Business Adviser. way to demonstrate this is by directly comparing investing in property, investing in shares and investing directly in a business.

Size: px
Start display at page:

Download "Business Adviser. way to demonstrate this is by directly comparing investing in property, investing in shares and investing directly in a business."


1 Business Adviser Autumn 2010 Issue 40 The myth of property s tax advantages It s common knowledge, isn t it, that property investors enjoy a whole raft of tax breaks not available to those who invest in shares or businesses? Actually, they don t despite the ongoing criticisms of property investors and claims of loopholes in the rental property taxation regime. The clearest way to demonstrate this is by directly comparing investing in property, investing in shares and investing directly in a business. Income All investment income is taxable. Rental properties earn rent from tenants. Shares earn dividends. Businesses profit by selling goods and/or services. To repeat, all income from each of these activities is taxable. Cash expenses Very broadly, if you have to spend money to earn money, the expense is deductible. Share investing may incur advisor management fees. Businesses incur materials, wages and overhead costs. Property owners suffer rates, insurance and repair costs. The rules for claiming expenses are the same across each class of investment. Contents 01 The myth of property s tax advantages 02 Complete your annual questionnaire online 03 Want to improve your cashflow? 04 Optimism soars to new heights 04 Red tape major hurdle to growth 05 Skills shortage in Australia 05 Alternative financing a sign of the times 06 Risk Management continued overleaf End-of-year tax considerations

2 Financing costs If you borrow to buy an income producing asset, the interest on your borrowings is generally deductible. Property investors pay mortgage interest. Business owners incur interest on business loans. Even share investors are entitled to a deduction for interest on funds borrowed to buy shares. Depreciation Businesses are entitled to a deduction for depreciation on assets. Property investors can also claim depreciation on assets, including buildings. Some people argue that that s wrong, since buildings tend to increase in value over time. However, that argument is based on a misunderstanding of the principle at work here. Depreciation is based on the assumption that certain assets wear out over time, regardless of how the market perceives their value. A depreciation claim is allowed for a notional expense that may, or may not, actually materialise. If it does not occur if, for example, a building sells for more than its depreciated value the previous depreciation deductions reverse, and become taxable. For that reason, depreciation claims on buildings are, at worst, no more than interest-free loans. Nonetheless, if buildings rarely decline in value, there is a strong argument for a depreciation rate of 0%. Shares are not depreciable (even though they can rise or fall in value), so no deduction is available. Capital gains If a business is sold for more than the book value of its net tangible assets, the capital gain is generally not taxed. Capital gains on shares are generally not taxed, as long as the investor did not buy them with the intention of selling them for a profit, and is not in the business of buying and selling shares. The rules applying to land investments are harsher. A property investor can be taxed on their capital gain simply by being associated with another person who is a property dealer, developer or builder. Tax rates Different tax rates apply to different entities; for example, companies pay 30%, trusts 33%, individuals up to 38%. These rates apply regardless of the activity of the entity. Loss Attributing Qualifying Companies LAQCs are often maligned for their special tax status that allows losses to be passed through to shareholders. Many property investors mistakenly believe they need an LAQC to offset tax losses arising from rentals. In fact, losses can be offset against other income where property is held directly by a person. LAQCs are useful for property investment only in a couple of specific situations. However, LAQCs are appropriate for situations other than property investment; and abolishing them would be disruptive and inappropriate. Conclusion New Zealanders love affair with property is often put down to favourable tax laws. But that s a myth: factors other than tax drive investment decisions. It may be that New Zealanders love property s tangible nature, or its perceived price stability or the comparative ease of gaining credit with which to buy. To point the finger solely at the tax system is a mistake. Current tax rules apply fairly equally to all investment categories and, in fact, you could argue that property is subject to some rules more onerous than those faced by alternative investment classes. My view is that the Government s 20 May Budget will almost certainly specify changes to property taxation (no more depreciation claims, perhaps, or the ringfencing of losses) that will lead to further distortions in the way that property is taxed compared to other investments. Geordie Hooft Grant Thornton Partner, Tax T +64 (0) E Complete your annual questionnaire online Annual client questionnaire time is almost upon us. To make your life easier, our annual questionnaires will be available for secure completion on our website from 31 March. We will send you an in early April with your login and password details, as well as other information you ll need to complete your questionnaire. If you haven t received your by 15 April, please contact us. If you prefer to complete your questionnaires the good old-fashioned way, with pen and paper, that option is still available. Please let us know and we ll get a questionnaire posted out to you. 2 Business Adviser - Autumn 2010

