EMAIL NEWSLETTER APRIL 2002       

Welcome again to the McLean and Co. Newsletter in which we discuss current taxation and business matters. We trust you find it informative.  Any feedback would be welcomed.

McLean and Co. is a home based chartered accountancy practice based in Clive, Hawkes Bay.    Readers are invited to peruse the practice website www.mcleanandco.co.nz,  which lists services provided, gives contact details and indicates how to become a client, contains an extensive base of articles on business and taxation matters,  and has links to other websites that may assist your business.    Being a small firm itself,   McLean and Co. strives to provide a personal and professional service largely to a self employed person and small business client base.  Enquiries are welcomed.

INDEX

1. Relevant Business and Taxation Articles

2. Business Structures for your Business

RELEVANT BUSINESS AND TAXATION ARTICLES

The McLean and Co. website contains an extensive number of articles prepared by McLean and Co. relating to taxation and business matters.    Here are a selection that will be of interest:

• Depreciation of Fixed Assets                                                     www.mcleanandco.co.nz/page72.htm

• You Are an Investor-  are you in Business                                www.mcleanandco.co.nz/Page59.htm

• Buying a Franchise-  what you Should Consider                        www.mcleanandco.co.nz/Page40.htm

• Goodwill and its Valuation                                                           www.mcleanandco.co.nz/Page66.htm

• Obtaining a Business Loan- Key Steps                                       www.mcleanandco.co.nz/Page64.htm

BUSINESS STRUCTURES FOR YOUR BUSINESS

This newsletter we will largely devote to discussing structures which are ideal for your business. the best known structures being:

• sole trader (if the business has only one owner)

• partnership

• company, or

• trust 

In deciding which structure to use you should consider the following factors:

• the taxation implications

• the funding arrangements

• the owner's liability (eg. for debt or other legal obligations)

• the type of business (e.g. certain professions can only be practised as sole traders or partnerships, such as law)

• whether the business is new or already established

• whether the business is a one-off project or whether it is expected to continue

• the administration requirements and costs

• the continuity of the structure (e.g. whether you hope your children will one day take over the business from you),  and

• the internal structure (e.g. the number of people involved, the proportion of their contributions, and management and profit-sharing)

SOLE TRADER

The sole trader business structure applies only to single-person businesses

Advantages

• simplest way to start in business

• easy to form and terminate

• simplicity- few legal formalities, therefore cheaper

• low start up costs

• owner has independence-   free to make his own business decisions, to take time off when he wants, to take holidays when he wants

• relatively little regulation and paper work

• all profits go to the owner

• possible tax benefits-   will be taxed at lowest personal marginal income tax rates, losses can be offset against other sources of income

• financial statements do not have to be shown publicly, and do not have to be audited

Disadvantages

• unlimited liability for owner, who is personally liable for the debts of the business-  personal assets can be at risk

• owner is responsible for negligent acts and other wrongs committed by employees within the scope of the business activity

• harder to raise capital than other forms of business ownership-   the owner may have to give a personal guarantee or security over personal assets

• working by yourself means that there is a limited amount of skills, experience and management expertise readily available

• lack of continuity- when give up the business ceases

• may be difficult to sell and get good price as it may be the case that a lot of the goodwill has been created by the efforts and personal relationship of the owner with the customers

• the potential for higher tax bills  (the highest marginal tax rate for individuals is currently 39% of income over $60,000 p.a. compared with the companies rate of 33%)

PARTNERSHIP

Any two or more people carrying on the same business with a view to making a profit are a partnership unless they have formed a company or other business structure.

Advantages

• has more than one business owner, therefore more skills, experience, management expertise available

• relatively low startup costs and inexpensive to operate

• no registration formalities, although a written agrement will help avoid future problems

• a partnership does not pay tax itself, but must be registered with IRD and file an annual return of income and showing the assessable income and how it has been divided amongst the partners- tax is paid by each partner on their share of income and business tax losses can be offset against other personal income

• privacy of affairs-   Financial statements don't have to be released to the public and don't have to be audited

• limited outside regulation

• easy to change the business structure

• can raise finance by introducing another partner who provides his rather then having to go to a lending institution

Disadvantages

• all partners are jointly and severally liable for the debts of the partnership-   this means that each partner is liable for the pertnership's debts, and if the partnership is unable to pay, a partner may have to pay the entire debt and not just their share

• no protection for partner's personal assets, which may be seized to satisfy partnership debts

• divided loyalty-   more than one person making the business decisions

• trust and confidence is needed between the partners-  friction can occur

• lack of continuity- when a partner pulls out the business ceases and legally the remaining partners are in a new partnership

• limitation on size

• the ability to raise finance is resticted in the same way as that of a sole trader-  banks may require personal guarantee and security over personal assets

• may be difficult to sell off the partnership business and get good price as it may be the case that a lot of goodwill is through personal effort and relationship with customers and partners.

COMPANY

A company is an artificial "legal" person.   It is owned by shareholders who have limited liability (i.e. they are not personally responsible for the company's debts).   A company is run by directors

Advantages

• can have a number of shareholders providing various levels of investment capital and personal services

• provides limited liability.  Claims against the company fall on the company, not the shareholders.   Banks may however require individuals to sign personal guarantees or to put up their own assets as security for loans

• easier to raise finance-  a company can issue shares or create a "floating charge' over its assets and ongoing business (in a document called a debenture) and these can be used as security for a loan

• may confer the impression of greater crebibility and that the business is there for the long term

• continuity- company can continue even if a shareholder or director pulls out

• leads to a clear distinction between the personal affairs of the shareholders and their business affairs

• may offer tax advantages due to the income tax differences between companies and individuals

• easier to sell part of a company in comparison to sole trader and partnership-   just sell some of the shares.

Disadvantages

• registration expenses and formalities

• ongoing administrative formalities and expenses  (e.g. financial statements, annual returns to be filed, forms to be lodged with the registrar when directors change)

• stringent legal regulations-  companies are governed by the Companies Act 1993 which sets out various proceedural rules and legal obligations

• personal liability in some circumstances-  the Companies Act says that directors are personally responsible for the company's actions in certain circumstances (e.g. letting the company trade when it is unable to pay it debts)

• tax administration requirements are more complex than those for a sole trader or partnership

• does not provide any opportunity to spread business income to family members on lower marginal tax rates other than through legitimate wages

• business losses have to remain in the company unless the company is a loss attributing qualifying company and cannot be offset against a shareholders income from other sources

• a public company has to declare financial results publicly and has to be audited

• depending on profit levels in first year, may have to start paying income tax earlier than other business structures

TRUST

A trust is an arrangement for the holding of property by one party (the trustee) for the benefit of another (the beneficiary) or else for some specified purpose.   Trusts are widely used for planning and protecting family finances and are useful to people exposed to comercial risk.   They can be used to operate a business

Advantages

• limited liability if a company is a trustee

• ability to distribute income to beneficiaries flexibly

• the beneficiaries of a trust are personally indemnified.   This means that should the business find itself in difficulty with creditors,  the only assets that can be called upon to pay debts are those owned by the trust, and personal assets owned outside the trust are not available for meeting any business liabilities

Disadvantages

•  entering into finance or other contractual arrangements may be difficult, as trusts as a business vehicle are less well known than comanpies

• the trust cannot pass losses back to beneficiaries

• tax compliance is fairly complex- income retained by the trust is taxed at the rate of 33%, but distributions of income that has been taxed are tax-free in the hands of the beneficiaries