Chartered Accountants and Advisors Tauranga New Zealand Walton Railton & Co

In November 2007 Mohammad Wasim received a prison sentence of 5 years nine months for his role in what the Inland Revenue called the biggest horticultural industry tax fraud they had ever prosecuted. The scheme, carried out between 1 April 2004 and 31 October 2006, involved contractors evading their tax liabilities by claiming they subcontracted work to another company or having another company issue an invoice for work completed by their employees.

The horticultural industry has been the subject of considerable IRD scrutiny due to it historically being an easy target for tax evasion. The Withholding Payment Regulations (WPR) currently require tax to be deducted from payments made to fruit pickers (individuals and companies). However, prior to 1 April 2006 if these services were carried out by a company for an orchard owner, withholding tax did not have to be deducted. Due to this exemption, companies were setup to carry out the work, with no withholding tax being deducted from the income earned. The individuals who set up the companies simply walked away without the tax being paid. From 1 April 2006 the rules were changed specifically to counter this scenario. Withholding tax is now required to be deducted from payments to companies that carry out work of this nature.

The problem with the WPR is that they can be confusing, as they appear to overlap the PAYE rules. This makes it hard to distinguish whether a WPR tax code or a generic PAYE tax code should be used. The mechanism used by an employee to select the correct tax code is the Inland Revenue form, IR330. The form itself requires a WPR rate (withholding tax rate) to be used if a person is operating under a “contract for service” and “not for salary or wages”, but the form does not explain the distinction. The basis for the distinction lies in the difference between how employees are taxed versus the self employed. A person employed under a “contract of service” is an employee and their income is taxed through the withholding of PAYE by their employer. The self employed on the other hand are employed under a “contract for service” and are responsible for meeting their own tax obligations as they are required to calculate their income and expenses and file an income tax return.

Whether a WPR rate or a generic PAYE rate applies will depend on the circumstances under which the person is to work. The WPR are not relevant if a person is an employee, i.e. the person is employed under a “contract of service”.

Indications that a person is an employee include an entitlement to annual and sick leave, having set working hours, no financial risk, and having a high level of control by their “employer”. If a person is an employee and therefore is receiving a salary or a wage, the WPR do not apply and the generic PAYE rates are followed. If a person is self-employed the WPR apply and withholding tax must be deducted at the rate of 20%.

The common cry from employers today is that finding good staff is getting harder. Therefore it would make sense that when new employees are signed up that their ‘first impression’ when joining the organisation is a positive, memorable experience that sets the scene for a long and productive working relationship.

A 2006 survey by the United Kingdom human resources firm Reed Consulting found that 93% of 5,700 UK employees surveyed believed that poor induction processes had an adverse effect on their productivity at work. Four percent of respondents also indicated that a poor or non-existent induction programme had directly affected their decision to leave a new job.

So what should employers include in a good induction programme?

To start with, a good induction programme needs to be well planned and executed. What information is important for the employee to receive on the first day? What can wait? Writing down a formal programme with dates and times for meetings with particular people and information sessions on particular topics will help ensure a smooth induction process.

It can often be at least one month from accepting a position until the employee starts work. A friendly welcoming letter closer to the start date, detailing what time to arrive, where to park, who to ask for, what to bring and what the employee can expect on their first day is a good way to help set the scene for working at a new organisation. It always makes a good impression on an employee’s first day to find that their office space is nicely set out and that their computer, email and telephone are all organised. The new employee should be made to feel that they are a priority. Meetings with key staff members should be pre-organised and times kept to. Meetings should be spaced over a period of time to give the employee time to digest the information that they will be receiving from a variety of sources.

Elements of the induction programme should include:

meetings with relevant staff, suppliers and customers
full health and safety briefing
outline of initial training organised for the employee
what guidance the employee can expect during the first six months of employment
setting of initial performance goals
explanation of and access to the organisation’s policies and procedures
expectations on attendance and breaks
information on any employee benefit schemes.

Remember that induction is a process, not an event. It takes time for employees to integrate into their new working environment. A good induction process will ensure new employees adapt quickly to the organisation, feel they belong to the organisation, and that they have become productive contributors.

There are about 325,000 small to medium sized enterprises (SMEs) in New Zealand. That’s over 96 per cent of the country’s total number of businesses.

The average age of business owners in New Zealand is 58 years old. Forty per cent of them plan to sell their business in the next five years. That’s about 130,000 businesses on the block during that period. Most of them won’t stand up to a great deal of scrutiny. However some could be potential gold mines for the right purchaser.

