Focus on companies
Forming a company – as opposed to being a sole trader or joining a partnership – makes your business a separate legal entity and provides you and other shareholders with limited liability for the business’s debts.
This legal arrangement can make your business more attractive to investors and more credible to your clients, but it requires more diligence and transparency on your part to make sure you meet your tax and reporting obligations.
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A company is defined as a business that is a separate legal entity from the people who have a financial interest in the business, who are known as shareholders and are taxed separately from the company on the income they receive from it.
This is different from sole traders, who are considered – in legal terms – to be their businesses.
There are two types of companies: private and public. Private companies have their shares owned within a private group, like a family for example, so they can retain control. Public companies have their shares publicly listed on the stock exchange so they’re available to be bought by the general public and other companies.
Regardless of whether it’s a private or public company, shareholders have what is called limited liability. This means they can lose the value of their shares in the business, but that’s all. They’re not responsible for any other debts or liabilities the company owes.
As the company is a separate entity, it owns all the assets and all the liabilities itself. This separation also means the company is not tied to one individual or one generation of owners, so it can last for as long as it remains viable.
To form a company, the business has to be incorporated with the Companies Office, the company registrar for New Zealand. This registry is a public record of the directors and shareholders of every company in the country.
Find out more with the Companies Office.
Profits from a company are distributed to shareholders, who are then taxed individually on their overall personal income.
Shareholders can choose to pay tax on their income from the company in the following ways.
- Give themselves a salary or wage and either pay PAYE and/or provisional tax to Inland Revenue (as a shareholder and an employee, it is not necessary to deduct PAYE although some “shareholder-employees” will choose to be taxed in this way rather than pay provisional tax). Any salary paid to shareholders should generally be at a fair market rate.
- Receive dividends from the company from the profits left over after tax. The dividends are taxed at the shareholders’ tax rates, with a credit allowed to the shareholder for tax already paid by the company on the profits.
Any profits the shareholders don’t take are the company’s and are taxed at the company tax rate, which is currently set at 28 cents out of every dollar.
If the company makes losses, the losses are retained by the company and they cannot be offset against the shareholders’ other income for tax purposes.
Companies that meet certain requirements (eg five or fewer shareholders) can make an election with Inland Revenue to become a “look through company”. This means they will be taxed like sole traders or partnerships, so tax is paid by the shareholders on the company profits at the shareholders’ tax rates. Any losses can be allocated to shareholders to reduce their overall tax liability or the LTC can carry them forward.
Find out more with Inland Revenue.
Find out more about the Tax implications for different business structures.
- Many business owners incorporate their businesses because it can add credibility in the eyes of clients, consumers and other businesses. Having limited liability status also makes a company a safer bet for investors.
- Business owners sometimes first reserve their business name on the company register before incorporating it as a company. Prospective company names must not be similar or the same as existing company names and must not use offensive or prohibited words.
- Incorporating a company with the Companies Office does incur fees, but they are not excessive. Reserving a company name, for example, only costs $10.22, while registering a company costs $150.00.
- A shareholder who is also a director can still be made liable for company debts greater than the value of their shares in court if he or she is deemed to have acted recklessly while in charge. Banks and other lenders also regularly include clauses in their contracts that cancel out shareholders’ limited liability in return for funds.
Find out more about Starting a business.
Always consult an accountant before incorporating your business as a company.