3 Want to improve your cashflow? Consider proactive tax management The recession led most companies to slash unnecessary or excessive expenditure. With little more fat left to trim, then, how will your businesses improve the bottom line in 2010? By striving to lift sales and productivity? Not so fast. Of course lifting sales and productivity is a good thing. But in tackling expenditure, most New Zealand businesses tend to overlook one of the highest overheads on their books: the costs associated with collecting, administering and paying tax. This is not simply a compliance issue which, in itself, is significant. Even greater can be the cost of getting it wrong once shortfall penalties and use of money interest have taken their bite. With Inland Revenue actively focusing on increasing the tax take, how comfortable are you with your historic position? Payroll tax and GST Payroll taxes and GST obligations are normally driven by internal processes that have often not been reviewed since inception ( we don t have the time or resources for that is a common complaint). But if your original system contains even a minor error, it can compound into a sizeable discrepancy over many transactions. Now is an ideal time to review your tax obligations and search for increased efficiencies and potential savings. Not only because of the recession, but also because a number of thresholds and exemptions have recently increased. For example: You may be able to defer your GST obligations by changing your accounting basis or filing frequency. Group GST registration may offer savings (particularly where a holding company exists). Fringe benefit exclusions have been reviewed. Are you claiming all that you are entitled to? You may be entitled to change from twice monthly PAYE payments to monthly. Taxation reviews can have a significant positive impact on cash flow by allowing you to defer some obligations. The bonus is that you also gain the comfort of knowing your obligations are being met. If an error is identified it can be actively managed. While the initial news is not always welcome, the net effect is a lower cost to the business than if the error had been allowed to compound. Income tax Income tax is a different beast again. The only sure thing is that you re going to have to pay and that if you underpay you ll be hit with 8.91% penalty interest, despite the fact that IRD pays a paltry 1.82% interest to you if you ve overpaid. Tax payments can create big holes in your cash flow. However, the introduction of tax pooling intermediaries, who operate tax pooling accounts with Inland Revenue, provides a new tool for smoothing out payments. Businesses deposit tax payments into the tax intermediary accounts until the intermediary instructs Inland Revenue what to do with them. Depositing funds in this way increases your options: you can easily transfer, refund or sell your deposited funds to another business to achieve a higher interest return. In the event of an underpayment, you can make a request to purchase a historic tax payment via a tax intermediary to reduce interest costs and avoid any penalty interest. As with all business costs, you should actively manage your tax. With a new year upon us, and a range of powerful tools available, now is a great time to start. We have some great comparative market analysis we would be happy to share with you. You may be surprised at the positive effect it will have on your cash flow and compliance costs. Dan Lowe Grant Thornton Associate, Tax T +64 (0) E Business Adviser - Autumn

4 Grant Thornton International Business Optimism soars to new heights New Zealand business people are the most optimistic they have been since the first Grant Thornton International Business Report (IBR), now in its 18th year. In this year s survey, which questioned more than 7,400 privately held businesses across 36 economies, New Zealand businesses registered an optimism score of 66% compared to a miserable -15% last year. That result also places New Zealand businesses near the head of the field globally: seventh out of 36 countries. Australia came in third most confident at 79%; however, optimism bounced back right across the globe, with several economies feeling more positive about their future than International Monetary Fund forecasts suggest. Most New Zealand businesses have become leaner and more cost effective as a result of the recession. This has set them up well for the recovery. As the global economy emerges from recession, we predict that many businesses will reap the rewards of their hard-won efficiencies with significant gains in the upturn. North Island businesses, it seems, are more confident than their South Island counterparts, recording 70% to 57% on the optimism scale. 66% of North Island businesses expected increased revenues in 2010, versus 42.9% in the South Island. Whether this signals a difference in inherent optimism, or simply a more cautious business approach in the south, perhaps only time will tell. Asked where they had placed the greatest focus to prepare for the upturn, most New Zealand businesses said workforce skills, followed closely by new target markets and new products and services. The composition of the supply chain, and mergers and acquisitions, came low on the list of priorities. The research confirms what we already suspected. Privately owned New Zealand businesses haven t preserved profit at the expense of their people. Half the businesses surveyed had instead focused on up-skilling and maintaining or even enhancing their workforce during the recession. We have also seen a resurgence of tactical recruiting, fuelled in part by the return of many highly talented business people to our shores. The next challenge will be to keep those who have returned. Their international experience is invaluable if New Zealand is to flourish on the global stage. However, that very same stage will call powerfully to them as global job opportunities once again begin opening up. Red tape major hurdle to growth Red tape is hampering the growth of New Zealand business. Whereas last year one of businesses primary concerns was a shortage of orders, this year 33% of companies rated red tape and regulation as the major constraint even more so than those who noted reduced demand for product or services (30%). This compares to last year s figures of 41% and 53%, respectively. Once again, New Zealand is not alone: globally, businesses think that regulations and red tape are the second biggest major constraint (32%) behind shortage of continued on next page -> 4 Business Adviser - Autumn 2010