So what are the options for small business owners who want to fund their retirement by exiting their business?

To be frank, there are not many. They include:

prepare it for sale to another business or would-be business owner,
transfer it to the next generation of the family,
sell it to the employees of the company,
liquidate the assets of the business, or
sell the shares to the public.

A lot of small business owners hope to have a family member take over on their retirement. In practice we find that children increasingly have no interest in taking over the family business.

The key to planning for succession is to grow the business so that it is less dependent on the owner and more attractive for sale.

For buyers there are a number of considerations.

It is important to have a good understanding of what you are buying. This can only be determined by adhering to a properly structured due diligence process. Due diligence is a term for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care.

External advisors can help to make sure that the process is not hijacked by a desire to complete the purchase.

Small businesses often depend on the owner’s commitment, contacts and history. The challenge the purchaser faces is to make sure the goodwill they have paid for sticks to the business in the future.

Businesses looking for new acquisition opportunities should look for potential acquisitions closely aligned to their core competencies and to which they can add value following the purchase. Follow the old maxim – “stick to your knitting”. Once they have selected the target they should follow the right process. That means putting the right team together to work through the due diligence process.

Trends of market convergence, the age of many business owners and difficult market conditions mean that many businesses will be on the market over the next five years.

For prospective business owners, who follow the right process, there will be some nuggets out there.

The Government recently sought submissions on a range of options that were put forward to reduce compliance costs for small to medium sized entities. The options were outlined in a Discussion Document (published in December 2007) and are intended to benefit small to medium sized entities (SMEs) because these entities tend to disproportionately bear the brunt of high tax compliance costs.

Amendments that will effect the changes will apply from either 1 April 2009 or 1 April 2010, depending on the complexity of the specific change.

The proposed options will be considered and chosen based on a number of different factors, including the level of compliance cost saving, fiscal cost and unintended or undesirable effects.

Threshold Changes

Some of these options only raise monetary thresholds, to reduce the numbers of SMEs having to comply. Threshold changes include:

where the PAYE paid in the previous year is $100,000 or less, an employer can file their PAYE returns monthly and FBT returns annually; this threshold may be raised to $250,000
raising the residual income tax threshold from $35,000 to $50,000 for individuals to avoid interest charges on provisional tax underpayments
increasing the compulsory GST registration threshold from $40,000 to $50,000
increasing the turnover threshold for 6 monthly GST filing from $250,000 to $500,000
increasing the low value trading stock threshold from $5,000 to $10,000.

Introduction of new thresholds are also being considered:

legal fees up to $10,000 per year to automatically be deductible
non-deductible entertainment expenses would not have to be recognised where total entertainment expenses are less than a particular amount (e.g. $2,500 – $10,000).

These threshold changes should provide some relief for SMEs.

Fringe Benefit Tax (FBT) Changes

The FBT rules are often an area where the compliance cost is relatively high compared to the tax paid, particularly in the case of motor vehicles. Currently, types of vehicles that qualify as “work-related vehicles” are not subject to FBT if the private use of the vehicle is restricted to “home-to-work” travel and “incidental” private use. It has been proposed that the “work-related vehicle” concession be phased out and a “restricted private use” category be introduced. Basically, this category would apply to all types of vehicles; however if the private use of a vehicle is within limits yet to be specified, the FBT value would be 10% of the vehicle’s cost or 18% of the vehicle’s book value (depending on the method used), as opposed to the current 20% or 36%, respectively. This change could be a double edged sword for “work-related vehicles”. On the one hand this will eliminate the need to determine if a vehicle qualifies as a “work-related vehicle”. But on the other hand as “work-related vehicles” that are still under the current rules are replaced, new “work-related vehicles” could be subject to FBT, although at a reduced rate. This change may lead to the Government deriving more FBT from vehicles overall.

Miscellaneous Changes

As is the norm in Discussion Documents of this nature the opportunity is generally taken to tweak or fine-tune existing rules.

Further miscellaneous proposals include:

relaxing various provisions relating to GST invoices to reduce their prescriptive nature, e.g. removing the need to state the quantity or volume of the goods supplied
the option to correct errors in a subsequent return, where the error involves less than $500 of tax
tweaking of the rules relating to the GST ratio method for paying provisional tax
a reduction in the period of time tax records must be retained
allowing businesses to assume in certain circumstances, that contractors subject to the withholding payments regulations hold certificates of exemption.

The Government has also used the Discussion Document process as an opportunity to request feedback on the low use of the PAYE intermediaries’ subsidy as well as information sharing between Government departments to reduce instances where businesses provide the same information more than once.

