Why You Should Always Have Your Accountant Incorporate Companies For You (SERIOUSLY)

You know that tax your company paid last year, and the year before last, and the year before that….?

That is an asset in the form of TAX PAID.

OR

You’ve got a second company that you are using to test out a new business idea. The company has been making losses. THOSE LOSSES HAVE VALUE.

Value in the form of reduced taxes. If the company has losses of $100k, there’s a tax value there of at least $28k.

You don’t want to lose all this value.

BUT, I see this happen all too often.

People incorporate companies without a clue about what they could be jeopardizing. The same goes for shareholding changes.

But, why? It doesn’t make any sense that I could be losing value by simply incorporating a company or changing the shareholding?

You see, New Zealand has a number of tax laws that are designed to discourage the wrong behavior. For example, selling tax losses to someone so that they can minimize their taxes. Or, selling shares in a company so the buyer can have access to imputation credits so their shareholders pay less tax on dividend income.

If done correctly, those losses I was talking about earlier can be offset against your main business’ income, and you end up paying less tax.

Say you invested $100k into that startup venture (the $100k goes into tax-deductible company expenditure) and the tax benefit of the $100k loss is $28k. That means you actually only invested $72k because you will receive the $28k in the form of a tax credit. See?

How can I screw this up?

There’s a little-known rule called continuity of shareholding. This must be maintained at 49% throughout the financial year(s) the loss was incurred.

For instance, if you own 100% of a company's shares on day 1, and then you sell 52% of your shares down the line so you’re left with a 48% shareholding, you have now lost all the $28k tax loss value. Gone.

If, however, you only sold 51%, then you would be fine.

Now, this is getting a bit technical, so if you’ve made it this far that’s excellent. Now we are going to get even more technical….😁

That tax that I mentioned earlier that your company has already paid on prior year earnings, tell me Ryan, how is that an asset?

Well, it’s an asset because of a piece of law called anti-double-taxation. The theory behind this is as the name suggests. If a company pays tax on the income it’s earned, then the shareholders who receive that income should not be taxed as well.

So, for example, your company has earned $200k in profits over the past two years and as a result, has paid $56k in tax (28% x $200k). You now wish to access those earnings. The company must issue and pay a dividend. The $200k is paid to you as a dividend which is taxed in your hands, and walking alongside that $200k income, is the $56k in imputation credits. These are tax credits.

Now, as with losses, shareholder continuity must be maintained in order to retain these imputation credits. The bar is set higher though, at 66%.

Let’s run you through the tax implications.

The tax on your $200k dividend is $58k. However, because the company has imputation credits, the tax you must pay is only $2k.

If however, during the year you changed the companies shareholding by more than 34%, your tax cost would be the whole $58k. So the ultimate tax cost of not doing things right ends up being $114k!!! ($56k paid by the company + $58k paid by you).

The consequences of getting things wrong are REAL.