Is NZ Company Tax Really 28%?

Posted on Tuesday, March 19 2013

New Zealand Company Tax Rate – Is It Really Attractive?

 

From 1 April 2011, the company tax rate in NZ has been 28%. At the same time, the personal tax rate for income from $48,000 has been 30% and from $70,000 has been 33%. So, with an apparent 2%- 5% tax saving, why wouldn’t you just allocate yourself $48,000 and leave all remaining profit in your company to reduce your tax?

Do you have the option of paying tax at the company tax rate?

Attribution Rules

Generally, if 80% of your company income comes from one source, then all profit must be allocated to you personally. This applies to most contractors who operate through a company as an example.

Market Salary

The IRD recently won a tax case at the Supreme Court so it can now be considered tax avoidance if you don’t allocate yourself a market salary.

However, this guide is intended as a reference for those small businesses that operate through a company where the attribution rules do not apply and where, after allocating a market salary, there is still sufficient profit to leave in the company if you chose to do so.

In these situations, there are still a number of reasons why I prefer small businesses operating under a company to allocate all of the profit to you personally as a shareholders salary as opposed to leaving any in the company and paying the lower tax rate of 28%.

The 28% company tax rate is only a temporary advantage

By leaving profit in the company (called “retained earnings”), you can save yourself up to 5% tax on your profit initially. However, what most clients don’t take into account is that those retained earnings must be paid to you as a dividend at some point in the future. That point is where you actually withdraw the retained earnings as cash from the company or when the company is wound up. At that point, you will be paying the difference between your personal tax rate (often 33%) and the company tax rate (28%) at that later time. So, the 5% saving is simply paid in a later year.

Some people will say that delaying the payment of that 5% tax is great, and they would be correct as long as they were aware of the pending tax liability and planned for it. However, in my experience, I’ve seen many accountants that don’t make this delayed tax liability explicitly clear to clients. Those clients that are told about it, don’t fully understand it. Those that do understand it, forget about it within a few months.
So, the end result is that you get a shock down the track as that 5% tax liability compounds year after year and you end up with a large unexpected amount of tax to pay.

For example, let’s say your profit was $120,000. $70,000 is allocated to you personally as a shareholders salary leaving $50,000 profit in the company. The company would pay tax on that of $14,000 ($50,000 x 28%) and initially save tax of $2,500. Say this is repeated over the following 3 years as well. The company is then wound up, a dividend is paid and you then realise that you have a $10,000 tax liability at that time. Would you have planned for that payment or would it take you by surprise?

Maybe it’s just me, but I think paying the tax now so that you don’t have to worry about it in the future is the better way to go.

When should profit be left in the Company?

A common scenario is a rental property owning company that used to be a LAQC. As these companies will often have negative retained earnings, a dividend may never need to be declared so leaving profit in the company and paying tax at 28% might be the way to go.

The only other time I might recommend leaving any profit in a company is where you may be retiring in the coming years when your income will drop and your personal tax rate will drop as well. In that case, it can be worthwhile paying 28% company tax and then paying the retained earnings as a dividend when the you have retired and are only on a lower personal tax rate so that no 5% tax top up is required.

Companies pay the IRD Interest

Provisional tax paid by you or your company is based on your previous year’s earnings. If your income increases, then the provisional tax will often be underpaid. This is generally not an issue for individual taxpayers as interest will not apply. However, this is an issue for a company as interest will be charged by the IRD (current rate is 8.4%).

So, when leaving profits in the company, you need to be much more careful about increasing profits and the subsequent exposure to interest charged by the IRD.

Forward Planning Required to pay Withholding Tax

As there is only 28% company tax to attach to dividends, your company required by tax law to also deduct 5% withholding tax as well. So forward planning is required as the payment of the withholding tax for a dividend declared on 31 March must be paid by 20 April.

Reduction in your ACC

Ok, this is actually more of a benefit of leaving profit in a company. ACC levies are based on the salary allocated to you by your company. If you leave profit in your company, this will reduce the salary allocated to you and will therefore reduce the amount of ACC levies you’ll have to pay.

When the retained earnings are later paid to you by way of a dividend, no ACC levies will apply as a dividend is passive income and exempt from ACC.

On the downside, by lowering the amount of salary allocated to you by your company, that also lowers the amount that ACC would pay you in the event you could not work due to an injury as ACC generally pay 80% of your past salary allocated to you from the company.

The above guide is intended as a generally overview of the company tax rules. As always, it’s best to seek expert tax advice for your specific situation.

 

By Tony Thorne
www.ThorneAccounting.co.nz

Auckland Accountants About NZ Company Tax Rate

 

 

 

 

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Expert's Bio

Tony Thorne

Thorne Accounting has been providing specialised accounting and tax services to residential and commercial property investors since 2004. Our mission is to provide the highest quality tax and accounting services to property investors. We are constantly fine tuning the way we work with property investors so we can provide this superior service at competitive prices.

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