It will be interesting to see what changes come out of the process; it is expected that some of the proposals will be introduced in the May 2008 Budget.

Student Loan Repayment Threshold

From 1 April 2008 the student loan repayment threshold will rise from $17,784 to $18,148.

Tax Legislation Enacted

The second major piece of tax legislation introduced in the 2007 Budget finally received Royal Assent in December 2007. The passing of the legislation introduces various changes, some of which received considerable attention by the media at the time of the Budget.

Key amendments include:

the introduction of employer and employee KiwiSaver tax credits and the requirement for employers to contribute to an employee’s KiwiSaver scheme
the introduction of tax credits for research and development
measures to enable a smooth transition to a 30% company tax rate.

Inland Revenue Alerts

The Inland Revenue (IRD) has launched what it has called an early warning system for tax professionals. The service is intended to highlight significant or emerging areas of concern that have been identified by the IRD. This could involve a scheme, arrangement or particular transaction. By fully informing tax professionals of these issues, the IRD hopes that voluntary compliance will improve as taxpayers become aware of what the IRD considers risky.

Most recently the Revenue Alert Service has been used to express the IRD’s concern over “the family home” being sold to a Loss Attributing Qualifying Company (LAQC), which then rents it back to the family, thus “allowing” what were non-deductible personal expenses to be claimed for tax purposes. Depending on the specific facts, the IRD may consider this tax avoidance.

End of Tax Year Approaching

For most taxpayers, the end of another financial year is approaching – 31 March, 2008.

Client Questionnaires will soon be arriving in the mail for you to complete. Although they may seem quite daunting, it greatly assists with the processing of your Accounts, if you fill in as much as you can. If you are unsure about anything on the forms, please give us a call.

Other matters to consider before 31.03.2008:

Bad Debts

If you have any Debtors which you are unlikely to collect, these must be physically written off before 31.03.2008 to make a claim for the loss. This does not prevent you from continuing to pursue the debtor. Note: if you are on the Invoice basis for GST, you will need to complete a GST adjustment for Bad Debts.

Stock

Review your stock, and identify any old or obsolete stock. Consider having a sale to clear this old stock. Put procedures in place to carry out a stock take on 31.03.2008.

Creditors

Review all invoices incurred during March, 2008, but not paid until after March, and ensure they are included in your Creditors schedule.

Annual Leave/Bonuses

Accrued annual leave/bonuses taken or paid within 63 days of balance date can be claimed as an expense in your annual accounts to 31 March, 2008. If you have staff that have accumulated annual leave, you may want to consider that they take some leave over the 63 day period after 31 March.

Computer Back Up

This is something that cannot be overlooked. It is critical that a good back up is completed at 31 March, 2008. TAKE TWO BACK UPS - one for your Accountant and one for your safekeeping. Print hard copies of Bank Reconciliations, Debtors, Creditors, and Stock ledgers as at 31 March.

Imputation Credit Accounts

For Companies, you should be reviewing your ICA account balances to ensure they are in credit, but also to consider declaring dividends to utilise ICA credits at 33% with the impending reduction in company tax rates to 30%.

Provisional Tax and GST

From 1st April, 2008, major changes to Provisional Tax and GST payments come into force.

GST Ratio Option

Prior to 31 March, 2008, you may elect to pay your Provisional Tax at the same time as you pay your GST based on a ratio determined by Inland Revenue. A formal election must be made to Inland Revenue before year end. This option is not available to all taxpayers ie partners in a partnership. It is only available to the registered GST entity, which must also be a Provisional Taxpayer. Taxpayers must meet certain criteria for the preceding tax year:

Residual Income Tax was more than $2,500 but less than $150,000
Must be registered for GST for the whole tax year, and the operation must not have commenced in that year
The ratio calculated must be between 0% to 100%.

Provisional Tax Payments

Alignment of provisional tax dates to GST dates will become mandatory for all provisional taxpayers from the beginning of the 2008/2009 tax year. From 1 April, 2007, the GST due date changed to the 28th of the month except for December which is due 15th January and April which is due 7th May.

6 Monthly GST Registrations

The GST Ratio option does not apply. Provisional tax will be paid in two instalments.

For a 31 March Balance Date this will be:

28 October
7 May

1 or 2 Monthly GST Registrations

The GST Ratio option is applicable if you meet the above criteria. Provisional Tax will be paid in three instalments which is linked to every second GST payment date for the non ratio option, or six instalments if the ratio option is elected.

