Bailey Ingham's Directors and qualified staff have a great deal of experience advising clients. This includes looking at prospective business and farm purchases, cash flow forecasting and budgets, giving advice on employment and related matters as well as giving advice on business structures.
Alternative Ownership Structures
There are many factors to consider when deciding which structure to use when going into business. These factors include the nature, size and complexity of the venture, the level of risk and need for creditor protection, tax effectiveness and flexibility requirements amongst others. The following article briefly outlines the main forms of business structures available, with farming as the main focus. This article is intended as a guide only and professional advice should be obtained specific to your individual requirements.
The most common business structures are as follows:
This is the simplest operating structure available. It is not necessary to register a business name and there are no particular legal formalities. A sole trader just needs to keep proper business records, file appropriate tax and other IRD returns and conduct business in a lawful manner. The disadvantage of this structure is that a sole trader has unlimited personal liability for claims, such as negligence and for business debts. Should the business get into financial difficulties, the owner may have to sell personal assets (such as their home), to pay off business debts.
A partnership involves two or more persons owning and operating the business. This structure too is inexpensive, quick and easy to set up, and with a partnership, more assets and expertise can be pooled in running the business. Partnerships are governed by the Partnership Act 1908 and although a written partnership agreement covering the administration and operation of the business is not essential it is advisable. Partners are taxed individually on their share of partnership income. The main disadvantage is that each partner has unlimited liability for the partnership debts and for any fraudulent or negligent activities of the other partners. Also any unresolved disagreement between the partners can, and often does, lead to dissolution of the partnership.
Companies have significant advantages over a partnership. A company is a separate legal entity and is governed by the Companies Act 1993. A company may have one shareholder and director, although there is usually more than one of each. Once incorporated it is the company that is responsible for the business debts and obligations, not the shareholders. Their liability is limited to the amount payable for their shares. Directors can be liable however for breaches of the Companies Act, such as trading recklessly or knowingly trading while insolvent.
Companies are ideal structures for ownership of large syndicate type farms where there are multiple owners. Transferring ownership can be as simple as selling all or some of the shares. Continuity of the business and goodwill can be maintained in this way.
Although a company structure confers limited liability in principle, this is often not the case in reality because the shareholders are often asked to give personal guarantees to major creditors and banks for their company’s obligations. A disadvantage of using a company is the on going administration and annual reporting requirements.
Almost without exception, any new farming property bought today in a farming situation should be purchased through a family trust, or purchased with a trust holding the shares in a farming company or Limited Partnership. There is also a substantial increase in the use of trading trusts to carry out farming operations. A trust has numerous advantages, namely protection of family assets, the ability to pass on assets to future generations, ease of estate administration and asset management, and the ability to ‘spread’ income amongst family members (which can be a significant tax advantage). The only real downside to using a trust is loss of ownership of the assets and the extra set up and compliance costs. Control of the assets can be retained however, by being a trustee of the trust, having the power to appoint and remove other trustees. Also future law changes could potentially cancel out some of the tax advantages of trusts.
This leads to the very important topic of taxation. Getting the structure of your business right will undoubtedly lead to tax savings, particularly if you can use a family trust and spread income to beneficiaries. The IRD however have significant power to challenge business arrangements where the principal objective is to avoid tax. Attribution Rules can apply on income that would otherwise be taxed at 33%, which has been diverted through a trust or company. In addition children under 16 who are allocated income from a family trust are taxed at the trustees rate of 33 cents in the dollar.
A look-through company (LTC) is a tax structure with limited liability which allows the company to transfer its income and expenditure to its shareholders directly. The LTC has replaced the previously popular loss attributing qualifying company (LAQC) and is a simpler alternative to a limited partnership, however this new structure differs from the LAQC in a number of areas.
A look-through company is the same as the traditional limited liability company established in accordance with the New Zealand Companies Act 1993. However, the laws differ regarding the taxation of the companies income. The LTC is unlike a typical company in that the income and expenditure of the company are expressly in the hands of the shareholders. In fiscals terms this creates a transparent mechanism that is identical to the New Zealand limited liability partnership. In contrast to the former rules regarding LAQC’s, LTC shareholders have an obligation to pay taxes on the profit of the company personally, as well as being able to claim losses generated by the company against their income for tax purposes.
- An LTC is a legal entity which operates under the usual rules of management and operation of companies of limited liability.
- In the realm of taxation an LTC is more transparent and the owners of an LTC will be considered the owners of the company’s assets in order to calculate income tax.
- Income, expenses, tax credits, deductions, gains and losses of the company are transferred to its owners in proportion to their share of the company.
Limited partnerships have a number of features that are desirable for certain investors. Key features of a New Zealand limited partnership include:
- They can be used for almost any purpose and are particularly suited for investment funds.
- Separate legal personality.
- Tax treatment of the limited partners. A limited partners profit or loss is ‘flow through’.
- Details of the limited partners and partnership agreement are confidential.
- Limited liability for the limited partners.
A limited partnership is often useful for projects that are high risk, capital intensive and/or with overseas investors. Investment may be in any form including cash and property and on the terms provided for in the written partnership agreement.
A limited partnership has a general partner who is responsible for the day to day management of the limited partnership and is liable for all the debts and liabilities of the limited partnership. It is common to see the general partner appointed to the limited partnership as a limited liability company in order to contain this risk.
Limited partners do not take part in the management of the business and the liability of the limited partners is limited to the capital contributions made to the limited partnership. A limited partnership is governed by the Limited Partnerships Act 2008 and the terms of the written partnership agreement entered into by the partners.
A combination of structures can be used in the ownership of one family business, and this is often the best method. For example a farm can be purchased by a family trust, the trust then leases the farm to another entity (partnership, sole trader or company), which carries on the farming activities. A sole trader or persons in a partnership can protect against losses or claims such as negligence by transferring their assets (such as their home and investments) to a family trust. In this way a single person or married couple can still take advantage of the simplicity of being a sole trader or partnership (such as in a contract or sharemilking situation), whilst having protection of their personal assets. There are other ownership structures available, such as joint ventures, which may also be worth considering.
Which structure suits will depend on a range of circumstances. It is essential that good accounting and legal advice is obtained before entering into a business venture, as each situation is different.