5 Report reveals... orders/reduced demand (39%). The major disappointment is that nothing has changed in New Zealand, despite the presence of a more businesssavvy Government. This Government, like so many of its predecessors, keeps imposing more red tape on business, which is already drowning under a deluge of regulations. The New Zealand regulatory environment is a major disincentive for entrepreneurs, who need a more simplified system in which to operate. Under Labour we had a Government that neither understood business nor showed an interest in doing so. Now we have a Government that does understand business, surely it s time for some meaningful change? We need a total rethink of what we are trying to achieve in New Zealand. What is it that we want to support, nurture and grow? Skills shortage in Australia: she s a worry, mate If you think there s a skills shortage in New Zealand, you may be heartened to know that it s even worse in Australia. But don t be: Australia s problem will inevitably make ours worse too. First, the numbers: 27% of New Zealand respondents rated skilled workforce shortage as one of the biggest constraints of business, compared to 31% of our Australian counterparts. Guess where Australia will look first to fill its labour workforce gaps? Exactly. (Well, wouldn t you?) Actually, that s not even a hypothetical question. For example, the state of Victoria recently advertised in New Zealand for childcare workers, offering $A57,000 per annum. This should ring alarm bells here. Australia is a highly attractive, accessible alternative for New Zealanders wanting higher salaries. The average pay is 30% higher, personal tax rates are lower, the Government has several individual and family support packages and, of course, there s the climate. Australia s acute skilled workforce shortage is attributed to the fact that it largely escaped the recession, helped by its Government s pro-active approach. Consequently, there s a shortage of outof-workers clamouring for new positions being created as Australian businesses gear up for better times. In our opinion, the New Zealand Government needs to develop a meaningful plan to lift the average New Zealand wage to the same level as Australia s. Skills shortage was just one area of constraint on business s ability to expand. Regulations and red tape actually rated highest (33%), followed by reduced demand for goods and services (30%), lack of skilled labour (27%), shortage of working capital (19%), cost of finance (14%), and shortage of long term finance (11%). With more than one million New Zealanders now living overseas, one of our big exports is quality people. Every taxpayer who leaves New Zealand represents lost tax revenue for the Government, and our average income potential drops yet again. Exacerbating our skills shortage is the number of major employers who have shifted their head offices to Australia and call centres to Asia. Alternative financing a sign of the times The growing use of factoring by New Zealand businesses up 16% from the previous survey, compared with a mere 4% rise in Australia is a reflection of the tougher economic times and the desperation some companies are feeling. Factoring, introduced to New Zealand by Scottish Pacific Business Finance about 15 years ago (where it has remained largely below the radar until recently), is an alternative means of external funding from traditional sources such as banks. A business sells its accounts receivable to a third party at continued on next page -> Business Adviser - Autumn

