If you’re a business or self-employed you can choose the structure that best suits you. The most common are sole trader, partnership or company. Each offers varying degrees of control and responsibility.
In 2014, small businesses in New Zealand were:
- 53% companies
- 17% sole traders
- 13% partnerships
- 17% other
Choosing the right business structure
You can choose one of three most common structures for you or your business – sole trader, partnership or company.
Becoming a sole trader — someone who starts trading on their own — is the simplest way to start a business. It’s a common choice for self-employed people.
Advantages – Costs are low. It’s easy to run. You retain control of your work and profits.
Disadvantages – You’re responsible for all taxes and debts. It’s harder to get loans and investment. It’s harder to sell your business.
Staff – Being a sole trader doesn’t stop you from employing people. All you need to do is register as an employer with Inland Revenue.
What sole traders are accountable for – Unlike a company, a sole trader’s business isn’t a separate legal entity from its owner. You’re responsible for all work-related debts and liabilities. Your personal assets, such as the family home, could be at risk if you have work debts you can’t repay or an unsatisfied customer sues you.
GST – If your turnover — what you earned — was more than $60,000 in the last 12 months, or you expect your turnover to be more than $60,000 in the next 12 months, you must register for GST.
Income tax – Your net profit — what you earn after working expenses — is taxed at individual tax rates. While you’re working as a sole trader, you must file an IR3 income tax return at the end of each tax year. You may have to pay provisional tax in your second year.
In a partnership, two or more people run a business together and agree to share assets, liabilities and skills. They’re most common among professional people, eg lawyers and accountants, and in farming.
Advantages – Easy to start. Shared business operation costs, eg when several professionals operate out of a shared office.
Disadvantages – Partners can be liable for debts incurred by other partners. It can put individuals’ personal assets at risk. Complications may arise if one of you wants to leave the partnership, or dies.
A partnership is an unlimited liability business agreement between entities (the partners), rather than a business that’s a separate legal entity. All profits and losses, responsibilities and liabilities are shared according to the partnership agreement. A partnership must have its own IRD number, but partners pay their share of tax on profits under their own IRD numbers.
Each partner can draw funds from business profits as they need them for personal use, just like a sole trader. The partnership agreement might put restrictions on this. All income, expenses, tax credits, rebates, gains and losses are accredited to each partner in proportion to their share of the business, as set out in the partnership agreement. Partners can take a salary and have PAYE deducted from their pay like an employee — the partnership agreement will set this out.
A company is a separate legal entity from its shareholders. Shareholders own the business — they’re people with a financial interest in it.
In some companies, one person or group, eg a family, may own all shares. Other companies list shares on the stock exchange, where the public and other companies can buy them.
Every company has a board of directors, even if there is only one director.
A company’s legal status limits the liability its shareholders have in the business to the value of their shares. This is known as a limited company — you’ll see the shortened form “Ltd” at the end of company names, eg Sweet As Candy Ltd.
- Company profits are distributed to shareholders, who are taxed individually on their overall personal income.
- Profits the shareholders do not take are the company’s, and get taxed at the company tax rate of 28%.
- Companies don’t pay tax on earned revenue if they make a net loss.
You can run a business as a trading trust. The trustees are given the power to carry on the business.
Operating a trading trust is complicated. If you want to go down that track, consult your lawyer and accountant first.
Still not sure of what business structure to use for your business? Give us a call. Our team will help you to decide your business structure by understanding your business requirements.