Q: When is a payment tax deductible to your business but tax free in the hands of your employee?

A: When the payment is for hurt and humiliation caused by the employer.

This may seem at first glance like an opportunity for tax arbitrage – notwithstanding the high price in terms of your reputation as an employer.

The IRD has confirmed in Public Ruling BR Pub 06/05 that genuine compensation for humiliation, loss of dignity, or injury to feelings is not taxable to the employee. It matters not whether the compensation is determined by the Courts or is an out-of-court settlement agreed by the parties.   Regardless of the payments being non-taxable to the employee, they are likely to be tax deductible to the employer.

Due to this one sided tax treatment, payments for hurt and humiliation have become an area of focus for the IRD. It is well worth having some background knowledge to the tax treatment of payments to employees who have a legitimate personal grievance.

Payments for lost income, redundancy entitlements, or exit inducements are taxable and are subject to PAYE just the same as ordinary salaries and wages are. Simply reclassifying a payment as being for hurt and humiliation and getting the settlement agreement signed by an independent mediator does not make the payment non-taxable.

In order to stack up as genuine compensation for humiliation, loss of dignity, or injury to feelings – and as such be legitimately non-taxable to the employee, the parties would need to be able to demonstrate to the IRD the following: 

1. That the employee had a genuine personal grievance , and;

2. That the amount paid to the employee was reasonable based on the level of compensation awarded by the Courts in similar scenarios.

The onus for getting this right is with the employer. If the IRD were to later investigate the transaction and deem that there was no genuine personal grievance – or that the payment was excessive, they would likely seek to “gross-up” the payment to calculate the PAYE liability. As a result, the employer would be assessed for the unpaid PAYE – plus penalties and interest.

Although the employee may be highly motivated to have payments classified in a not taxable manner, the costs of getting it wrong fall entirely on the employer’s shoulders – so care must obviously be taken in this area. Because of the asymmetrical tax treatment and opportunities for abuse, payments for hurt and humiliation will likely continue to be an area of focus for the IRD.

Do you need to know the value of your business?  If you’re doing any of these things, the answer will be “yes”:

• Your business is insured with a buy-sell agreement;
• You’re transferring shares to your family trust;
• You’re transferring your business into a company;
• You have a shareholder entering or exiting your business;
• You’re focussed on maximising the value of your business for an eventual exit;
• You’re in a matrimonial dispute or a dispute with your fellow shareholders.

The first step is to determine what exactly is being valued:

Business Assets and Goodwill:  Often this approach is used when a business owner is contemplating a sale, as typically a purchaser will buy assets and goodwill leaving debtors, creditors, term loans, tax liabilities, shareholder current accounts and often some company vehicles behind to be dealt with and wound up by the vendor.

Shares in the Company:  This approach is often used for periodic valuations for buy-sell insurance purposes, where a new shareholder is being introduced to an existing company, where an existing shareholder is selling out or where shares are being transferred to a Trust.

Minority Interest:  Depending on the company’s constitution or shareholders’ agreement, a minority shareholder may have little influence in matters like dividend policy or remuneration of directors.  This may make a minority shareholding worth significantly less than a controlling interest.   

Majority Interest:  On the other hand, the shares that give a shareholder a controlling interest may attract a premium.   But often a “fair value” approach is stipulated, in which case it might be appropriate to ignore differences in value between minority and majority holdings.

A valuation can form the basis of strategic planning for your business. It is a powerful starting point to establish the value of your business today and devise strategies that will increase value over time.

Business Valuations typically fall into two categories:

Indicative Valuation:  The appropriate information is considered and a robust written valuation opinion is provided.

Independent Valuation to Chartered Accountants Australia and New Zealand standard AE2:  This requires full independence and a more robust level of verification and investigation.

If a valuation is to carry weight for example as evidence in court, an Independent Valuation will be required – otherwise an Indicative Valuation tends to be sufficient for most other purposes.

Elevate CA are Chartered Accountants and professional Business Valuers, and we can meet your business valuation needs. There is no need to disturb your relationship with your existing accountant as we can work with them to gather the necessary information.   We also provide peer review services for Chartered Accountants who may wish to sanity check their own opinions with an independent party.

We are happy to discuss your business valuation needs and give you an estimate of the likely cost – just contact Fraser Hurrell to start the ball rolling.

Changes to Companies Office Annual Return Requirements

From 1 July 2015, we will be requesting some additional information from our clients’ New Zealand incorporated companies before we can file their Annual Return with the Companies Office.  This is because of new requirements under the Companies Amendment Act 2014.  The key dates and the new requirements are as follows:

1 July

From 1 July 2015, all New Zealand companies must provide the following information. Without this information, it will not be possible to file an Annual return:

The place and date of birth of every director.  Note this won’t be available for the public to view.

