Year-end tax planning is an important part of managing your business affairs and should be undertaken prior to year-end. However, some of the matters referred to below can be considered post balance date and before accounts are finalised. For example, for the year-end March 2004 you may identify that you have terminal tax to pay. In order to reduce use of money interest that may apply, you may choose to make voluntary payments before the due date of payment of terminal tax.
The purpose of year-end tax planning is twofold:
- Year-end tax planning aims to identify core changes in tax legislation that will affect your business. Changes in tax legislation can create opportunities and traps for your business.
- Year-end tax planning specifically addresses taxation matters that typically arise at year-end.
The financial accounts snap shut at balance date meaning that actions taken after balance date can be too late to respond to changes in legislation and to implement year-end tax saving ideas for that year. Therefore, the following matters should be considered prior to year end.
Year-end is an excellent time to review your asset purchases for the year and ensure that you are claiming the maximum depreciation rate available for each asset.
If you have purchased a capital asset which itself contains a number of separately identifiable assets you should break the purchase down and depreciate the individual asset components.
Let’s say you purchase a commercial building. The depreciation rate available for your particular commercial building may be 4% diminishing value. Clearly, this does not create a substantial depreciation deduction!
However, when you refer to your sale and purchase agreement you may find that the purchase price includes, suspended ceilings (depreciable at 9.5% DV), motor for roller doors (depreciable at 15% DV) and so on. These rates may be increased by 20% loading if the assets are New Zealand new assets.
By splitting the purchase of major assets into components, substantial increases in depreciation can be achieved. Ideally, the breakdown of the purchase price should be contained in the sale and purchase agreement (or attachments). However, if the sale and purchase agreement does not include such a breakdown, the purchaser still has the option of obtaining a reputable valuation and breaking down the purchase price into sub-components.
We are able to direct you to an appropriate valuer to undertake that task.
Deduct Don’t Depreciate
Business operating expenses are deductible while expenditure on capital assets is non-deductible. Capital assets can only be depreciated over time, and are not immediately deductible. However, a special concession is available for “low cost assets”. Low cost assets are assets costing less than $200. These assets can be expensed in the year of purchase.
As you will appreciate, certain rules exist to prevent abuse of this deduction:
- The total cost of the asset purchased or manufactured must not exceed $200
- If the item is purchased along with other items at the same time and from the same supplier and the same depreciation rate would apply to all of those items purchased then the total aggregated cost of those items must not exceed $200
- The item purchased must not become part of any other depreciable property. This is an anti-avoidance rule that stops taxpayers acquiring one asset in a series of component parts costing less than $200.
Any small asset purchases costing more than $200 must be capitalised and depreciated.
Many businesses sell goods and services on credit. If these debts owed by customers become irrecoverable, a bad debt deduction may be obtained.
In a tax investigation situation, the Department can be expected to closely scrutinise your bad debt deduction. In particular, they will want to ensure that:
- The decision to “write off” the debt must be a genuine commercial decision. It is not necessary to show that legal or collection action has been taken to recover the debt in circumstances where this action would be futile.
- To support the commerciality of the debt “write off”, it is most helpful if the Department can see actual directors resolutions or an authorisation by a senior employee authorising the debt write off.
- The required accounting/journal entries made to write off the debt in the books must have occurred before balance date.
Remember too, that you may be entitled to a GST benefit for bad debts written off. In particular, if your business accounts for GST on an invoice basis (i.e.you pay GST when invoices are issued) you will be entitled to a GST refund on the debt written off. Note, this does not apply to businesses registered on a GST payments basis, i.e. businesses on a payments basis only pay GST on sales when the cash is collected. Because no cash has been collected on a bad debt, there is no need to make a GST adjustment when the debt is written off.
If your business operates as a company, interest free or concessionary loans to shareholders will give rise to taxable deemed dividends. Likewise, interest free or concessionary loans to employees or shareholder/employees may give rise to fringe benefit tax obligations.
The annual accounts prepared for your company disclose the extent of interest free loans provided at balance date. For this reason, it can be sensible to ensure that these loans are repaid to the company at balance date. (Note, the fringe benefit tax and deemed dividend consequences referred to above apply at any time during the year when interest free or concessionary loans are made).
