Paying your way Tax issues for the self employed May 2012
Tax issues for the self employed This is a brief overview of tax issues that affect the self employed. Understanding your tax responsibilities and putting effective systems in place will ensure that you minimise the time and effort you need to spend on your accounting and tax affairs and understand and manage your tax liability effectively. 1. Income tax Income tax return Your income tax return is due at Inland Revenue by 7 July ie your 31 March 2012 return must be filed by 7 July 2012. If you have an accountant you will normally get an extension of time to file your return - to 31 March of the following year. Provisional tax basis 2013 provisional tax Every taxpayer who is liable to pay residual income tax exceeding $2,500 for the 2011/2012 income year is a 2012/2013 provisional taxpayer. Residual income tax is the amount of income tax payable by a taxpayer after deducting tax credits but before deducting provisional tax paid. Provisional tax is generally payable in three equal instalments. Calculating provisional tax Provisional taxpayers have the following three options for calculating their provisional tax: The standard uplift method The estimate method The GST ratio method The standard uplift method The general rule is that provisional tax payable is 105% of the residual income tax for the previous income year. If the prior year income tax return has not been filed the provisional tax payable can be based on 110% of the residual income tax for the income year before the previous income year (ie two years ago). Due to recent changes to tax rates, the rates used to calculate provisional tax under the standard uplift method have been modified for the 2012/2013 income year. The rates are as follows: The estimate method Under this method an estimate is made of the residual income tax, which then forms the basis for the provisional tax payable. A taxpayer who chooses this method is required to take reasonable care in making the estimate. The GST ratio method This option calculates provisional tax by reference to the taxpayer s GST taxable supplies in the relevant provisional tax instalment period. Further voluntary payments may be made. Such payments can minimise exposure to use of money interest. General rule Income year 2012/2013 Individuals Uplift based on prior year RIT RIT * 105% RIT * 105% Uplift based on year preceding RIT * 110% RIT * 100% prior year RIT Companies and other entities taxed as companies (eg, PIEs) Uplift based on prior year RIT RIT * 105% RIT * 105% Uplift based on year preceding RIT * 110% RIT * 105% prior year RIT Other entities (eg, trusts) Uplift based on prior year RIT RIT * 105% RIT * 105% Uplift based on year preceding prior year RIT RIT * 110% RIT * 110% 2 PwC Tax issues for the self employed 3
Individuals who begin receiving self-employed or partnership income are eligible for a 6.7% discount. Terminal tax When the taxpayer s return of income for the year is furnished, the provisional tax paid for that year is credited against the tax assessed. This results in either a refund or further tax to pay by way of terminal tax. Tax discount in first year of business Although individual taxpayers are not required to pay provisional tax in their first year of business, they are still required to pay income tax on any income derived in the first year. Generally, this income tax is payable at about the same time as the third instalment of provisional tax for the next year is due. Individuals who begin receiving self-employed or partnership income are eligible for a 6.7% discount. Essentially, the discount operates so that an eligible taxpayer who pays income tax prior to the end of an income tax year receives a credit for the lesser of 6.7% of the amount paid or 6.7% of 105% of the residual income tax for that income tax year. The discount is designed to relieve eligible taxpayers of the financial strain of making two years worth of tax payments at the same time. From 8 May 2012, the UOMI rates are: 1.75% (overpaid tax) 8.4% (underpaid tax) Use of money interest (UOMI) UOMI is payable by: all companies and trusts with RIT greater than $2,500 all taxpayers who estimate their provisional tax individuals with RIT greater than $50,000. Depending on your situation, interest will be calculated on any terminal tax due (ie after provisional tax payments are taken into account) from the due date of the provisional tax payments to the date the terminal tax is paid. UOMI received is taxable income and UOMI paid is tax deductible. From 8 May 2012, the UOMI rates are as follows: overpayments 1.75% (IRD pays you) underpayments 8.4% (you pay IRD) Previously, the rates were 2.18% for overpaid tax and 8.89% for underpaid tax. Taxpayers are able to pool their provisional tax payments with those of other taxpayers through an arrangement with a commercial intermediary. Tax pooling allows underpayments to be offset by overpayments within the same pool and vice versa. Tax pooling can reduce exposure to UOMI and late payment penalties. 2. Penalties Under the current penalties regime, tax shortfalls may result in: Use of money interest charged from the original due date to the date of payment; and Possible penalties depending on the taxpayer s conduct. An initial late payment penalty of 1% applies if the taxpayer does not pay tax by the due date. A further 4% late payment penalty applies if the tax is still not paid within 7 days of the due date. An incremental late payment penalty of 1% is then imposed monthly until the payment is made. Inland Revenue is required to notify the taxpayer the first time their payment is late rather than imposing a penalty immediately. The taxpayer is entitled to one notification every two years. After receiving the first notification Inland Revenue will not send further notifications for two years and will impose an initial late payment penalty in the normal manner. Penalties are levied if Inland Revenue considers the taxpayer is guilty of: Lack of reasonable care (20%) Unacceptable tax position (20%) Gross carelessness (40%) Taking an abusive tax position (100%) Tax evasion (150%) When a taxpayer discloses a shortfall voluntarily before notification of a tax audit or investigation, penalties imposed for a lack of reasonable care and for taking an unacceptable tax position are reduced by 100%. These penalties also apply to all other tax types including GST, PAYE and FBT. It is therefore particularly important for you to take care in preparing all your returns. 