When choosing the right business structure, several factors come into play. Here are some key considerations:
- Type of Business: Consider the nature of your business.
- Income Expectations: Think about how much income you anticipate earning.
- Income Sources: Identify where your income comes from, be it individual customers, other businesses, or government agencies.
- Partnerships: Decide if you plan to collaborate with someone else in running the business.
- Financial Needs: Assess if significant costs require loans or external investment.
- Assets and Debts: Take stock of the assets and debts of the business.
- Future Plans: Consider your long-term plans for the business.
Company vs Sole Trader
One of the most common questions we get asked is “should I trade as a company or sole trader?”
Trading as a sole trader is the simplest option. It is easy to setup, there are no ongoing registration fees, and you have complete control over the business. All the business income and assets belong to you as an individual and the responsibility for all business expenses and obligations (including tax) also rest solely with you.
While the sole trader option is simpler, if you’re planning on selling the business down the track or applying for loans and/or investment then a company is often seen as more credible than a sole trader. One of the other main benefits of trading through a company is that your own liability for company debts is limited to any business loans that were personally guaranteed.
Setting up a company is more of a process than continuing as a sole trader. You must incorporate the company with the Companies Office and register with IRD. Returns must also be filed with the Companies Office annually, and all of this incurs a fee.
Once set up, the company is considered a separate legal entity to you even if you own all the shares, so it can help to think of it as a person itself. The company will have its own IRD number and be required to pay tax on any profits that aren’t distributed to you as a shareholder.
Depending on the size of your business there may also be tax benefits with trading as a company. Company profits (income less expenses) are taxed at a flat rate of 28%. While sole trader profits are taxed at the individual income tax rates which increase as income increases. Currently any income received by an individual over $48,000 is taxed at, at least 30%.
However, if you are expecting the business to incur losses (when expenses are more than income), it may be more beneficial to continue as a sole trader since you will be able to offset those business losses against any other income incurred (e.g. wages, benefits, interest etc). Company losses must be carried forward and offset against future profits.
As you can see there is no one answer fits all. The upside of trading as a sole trader is that you can always set up a Company later if required. Once a company is setup though, it isn’t so easy to close, even if you stop trading there is a process to follow to deregister the company which unfortunately means additional time and costs, so always be sure before forming a company.
Partnerships
Another common structure to consider trading though if you are running the business with at least one other person is a partnership. With partnerships all business profits are split between the partners either equally or in some other split as set out in the partnership agreement. The partners then pay tax on their share at their individual income tax rates.
Benefits of trading through a partnership include sharing the load of running the business and being able to offset any losses (where expenses exceed income) against any other income earned. But unless the partnership has limited liability, partners are personally liable for the business debts.
Partnerships can work well for rental properties owned by couples who want to split the income and for professionals and freelancers who are in business together. However, problems can come up when partners disagree on business decisions so as with company’s always be sure before forming a partnership.
If you're uncertain about the right structure for your business, feel free to get in touch with us for personalised advice.