If the decision is made to not repay a loan and the shareholder has a balance in a loan account owed to the company and interest of more than $5,000 is debited to that account in a year, then RWT should be deducted from that interest and remitted to the Inland Revenue Department by 20 April 2004.
Consumable aids are items used in a manufacture or production process but not incorporated in the final product. For example, diesel in the tanks of a fishing boat at balance date is a consumable aid. Consumables of less than $58,000 at balance date can be written off and not added into your trading stock on hand at year-end. This deduction is subject to various requirements and, therefore, you should consult your tax adviser.
Accrued holiday pay and bonuses paid by 2 June (i.e. within 63 days of balance date) are deductible for 31 March balance dates. The opportunity exists to obtain a deduction if cashflow permits.
A review of the fixed assets register should be carried out to identify assets that may be scrapped or not longer used. You may be eligible for a tax deduction (asset write off) in certain circumstances.
Ensure that your company’s ICA is in credit at 31 March otherwise penalties will be imposed. Voluntary tax payments (equal to the debit balance) can be made by 31 March.
The tax rules provide that where your
business incurs expenses prior to balance date (say 31 March 2004), but the benefit of the expenditure will be obtained in the next income year, no deduction is available in the current year to balance date. A deduction would be available in the subsequent year.
There are, however, a number of exceptions to this non-deductible prepayments rule. These include:
- Prepaid rental for land and buildings up to $23,000 can be deducted if the rental is paid for a period not exceeding six months after balance date.
- Payments in respect of service or maintenance of plant and equipment or machinery where the prepaid amount is less than $23,000 and the prepaid period is less than three months after balance date.
- Advance bookings for travel and hotel or motel accommodation can be deducted in the current year where the amount is less than $12,000 and the prepaid period is less than six months after balance. (Clearly the travel and accommodation would need to be business related.)
At present, a current year expense deduction is possible only when a tree or vine is replaced with one of the same species or variety that has died or been destroyed.
There are proposed new rules to allow the cost of replacement planting in relation to 5% of the orchard area to be treated as repairs and maintenance and be deductible in a single income year. Growers will be able to replace plants at their discretion, using different varieties if they wish.
The Government is currently consulting with the fruit growing industry over these new rules.
In a recent case a salary paid from a trading trust to a dentist was challenged by the Inland Revenue Department because it was not at market rate.
After the termination of a dentistry partnership, the taxpayer decided to restructure his business activities. He decided that a trading trust structure was flexible and would provide him with limited liability and asset protection for the future. The taxpayer set up a company and settled a family trust (of which the company was the trustee) and entered into an employment contract with the company. The taxpayer’s dentistry practice was carried on by the trading trust. His income was earned by the trading trust; the net income was distributed among the beneficiaries of the trust by book entry and the money was lent back to the taxpayer. The Inland Revenue Department considered that the actions taken by the taxpayer amounted to an arrangement to which the avoidance provisions applied.
It was found that the salary paid by the corporate trustee of the trading trust to the dentist at an artificially low figure, and that the taxpayer had avoided personal income tax.
Individuals employed by a trading trust should agree a salary at market value and prudence suggests that one should not set a salary at simply $60,000 otherwise they are asking the IRD to look closely at the arrangement. Evidence should be held to substantiate the market based salary. By paying a salary whereby some tax is suffered at the 39% tax rate there is less risk of IRD scrutiny.
The Inland Revenue Department cannot challenge remuneration paid to shareholders, directors or relatives of directors of close companies where the employee is an adult, a tax resident of New Zealand, and employed substantially fulltime in administration and management duties of the business. The employee should also not be able to influence the amount of remuneration. A close company is one that has 5 or less natural persons with voting interest of greater than 50%.
The Inland Revenue Department can challenge the remuneration paid where those conditions are not met.
A spouse is employed principally in other employment and the company claims a deduction for a salary of $30,000 paid to the spouse for marketing and administration work. In this case the remuneration is excessive and, therefore, the company is at risk that the Inland Revenue Department will disallow the deduction in the company tax return and assess the remuneration as a dividend to the shareholder employee.
Every time you file a tax return, whether GST, PAYE, FBT or income tax, you are taking a tax position and can be penalised if that position is later found to be incorrect. You do not have to gain any financial benefit for a penalty to apply.
The two most common penalties that taxpayers incur are the “Lack of Reasonable Care” penalty and the “Unacceptable Tax Position” penalty. Both of these penalties are outlined below:-
Lack of Reasonable Care
The penalty for not taking reasonable care when adopting a tax position is 20% of the tax shortfall that arises.
