, certain properties; and While an enduring power of attorney for personal care and welfare can come into effect only when the person granting it becomes mentally incapacitated, the power in relation to property can (if provided) become effective immediately. Wills It is recommended that wills be updated as circumstances change. For example, marriage automatically revokes a will. Where a person dies without a will: * Their estate is wound up in accordance with the Administration Act 1969 – which may not have been what they wished; Please contact us if you require further clarification of any issues surrounding your will.
There has been a big rise in the use of flexiloans or revolving credit. Major lenders now offer the ability to bundle business and private debt. Surplus cash can be used to reduce your interest costs, and if you can pay more than the minimum repayment in one period, the buffer built up can be drawn down later. These products are promoted as minimising interest costs and the term of the loan. But the ability to redraw, if exercised, will negate some of the savings. And, if the facility combines business and private borrowings, the apportionment of interest can create a tax headache and in extreme cases a complete haemorrhage. For example, a manufacturer has a flexiloan which permits deposits and redraws up to a set limit at any time. Deposits are made to reduce the loan balance by $60,000. Later on the manufacturer draws down $40,000 for a new boat. Here’s the rub. The interest on the boat is not tax deductible – ouch! Tax deductibility requires a link between the money borrowed and earning taxable income. No link - no deduction. Our manufacturer example was straightforward. Imagine what happens when the flexiloan goes: up for a boat, down for a research grant, up for a trip to Aussie, up to buy more machinery and pay provisional tax, down for a major sale deposit. Technically each draw down must be tested for a link to the manufacturing business. Analysing the interest is a beanie’s nightmare. To avoid the work involved in analysing the loan interest, we recommend: * Private and business transactions are kept separate. Loan interest is often a “big ticket” item for businesses. Losing part or all of the tax deduction for interest can be a big cost, and you will get pretty upset if we have to tell you some of your interest bill is not deductible. Plan and seek advice before you start. Inland Revenue has issued an interpretation statement providing guidelines for taxpayers in determining the deductibility of sponsorship expenditure. Sponsorship expenditure will be deductible where Inland Revenue is satisfied that there is a nexus (necessary relationship) between the taxpayer's business or income-earning activity and the expenditure. In order for the nexus test to be satisfied, the taxpayer needs to show that the sponsorship expenditure actually promotes their business. The following factors will be considered by Inland Revenue as important criteria in satisfying this nexus: * Is there a specific requirement in the sponsorship agreement that the recipient must promote the sponsor's business? Can it be evidenced that the sponsorship resulted in increased sales/revenue? In attempting to give taxpayers some clarity on the deductibility criteria, Inland Revenue seem to have overlooked the practicalities of measuring these criteria. For example: * How does a taxpayer prove that increased sales revenue resulted from sponsorship as opposed to other marketing activities? or Capital expenditure Sponsorship expenditure of a capital or private/domestic nature is not deductible. The capital/revenue distinction tests have been identified from case laws although the statement indicates that the most important test is whether the expenditure creates an identifiable asset. Where a benefit of a private/domestic nature accrues to the recipient of sponsorship expenditure or to any other person, but this benefit is incidental to the taxpayer's income-earning or business activity, the deduction is still allowable. Sponsoring an employee If an employee is sponsored by an employer to participate in some event by way of paying their entry fees, such expenditure will not be deductible as sponsorship expenditure, but as monetary remuneration. Trustees have a fiduciary responsibility to act in the best interests of the true owners of the trust - the beneficiaries. To this end trustees have responsibilities to adult* beneficiaries. These responsibilities include: * Making certain that the sum required to ‘settle’ the trust is paid into an account under the trustees’ control at the outset. Final beneficiaries are those entitled to receive a portion of the final distribution from a trust on its winding up. We can help you ensure that trustees meet their on-going custodial responsibilities. *Children are regarded as adulta at age 20. Until and including the 1998 year, taxpayers enjoyed all kinds of options, which could be used to manipulate income from year to year. They could value stock on hand at cost, market value, or selling value. They could change the basis from year to year and effectively manipulate incomes to suit. One could take obsolescence into account in assessing value, and certain formulae for use by particular industries (e.g. motor vehicle franchisees) could be used without specific IRD concurrence. Standard obsolescence formulae are out, and valuation methods must be consistent from year to year. The substance of the standard rules is outlined first with some of the following exceptions: 1. Year-end trading stock must generally be valued at (defined) cost, but market selling value may be used (if lower). Small Taxpayers Special rules exist for those with a turnover of $3,000,000 or less. 1. Small taxpayers may use the same methods as those applicable to their larger cousins. Excepted Financial Arrangements Taxpayers dealing in shares and similar securities must value these at cost. Market value and other variations are not acceptable. There is an exception for stock items, which have been written off as having no value. Transitional Rules Certain taxpayers especially affected by these rules will be able to spread the extra income arising over three tax years. Please let us know if you would like further help with any aspects of this new regime. |
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