6 a discount in exchange for an immediate cash injection. While it improves cash flow, it does so only at the cost of some of the value of the invoice. The data suggests that businesses expect less support from banks this year and so have begun looking more closely at alternative funding. Last year 90% of those surveyed felt confident about bank support, but that figure has slumped to 74% for While this loss of confidence is not restricted to New Zealand, we have recorded the second biggest decline among the 36 countries surveyed. No wonder that factoring is increasing in popularity. Partly as a result of that, only 21% of businesses expect finance to be less accessible this year, compared to 74% last year. But these numbers should not be read as a positive. What they actually reveal is a shortage of long term finance and working capital the keys to sustainable business. An increase in factoring demonstrates an element of desperation among some businesses, which are finding it harder to borrow from banks. It s not unusual in a recession to see growth in non-prime lending sources, but the concern is that such funding is almost always more expensive than a bank facility. Peter Sherwin Grant Thornton Partner, Business Advisory D +64 (0) E Risk Management no need to worry, we have good insurance It is surprising how often we hear this when we talk to people about risk management. Yes, insurance is useful for some things but most risks that businesses face cannot be covered by insurance. Let s look at a few of these. Information Most businesses cannot function without their information systems whether that is financial systems, patient records, client contacts, supplier details or stock records. These days most of that sits on a computer somewhere. Yes you can (and should) insure the computers but if these are damaged, stolen, or break down no amount of insurance will get that information back. Good risk management dictates you should back this information up regularly and keep it secure. (So when did you last check that this occurs in your business?) One freelance journalist I worked with recently has actually scrapped his insurance in favour of a discipline of regular backups. (We don t recommend that - insurance is still useful.) Back up security matters too. A couple of years ago a very large stock exchange company (not in New Zealand) invested millions of dollars in a server backup system but put it in the same room as their main server. One rumour was that it was even linked to the same power supply! People Think about how much of the value of your business is tied up in people s heads. What would happen if two of your key people left, and the week after another was involved in a serious car accident making them unable to work for a month? The solutions are very dependent on your type of organisation, but we do recommend businesses seriously consider this, and come up with options to reduce the impact. Legal compliance As one example of the pitfalls, according to the 2009 ERMA Monitoring report, about 20,000 workplaces in New Zealand handle enough hazardous substances to require a test certificate or chemicals warrant of fitness. The ERMA report shows only 4,000 test certificates currently issued. About 80% of workplaces (16,000) risk being prosecuted for breaking the law right now. Incidentally, many insurance policies exclude coverage if the insured organisation is not complying with the law. Does yours? So what is risk management? In a nutshell, risk management means 6 Business Adviser - Autumn 2010

7 Fig 1: Risk Management process Communicate & Consult PROCESS Establish context ASSESS Identify risks Treat risks Analyse Evaluate Monitor & Review systematically identifying what you want to achieve, working out what might affect that and how likely it is, and deciding what systems and protocols to put in place to address those situations. Good risk management requires two way communication with those affected and continually monitoring what is going on. At a quick glance, this suggests we consider risk management all the time. At one level that is true, but problems arise when some steps get missed out. For example, few organisations sit down and make absolutely clear to themselves what they want to achieve and what they don t want to achieve. Did those 16,000 organisations really sit down and say to themselves complying with the law is not one of our objectives we suspect not. This first (and critical) step is part of establishing a context. computers) and treated it, but ignored a larger risk (loss of information on which the business operates). Treating a risk is doing the best thing to reduce that risk. The effort in identifying and assessing risks will be no use if you don t do something to treat those risks which your assessment shows need attention. In our earlier example both backing up data and having insurance are types of risk treatment. Our experience suggests the most ignored aspects of risk management relate to communication and monitoring. Communicating risks and what is being done about them to all those who might be affected is so important that in risk management we recommend putting it at the start of the process. This means identifying the people and organisations to be communicated with and doing so early. For example, in the public row last year about Auckland s community diagnostic services, there appeared to be inadequate communication with those most affected (the Auckland Community) about the risks inherent in delivering on the objective of saving money. The result was, from a risk management point of view, totally predictable public outrage. Monitoring risk management, or making sure that what you put in place to treat risks is actually happening and getting the right results, is equally important and often overlooked. For example, making someone responsible for backing up computer information and then never checking that it is done invites the I have to leave early today and nobody will notice if I don t do it response. Not really useful if that night someone steals the laptop off the senior partner s desk and a burst water pipe drowns the computer that has the financial records on it. So having a good risk management system in place will give you a lot more peace of mind and help your business, weather the inevitable storms of day to day business (be it a medical practice, a laboratory, a law firm, or a distribution centre). It will often also show you things that you may not have otherwise thought of, which actually help achieve your goals. An added bonus - good risk management reduces the cost of doing business. Not only will you find that you are able to spend time and effort managing only the important risks, but you may well find that your insurance bills go down. It will certainly be worth talking to your insurance broker after you have put in place good risk management processes you may be pleasantly surprised by the result. Steve Vaughan Director, InsideOutWorks Ltd InsideOutWorks is a consultancy offering foresight, insight and relationship management for sustainable business. Steve is a risk management specialist and is part-time Executive Director for the NZ Society for Risk Management. T +64 (0) E Risk identification and assessment We often think about the things that might affect our goals. However, too often that thinking is not done on any consistent basis, and certainly is not documented. This can mean that serious risks are often not dealt with and minor ones can have too much focus on them. Using consistent methods to identify and assess risks avoids this particular pitfall. This process will also often identify advantages, or things which help achieve your objectives. All those people who insure their computers and servers but don t backup their information regularly are a good example. In a sense they have identified a small risk (failed, damaged or stolen Business Adviser - Autumn