A taxpayer is careless in claiming in the wrong GST return GST on an asset purchased for $90,000. The tax shortfall is, therefore, the GST claimed of $10,000 ($90,000/9) and the 20% penalty would be $2,000 (being 20% of the tax shortfall of $10,000).
In general terms, where a taxpayer engages the services of a tax agent or accountant to assist with the completion of a tax return, the taxpayer will have taken reasonable care and the penalty won’t apply.
Unacceptable Tax Position
A taxpayer is liable to pay a shortfall penalty of 20% of the tax shortfall if the taxpayer takes an unacceptable tax position and the tax shortfall arising from the taxpayer’s tax position is more than both:
- $20,000; and
- The lesser of $250,000 and 1% of the taxpayer’s total tax figure for the relevant return period.
A taxpayer takes an “unacceptable tax position” if, viewed objectively, the tax position fails to meet the standard of being about as likely as not to be correct.
A taxpayer does not taken an unacceptable tax position merely by making a mistake in the calculation or recording of numbers in a return.
A taxpayer returns the sale of a commercial property in the GST return when the property was settled rather than in the return when the time of supply was triggered. The sale amount is $450,000. The tax shortfall is, therefore, $50,000 and the 20% penalty would be $10,000.
Penalties May be Reduced
These penalties may be reduced in the following circumstances (the percentage reduction is shown in brackets)
- Voluntary Disclosure (40% or 75%); or
- Timing Difference (75%); and
- Good Behaviour (50%); and
- Penalty Capped at $50,000 (provided the error is either voluntarily disclosed or discovered by the Inland Revenue within prescribed time limits).
Note: only one reduction is possible for voluntary disclosure and timing differences (e.g. temporary shortfalls). Other rules apply.
No Discretion to Remit
The Inland Revenue has no power or discretion to remit these penalties, except under limited hardship grounds. While it is possible to argue against the application of the Lack of Reasonable Care penalty (as the word “reasonable” is subjective in nature), it is much more difficult to argue against the application of the Unacceptable Tax Position penalty.
As these penalties apply to any tax position taken in a tax return, it is imperative that your accounting and financial systems are robust to mitigate unnecessary risk of penalties applying.
In particular, the scope of the Unacceptable Tax Position is so wide that it will penalise most errors where the tax at stake is more than $20,000.
If you are at all uncertain about the tax effect of any transaction, we strongly advise that you discuss the matter with us prior to filing a tax return to ensure these penalties are not incurred.
Tax payments are considered paid by the due date where:-
- Payments by post (in New Zealand) – when payment mailed and postmarked by the due date;
- Payments by post (from overseas) – when payment received by Inland Revenue by the due date;
- Electronic payments – when payment credited to an Inland Revenue account on or before the due date. Internet payments must be completed prior to the end of the bank’s online business hours.
- Physical delivery – when payments received into an Inland revenue drop Box or at Westpac Bank prior to the close of business on the due date.
- Post-dated cheques – Inland Revenue will not bank these cheques until the specified date. If this falls after the due date then the payment will be treated as late.
- Weekends and public holidays – If the due date falls on a weekend or public holiday Inland Revenue will treat payments received the next working day as received in time. Payments of GST are the exception to this rule. GST payments are due on or before the last working day of the month.
The Inland Revenue charges interest at 11.93% on most forms of underpaid tax. The Inland Revenue generally pays interest at the rate of 4.83% on most forms of overpaid tax. As a general rule, it is better to be conservative and overpay your taxes than underpay them (where your cost of funds is less than 11.93%).
Income thresholds for student loan repayments and interest write-offs will rise from 1 April 2004. The income level at which borrowers must begin to repay their loans will rise to $16,172 and the maximum income level for a full interest write-off for part-time or part-year students will rise to $26,140.
The minimum hourly adult wage will increase to $9.00 from $8.50 from 1 April 2004 while the rate for 16 and 17 year olds will increase to $7.20 from $6.80.