3. GST General background Goods and services tax (GST) is a tax on the supply of most goods and services in New Zealand. It is generally charged and accounted for at a rate of 15% on all taxable supplies. Persons and organisations who have registered with Inland Revenue collect GST from their customers on behalf of the Government. Registration Any person who, in a given 12-month period, makes total taxable supplies in excess of $60,000 in New Zealand in the course of all taxable activities is liable to be registered for GST. Registered persons must generally file a GST return once every two months. Frequency of returns - 1, 2 or 6 months? You can choose to prepare GST returns every month or six-monthly depending on your circumstances. A person may apply to file on a six-monthly basis if taxable supplies do not exceed $500,000 in a given 12 month period. Registered persons whose turnover exceeds $24 million per annum are required to submit GST returns on a monthly basis. Calculation basis There are two main bases by which you can account for GST: Invoice basis Using the invoice basis you claim GST at the earlier of when you receive an invoice or make payment. You account for GST at the earlier of when you issue an invoice or receive a payment. The disadvantage of this basis is that you may have to account for GST before actually receiving payment. You must use this basis if your taxable supplies are greater than $2 million. Payments (or cash) basis If you use the payments basis you account for GST in the taxable period in which you make or receive payment. 4 PwC Tax issues for the self employed 5
4. Tax credits Common tax credits are: Independent earner tax credit (IETC) if your annual income is between $24,000 and $48,000 and you are not entitled to Working for Families assistance. The entitlement to the IETC decreases by 13c for every additional dollar you earn over $44,000 Donations, childcare and housekeeper credits Claims for the housekeeper / childcare credit and the donations credit must be made on a separate rebate claim form. Inland Revenue will forward claim forms to every taxpayer (or their agent) who has claimed either of these rebates in the last two years. Family assistance payments are available in certain circumstances. Working for Families tax credits are provided to families with dependent children (under the age of 18). The four types of family tax credits are: Family tax credit In-work tax credit Minimum family tax credit Parental tax credit 5. Record keeping To prove your deductions are legitimate you must keep all relevant records for at least seven years. The following records, which are not an exhaustive list, must be kept: all income received (copies of invoices issued etc) all tax invoices and receipts for purchases, insurance, power, phone and all other costs incurred bank statements cash books or computerised accounting records wage records for any employees loan statements interest and dividend payments a list of business assets and liabilities statements of year end trading stock and stock take records credit and debit notes motor-vehicle log books Keeping records in order makes good sense. If you are investigated by Inland Revenue you should be able to justify all your claims with a minimum of time and effort. Help yourself record keeping Your record keeping is the key to making your GST and income tax returns easy to prepare. You should have a system which allows you to track transactions easily. This may include the following: One bank account through which you do as many of your business transactions as possible. Always keep private transactions out of this account. Moving funds regularly from your business account to your private account, eg regularly weekly or monthly amounts just like you were receiving a salary. A system for paying transactions privately eg on your credit card by which the business reimburses you eg via a monthly expense claim. Filing all your receipts and invoices regularly. It doesn t matter which order you file them in as long as you can find them if you have to. It is common to file them in batches which correspond to your GST returns. You can also staple them to the back of the bank statement to which they relate. A very simple easy to find system is to file them in a ring binder in ascending cheque number order. You don t have to have a computerised accounting system. However, this can make it easier to prepare GST and income tax returns. 6. Expenses You can deduct expenses incurred in deriving income or in carrying on a business for that purpose against your income unless the expense is private or capital in nature. Assets that cost over $500 must be capitalised and depreciated (essentially you are claiming the cost of the asset over a number of years). Common deductible expenses include: Advertising Bank charges Computer expenses Conference and seminar costs Depreciation* Entertainment (50% only)** Fringe benefit tax Home office expenses Insurance and ACC levies Interest Lease costs Legal fees (not for purchase/ sale of business or company formation). If your legal fees total less than $10,000 in a year you can deduct them regardless of whether they are capital or revenue in nature Motor vehicle expenses Postage Printing and stationery Repairs and maintenance Staff training Subscriptions Telephone and tolls Travel Wages and salaries *From 20 May 2010, the depreciation rate for buildings with an estimated useful life of 50 years or more is 0%. ** Certain entertainment expenditure such as meal costs while travelling on business are fully deductible. Many of these types of expenditure may include an element of private use. Read on for further information on home office, mobile phone and vehicle expenses. 0% depreciation rate for buildings with an estimated useful life of 50 years or more from 20 May 2010 6 PwC Tax issues for the self employed 7