8 End-of-year tax considerations Most New Zealand businesses follow the standard 31 March fiscal year. However, no matter what balance date your business has, certain end of year tax considerations will always apply as your balance date approaches. In general (and subject to cash flow considerations), any planned expenditure should be brought forward so that it is incurred in the current financial year. Case law has determined that expenditure is incurred when it is definitively committed to. It is not necessary that actual payment be made. However, there are various provisions in the Income Tax Act that do not allow a deduction for prepaid expenditure. Below are some examples of where tax advantages can be gained from year-end adjustments/prepaid expenditure. Note that prepayments will not be deductible if they are treated as prepayments in your financial statements: Bad debts are deductible, but only in the year that they are written off. This requires something more than the decision that a debt is bad. You must make appropriate bookkeeping entries in most cases, which ensure the bad debt is written out of the debtors ledger at year end. Consumables used in conjunction with, but not forming part of, the final product (for example, fuel and electricity) can be deducted in the year of purchase provided the unused stocks at year end do not exceed $58,000 in value. Insurance premiums are deductible in full when paid provided they are not prepaid for more than 12 months and the total annual premium under an individual contract does not exceed $12,000. Leave provisions Amounts owing at balance date for holiday pay and long service leave are only deductible for tax purposes if paid out within 63 days of balance date (by 2 June for a 31 March balance date). Staff bonuses Similar to leave provisions, these must be determined before year end and paid out within 63 days of balance date. Rent Prepaid rental for land and buildings, livestock or bloodstock is deductible in the year paid unless the prepaid amount is for a period greater than six months after balance date, or for an amount greater than $26,000. Stationery, postage, motor licensing fees, subscriptions for newspapers/periodicals These items can be prepaid with no limits on how much can be prepaid or for what period. Membership subscriptions are deductible provided they extend no more than 12 months after balance date and the individual subscription does not exceed $6,000. Business-related travel and accommodation costs paid in advance are deductible provided they are paid no more than six months in advance and the prepayment portion does not exceed $14,000 per contract. Purchases of capital assets Bringing forward the purchase of capital assets will have limited benefits, as depreciation is deductible on a monthly basis based on the number of months that the asset is owned and used or is available for use. An immediate tax deduction may be available for assets which cost less than $500. However, the $500 deduction is subject to a number of restrictions including same day/same supplier/same asset category limitations. These limitations prevent the splitting of asset purchases into simultaneous multiple transactions of $500 or less each in order to take the upfront deduction. For example, the upfront write off would not be available where the taxpayer acquired 100 individual chairs at $200 each on the same day. If you require further information on any of these topics or would like details on other accounting matters, contact your local Grant Thornton office: Auckland L4, Grant Thornton House 152 Fanshawe Street Auckland 1140 T +64 (0) F +64 (0) E Wellington L13, AXA Centre 80 The Terrace Wellington 6143 T +64 (0) F +64 (0) E Christchurch L9, Anthony Harper Building 47 Cathedral Square Christchurch 8140 T +64 (0) F +64 (0) E Prefer to go electronic? If you would prefer to receive your copy of our Business Adviser electronically, please contact your local office. If you would like to be deleted from our mailing list, please contact your local office. Grant Thornton New Zealand Ltd is a member firm within Grant Thornton International Ltd Grant Thornton. 8 Business Adviser - Autumn 2010