For a 31 March Balance date, payments dates will be:

GST Ratio elected: Non Ratio option:

28 June
28 August
28 August

28 October
15 January
15 January

28 February
7 May
7 May

Non GST Registered Taxpayers

For a 31 March Balance date, payments will be:

28 August
15 January
7 May

We suspect all of the above is going to cause a huge amount of confusion – but we will work closely with you to, to inform you as early as possible when your new Provisional Tax date falls due.

Kiwisaver – Employer Contributions

Just to add to the changes occurring on 1st April, 2008, Employers will commence contributing 1% to Kiwisaver Accounts for employees who are registered in the Kiwisaver Scheme. Employers will however receive a maximum $20.00 credit from the Government, for each employee. This credit will be deducted from the PAYE payment due to Inland Revenue each month.

TRIPLEJUMP - Managing Key Person Risk

At least 40% of all small businesses have a critical dependence on a key person for ongoing business and balance sheet solvency. Is your business one of the 40% and if so, do you have a risk management plan in place to protect your business against key person risk?

Key Person Protection is a planned response to assist a business to maintain its financial commitments when a key person unexpectedly dies or is seriously incapacitated. It is designed to minimise the likelihood of insolvency and to protect the value of the business.

In last months article I highlighted the statistical risk of premature death. The statistics for disability is more significant than most of us realise. Out of 415,000 males in New Zealand between the ages of 30 and 45, 12 out of every 100 will experience at least one period of disablement lasting six months or longer. A further 8 out of every 100 will be disabled for at least one period lasting 12 months or longer.

The statistics for women are even higher. From a group of 433,000 females aged between 30 and 45, 18 out of every 100 will experience at least one period of disablement lasting longer than six months and 12 out every 100 will be disabled for 12 months or longer.

The downstream effects of key person loss are often predictable and to a reasonable extent measurable ahead of an event.

The most obvious short-term effects (within two to six months) is a loss of revenue. If the key person is directly responsible for generating revenue and cannot be replaced immediately with someone who can maintain your relationship with customers and clients, income will start to decline. In many small businesses it is the effort of one or two people, which keeps a business above the solvency line. If your revenue is declining you may not be in a position to meet the financial obligations of the business. Inability to service debt obligations, over which you have personal guarantees, will put both your business and personal assets at risk.

The loss of a key person will often give rise to an immediate increase in costs due to the need to recruit and train a replacement (if it is a viable option). Typically, the direct costs will be 15% - 20% of the salary. Many small businesses do not have cash reserves aside to meet these unexpected contingencies.

If the key person has the main relationship with customers, suppliers and creditors you will need to consider:

If your customers will want to do business with the replacement
Can someone be found with the necessary skills?
Will your creditors give you the same terms of trade and will pressure come to bear on credit facilities.

Consideration of these issues will assist you to determine if your business will be able to trade on despite the loss of the key person or whether you would be best to plan to wind the business up. If you judge it is not viable to trade on, your Key Person Protection strategy will need to ensure there are sufficient funds available to pay creditors, clear all debts thereby releasing personal guarantees and meet the wind up costs. This enables you to walk away without placing your personal assets at risk, or being forced into bankruptcy or insolvency.

If you believe it is possible to transfer the relationship and skills to another person, trading on may be a viable option. However, you need to plan to have funds available to:

Cover short term loss of revenue
Meet recruitment and training costs
Reduce debts to ease pressure on the cashflow.

In a perfect world all businesses would have a succession strategy in place to reduce their dependency on a key person. However, this is not always possible and if it is, it may take years to develop. As a business owner you therefore need to put in place contingency planning for the worst-case scenario for your present situation.

Key Person Protection insurance provides a business with funds to manage the financial risk arising from death or disablement of a key person. The appropriate type and level of cover should be assessed for your business based on your unique needs. Structured correctly, it will minimise both your business and personal risk and give you the greatest chance of surviving a crisis in a timely and orderly manner.

“Think of the worst thing possible that can happen & believe it could happen & and protect yourself against it.”

Philip Holland is the Senior Risk Consultant of Triplejump Tauranga, a nationwide franchise specialising in Business Risk for SMES and Personal Risk. Visit www.triplejump.co.nz for further information. If you would like a review of your key person risks please phone Philip 07 577 0330.

If you have any questions about the newsletter items, please contact us, we’re here to help

All information in this newsletter is to the best of the authors' knowledge true and accurate. No liability is assumed by the authors, or publishers, for any losses suffered by any person relying directly or indirectly upon this newsletter. It is recommended that clients should consult a senior representative of the firm before acting upon this information.