Home office expenses If you use an area in your home principally as an office or storage area for your business, then you may be able to claim part of the overall costs of running your house as a business expense. Floor area is the most common base used for calculating the portion claimable. For example, if the area you use amounts to 10% of the house s total floor area, you can claim 10% of expenses such as annual rates, house insurance premium, power, mortgage interest, and house depreciation. It may also be possible to claim a portion of your home telephone rental. Vehicle expenses If you have a vehicle (not a company vehicle) which is used for business and private purposes, there are several options for claiming the business portion of expenses: i. If your business use is less than 5,000 km per year, you can use predetermined Inland Revenue rates as the basis of your claim. For distances of more than 5,000 km, you must keep a record of actual vehicle expenses. ii. Keep a logbook for 90 consecutive days recording all journeys. Based on the business use percentage from the logbook, you can claim this proportion of all vehicle expenses. You can continue to use this percentage for three years, provided that the actual business use in any month does not vary by 20% or more from the percentages established by the logbook. Option (i) can be particularly useful if a private vehicle is only used occasionally for business use. There are also GST implications to consider. Mobile phone expenses Your business mobile phone rental and call expenses are deductible. If your business phone is used privately, Inland Revenue will let you claim 50% of the rental expense along with the business calls. 7. ACC ACC provides cover for accidents including earnings related compensation if you cannot work due to an accident. ACC receives your income details from Inland Revenue when you file your tax returns. They will send you an invoice for the past year and a provisional invoice for the current year. ACC rates change each year and will depend upon the industry class you are in. The maximum amount of liable earnings for the 2012/2013 income year is $111,609 for self-employed persons. ACC works out your earnings-related compensation based on the income in your tax return. This is normally 80% of your normal income (subject to a maximum). However, for the first couple of years of contracting you may only receive a minimum cover as your contracting income history is not long. You may therefore only have limited cover if you have an accident within the first couple of years of any employment. ACC offers Cover Plus Extra which allows you to negotiate agreed levels of cover in advance at an additional cost. ACC only covers you if you have an accident. There is no cover for illness. You should therefore also consider private income protection insurance. 8. Fringe benefit tax (FBT) FBT is payable by employers on the value of the fringe benefits provided to employees and shareholder employees. The value of the fringe benefits is not included in the gross income of employees. FBT Rates The rate of FBT payable will depend on the marginal tax rates of the employees receiving the benefits. Alternatively a flat FBT rate of 49.25% can be applied to all attributed fringe benefits and 42.86% (or 49.25% for major shareholders and associates) to all non-attributed benefits. The four main groups of fringe benefits are: motor vehicles low interest loans employer contributions to sick, accident or death benefit funds, superannuation schemes and specified insurance policies. free, subsidised or discounted goods and services, including subsidised transport business. Benefits that are not liable for FBT include specified superannuation contributions, accommodation provided by the employer (which is subject to PAYE), use of a business tool (used primarily for business purposes and the cost of which does not exceed $5000). FBT also applies to benefits received by an employee from a third party when there is an arrangement between the employer and the third party and when the benefit would be subject to FBT if the employer had provided it. Generally goods or services received by the employee from a third party are not subject to FBT if the third party would have given the same discount to other groups of people FBT is payable by employers on the value of the fringe benefits provided to employees and shareholder employees. The value of the fringe benefits is not included in the gross income of employees. 8 PwC Tax issues for the self employed 9
Get in touch Owen Gibson Partner +64 4 462 7230 owen.d.gibson@nz.pwc.com Chris Leatham Partner +64 4 462 7304 chris.j.leatham@nz.pwc.com pwc.co.nz 2012 PricewaterhouseCoopers New Zealand. All rights reserved. PwC refers to the New Zealand member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. Disclaimer: This publication is intended as comment only and should not be relied upon or used as a substitute for professional advice. No liability is accepted for loss or damage incurred by persons who rely on this commentary. Professional advice should be sought in relation to any particular situation or circumstance. 244170