Whether you are starting a new business or purchasing an existing one, one of the most important decisions you make will be how to structure your business. While there are several different business structures available, most owners will elect to either run their business through a company or as a sole trader.
It is essential to make an informed decision about how to structure your business, and although you can change this as your business grows, it pays to be informed.
Sole Traders
A sole trader is someone who undertakes running their business in their own name, using their own IRD number. For this reason, sole traders are by far the simplest business structure available and the cheapest to set up. Sole traders are particularly:
starting a business for the first time;
turning a hobby into a business; or
working as a contractor for other businesses.
A key disadvantage of working as a sole trader is that you are personally liable for the business’s debts and liabilities. When engaging with third parties (such as lenders, suppliers, customers), you do so in your own name. You can hire staff as a sole trader, however you cannot be an employee on wages, so as your business grows, you need to ensure your structure changes as well.
There is no legal distinction as a sole trader between personal and business assets as a sole trader. So in other words, and unlimited liability and this means that if the business occurs debts or liabilities the owners personal assets are at risk. It can also limit access to funding and capital investment or grants if this is required at anytime.
Paying Tax as a Sole Trader
From a taxation perspective, as a sole trader, your business income is included in your personal income. You pay tax on this income at your regular income tax rate. You use your personal IRD number for all taxation matters with Inland Revenue (IRD) relating to the business.
While it is not legally required, we would recommend that you get an NZBN – a New Zealand Business Number. An NZBN is a unique 13-digit number that identifies your business. Getting a NZBN is free and makes your dealings with government bodies and other businesses easier.
Further to this, if your business is making over $60,000 in annual revenue, you will also need to register for GST. As a sole trader, your GST number will be the same as your IRD number.
Companies
A company is a formal legal entity that is distinct from the people who own or manage it. Companies are managed by directors, who make decisions on behalf of the company. A company is made up of shares (or ‘share capital’). The people who own these shares are known as shareholders (who may or may not be directors as well). Shareholders are entitled to a share of the company’s profits in the form of dividends.
Another key advantage of companies is that they have limited liability. This means that if the company goes into debt or another party sues the company, the shareholders and directors of the company are not personally liable. The company provides limited liability protection to its shareholders.
If a third party brings a successful claim against the company, this will be met by the company’s assets and bank accounts, not the personal assets of the directors and shareholders.
It may offer a perception of professionalism and credibility that sole traders may not enjoy, and contractors and clients may prefer to work with as a consequence.
It is easier to raise capital through banks, grants or issuing shares to other investors.
Paying Tax as a Company
Because a company is its own legal entity, it has its own IRD number and pays tax on its own company income. This means that the company must file its own tax returns and have its own set of company accounts. The company tax rate is 28%, which is lower than some income tax rates for individuals, being:
30% for income over $48,000 and up to $70,000;
33% for income over $70,000 and up to $180,000; and
39% for income over $180,000.
There is also benefits to structuring the tax to save income tax and use more claimable expenses by utilising dividends and planning which can lead to substantial savings to a limited liability company.
Still unsure, get in touch with Leah to find out more.
