Understanding business structures

Starting a business in New Zealand can be quite straightforward. If you woke up tomorrow and started a business on your own, you’d automatically be a sole trader. If you joined forces with a partner to pool your assets, you’d most likely be in a partnership.

Starting a company requires the incorporation of your business with the Companies Office, but even then the process, which can be carried out online, is less complicated than most people expect.

Starting a trust involves setting up and signing a trust deed.

On this page:

• Sole traders
• Partnerships
• Companies
• Trusts

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Sole traders

If you’re in business on your own, you’re a sole trader. You register with  Inland Revenue to become an employer or a GST-registered business. But apart from that, you’re free to start your business without going through any extra paperwork with the government.

It’s so simple because you and your business are considered the same legal entity. This means you control the business in its entirety, you keep all the profits, you’re liable for all the debts and your business activities only register with Inland Revenue through your personal  IRD number.

The key thing to remember when operating as a sole trader is to keep thorough records. You effectively pay yourself a wage by making drawings from your profits for personal use – so always make sure your cashbook clearly separates these from your tax-deductible business expenses.

Pros:

• Easy to set up.
• Owner has total control.
• Profits go directly to the owner.
• Offers the simplest tax obligations.
• If losses are made, they can be offset against your other income.

Cons:

• Unlimited liability – the owner is personally responsible for all debts, putting their personal assets at risk.
• The business structure doesn’t easily allow for growth.
• Can be harder to attract loans or investment due to unlimited liability.
• Can be harder to sell as a going concern.

Find out more with our Focus on sole traders.

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Partnerships

A partnership is a group who’ve chosen to work together. You might want to do this to increase the services your business offers or to share resources.

The collective profit is shared out – typically according to a private legal document known as a partnership agreement or a deed of partnership – before each partner is taxed on his or her individual income. If one of the partners leaves, then in some circumstances the partnership is dissolved before another agreement involving the remaining partners is drawn up to form a new partnership.

Pros:

• Shared responsibility.
• Shared costs.
• Partners can specialise and focus on strengths.
• Partners bring in more capital investment.
• There is someone else to consult on business decisions.
• If losses are made, they can be offset against your other income.

Cons:

• Each partner has unlimited liability, putting their personal assets at risk.
• There is joint and several liability – so a partner can end up paying not only their share of the business’s debts, but their partners’ (if all other partners are insolvent or unaccounted for).
• Shared responsibility can lead to disagreements.

It is possible for some partners to achieve limited liability through the use of a limited partnership.

Find out more with our Focus on partnerships.

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Companies

A business isn’t a company unless it’s registered with the Companies Office, which manages the public registry of companies in New Zealand.

This transparency is important, because unlike a sole trader or a partnership, the company itself operates as a separate legal entity to its shareholders. It owns all the assets and liabilities, whereas a sole trader would own them directly.

This defining feature of companies is called limited liability and is designed to give shareholders in the company protection from having to shoulder more than their fair share of debt. In other words, they can only lose the value of their shares.

However, if you’re involved in the running of the business as a director, you can be held liable for debts if your conduct is deemed to have been reckless, fraudulent or not in the company’s best interests. Lenders will also often only lend you capital once you’ve signed a personal guarantee over-riding your limited liability status.

This limited liability protection and the transparency of the company registry system (which allows anyone to see who’s involved with a company as a shareholder or director) foster greater confidence in this type of business structure compared with others.

Companies are taxed at the company tax rate – which is currently 28 cents in every dollar – while the profits received from companies by shareholders (usually as a dividend) are taxed as part of their individual income. This means tax will ultimately be paid on company profits at the shareholders’ tax rates, even though the company rate is 28%.

Find out more with the Companies Office.

Pros:

• Easier to attract funding and investment.
• More credibility in the marketplace.
• Easier to sell the business because it’s a separate entity.
• The business can grow and last indefinitely because it isn’t tied to one person.
• Shareholders’ liability is usually limited to their share of ownership.
• Tax rate is lower than the top personal rate and the trust rate.

Cons:

• Higher levels of regulation compared with sole trader and partnership structures.
• Can require larger amounts of investment.
• Directors need to carefully understand their responsibilities.

If losses are made, they are retained by the company so they can’t ordinarily be offset against the shareholders’ other income for tax purposes.

It is possible to tax some companies more like a sole trader or partnership by making an election with Inland Revenue for it to become a “look through company” (LTC).

Find out more about LTCs with Inland Revenue.

Find out more with our Focus on companies.

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Trusts

Alongside the three core business structures, businesses can also be run as trading trusts.

The trustees of a standard private trust are individuals, usually holding wealth or property on behalf of a beneficiary until they are ready to claim it. However, the only trustee of a trading trust is a limited liability company. The directors of that company then effectively act as the trustees while they trade.

Trusts are most commonly used for owning private assets (like the family home) or investments rather than for running businesses. This is because they are most useful for asset protection and estate planning, although there can be some tax benefits as well.

Running a business as a trust is one of the most complicated operating structures you can opt for, but many businesspeople choose it because it fits best with their personal situation. If you want to go down this road, you should consult your lawyer and accountant first.

Find out more about trading trusts with Inland Revenue.

Find out about the Tax implications for different business structures.