It is important that the ATO are kept informed of changes in circumstances of those receiving National Superannuation benefits. Change of address is commonly overlooked. Another situation sometimes overlooked is where there has been a change of circumstance such as the death of a spouse or partner. The surviving beneficiary maybe entitled to receive the living alone National Superannuation entitlement and that equates to a significant increase in benefit. However, if ATO is not notified of the change, and the allowance is not paid then there is no recovery for the unpaid balance of the entitlement at a later date, nor it appears the ability to ask for relief or discretion in that circumstance.
The Holidays Act 2003 has been passed. The 2003 Act repeals the archaic Holidays Act 1981, and provides holiday and leave entitlements that are easier to understand and apply.
It provides minimum entitlements of three weeks’ paid annual holiday per year (until 2007); 11 public holidays per year; five days’ paid sick leave after six months’ employment; and a separate entitlement to bereavement leave after six months’ employment.
The Act also gives comprehensive guidelines for calculating payment for all the above types of leave. Also, employee’s annual leave entitlement will increase to four weeks from 1 April 2007.
Other changes made by the Holidays Act 2003 including the following:-
- “ordinary weekly pay” is to be used to calculate annual holiday pay;
- “relevant daily pay” is to be used to calculate pay for leave other than annual leave;
- pay as you go holiday pay can be paid to employees on fixed-term agreements of less than 12 months, or to employees whose employment is irregular;
- the rules applying to annual closedowns are tightened; with employers only allowed one customary closedown period a year where they can require employees to take annual holidays;
- pay rates of time and a half must be paid for working on public holidays (employment agreements must be amended within 12 months to reflect this change);
- bereavement leave entitlements are set at three days for close family members (i.e. grandchildren through to grandparent) or one day for any other person the employer accepts the employee has suffered a bereavement for as a result of the death. Note there are specific factors that need to be considered in the latter case.
- new rules govern when annual leave can be treated as sick leave; and
- payment and alternative holiday entitlements for Australia Day and ANZAC days are now consistent with other public holidays.
The Holidays Act 2003 comes into effect on 1 April 2004 (except for the four weeks’ annual leave provisions).
The IRD and ACC only share limited information from tax returns each year. That means ACC needs to be regularly updated by taxpayers on any change to circumstances, such as a change in the amount of liable earnings, business classifications, full-time or part-time work, non-active income from business and business cessations.
In the past those details would have been disclosed in year end tax returns and taxation advisors checked them to ensure the disclosures were correct. However, ACC now deal directly with taxpayers and taxpayers receive invoices directly from ACC. Advisors do not now get an opportunity to review assessments of ACC on an annual basis, nor ensure that the invoices are paid on time.
It is important that the invoices are reviewed and if assistance is required that taxpayers contact their tax advisors.
Legislation passed in 2003 significantly overhauls the tax system relating to Aboriginal authorities. These changes lower the tax rate for Aboriginal authorities from 25% to 19.5% and simplify accounting processes for authorities and their individual members. The definition of a Aboriginal authority now includes not only trustees of a trust but also companies. The legislation takes effect 1 April 2004.
If the authority chooses not to come under the new tax system, it is just as important that the Inland Revenue Department is notified.
Legislation giving the self-employed a discount on the tax liability on income derived in the first year of business will be introduced to Parliament within a few weeks. The new law is expected to take effect from April 1 2005.
First year self-employed people and individuals that receive income from partnerships that make voluntary payments of provisional tax during the first year of business will be entitled to a 6.7% discount on the first year’s tax liability. It is likely that the individuals will need to elect to join the scheme and there may be use of money interest issues relating to underpayments. The final liability will be determined when the tax is assessed.
Individuals that elect not to join the scheme do not have to pay tax on income earned during their first year until the second year. However, both year’s payments can be due about the same time which can put financial pressure on some small businesses at that time.
Tax can have a major impact on cashflow and having the incentive to make earlier payments encourages individuals in their first year in business to spread their tax payments and preserve their cashflow.
Although we do not promote our practice as being qualified in providing financial advice, investment issues do arise at meetings and we do get involved in discussion on the subject. We are careful not to step outside our area of expertise in providing advice and tend to work in with our clients professional investment advisors or outsource matters to professionals in that field.
We have had recent discussions with Gary Stewart and Peter Hawes of Goldridge Limited, a nationwide financial planning company. In keeping with our commitment to provide topics of interest and value in our newsletter, Gary and Peter will be running a series of articles on investment matters. So look out for these articles in the future; if you need assistance now, or want to learn more, contact us and we will refer the issues to them.