Details of the ultimate holding company if applicable.

29 October

From 29 October 2015, all New Zealand companies must have at least one director who lives in New Zealand or Australia. If Australia, that individual must be a director of a company incorporated in Australia.

For newly incorporated companies, these changes apply immediately.

Companies that do not comply may be removed from the register – with any company assets then passing to the Crown.

The idea behind these changes is to prevent misuse of the Companies Register – and to provide the Registrar of Companies with some additional information to assist in holding those who misuse the register to account.

As usual on Budget Day, it’s all ears on the live stream at Elevate CA as Bill English reads Budget 2015.  Here are our first impressions and some initial comment around the tax and business related aspects of Budget 2015 …

2:08pm

Mr English is telling us of a more confident and resilient country than the one we lived in seven years ago.  There’s a bit of political and economic spin going on for a few minutes as one expects at the lead in to a budget delivery.

2:12pm

Mr English is glossing over that wafer thin surplus he spoke about this time last year.  Now he is budgeting for a deficit of $684m – and a surplus next year.  The rationale we’re hearing is that spending allowances are being maintained rather than chasing a surplus in this coming year.

Yes, this resonates with me.  The ideological return-to-surplus-on-a-tight-timeframe-because-that’s-what-we-promised didn’t sit well

2:16pm

The Budget provides up to $25 million over three years to support establishment of Regional Research Institutes for regional areas outside of Auckland, Wellington and Christchurch.  As announced previously, there is provision for R&D growth grants for innovative businesses which will contribute 20 per cent of their R&D costs.

Yes.  This is a no brainer.  The free market can’t compete with government assisted innovation in countries like the USA.  We need to take a lesson from them in supporting our best and brightest – and this is a step in the right direction.

2:17pm

Further ACC Levy cuts of $375m across businesses, workers and vehicle owners

This has been well flagged over the last few months.

2:19pm

As announced by Mr Key on Sunday, some measures to clarify tax rules for those buying and selling properties.  Foreign buyers and Kiwis who are buying and selling properties that are not their main home will now have to provide an IRD number when they buy or sell.

This will no doubt make the job of the IRD Property Compliance Unit a little easier in the future.  The idea of regularly buying and selling property without paying tax on the profits is rightfully a thing of the distant past.

2:19pm

Also, as Mr Key announced earlier, if someone sells a residential property within two years of purchase they will now have to pay income tax on any profit they make from the sale.

This will likely catch very few people who should not already have been paying tax on the proceeds of their sales – but this new bright line test does send a clear message.  Of course sales of properties that were purchased with the intention of resale will still be taxable regardless of the two year bright line – just as they always have been.

2:20pm

The Budget also contains a funding boost of $74 million over five years for extra tax compliance and enforcement, of which $29 million is focused on property investment.

No surprises here.  A dollar spent by the Property Compliance Team returns significantly more than that dollar spent, so we have come to expect a little something extra for them in every budget.

2:21pm

The rhetoric has been strong in recent months about Auckland’s housing shortage.  The Government is also a major owner of under-utilised land in Auckland – and Budget 2015 sets aside $52 million to facilitate housing development on Crown owned land.

Also a no brainer.  The idea of government land sitting idle in Auckland seems daft at a time of significant shortage of land for residential housing.

2:22pm

We’re hearing about an additional $210 million for additional investment to bring UltraFast Broadband to 80 per cent of New Zealanders – and $150 million for improvements in rural broadband.

We need to be wired with the rest of the world.  Bring it on.

2:23pm

As previously announced, the Budget also provides $97 million in capital for regional  highways and $40 million for urban cycleways.

Urban cycleways are a no brainer.  Think Amsterdam or Copenhagen.  The savings in fuel, the increases in well-being and the reduction in healthcare costs by leaving the car at home and cycling would seem to make this an excellent long term investment.

2:24pm

Another $37 million to push along the Government’s resource management reforms.

Mr Key’s pet project, so no surprises here.

2:25pm

Mr English is explaining an additional $32 million over four years to increase the number of  labour inspectors and strengthen enforcement of employment law.

Seems like a political response to Pike River and the anecdotal mass exploitation of migrant workers.  So no surprises at all here.

2:26pm

The $1,000 KiwiSaver kick-start payment is axed as of 26 minutes ago at 2:00pm today.

Surprise, surprise

2:30pm

There will be a new Border Clearance Levy from 1 January 2016 so it will cost $16 to enter the country and $6 to leave.

So an exit tax from New Zealand?  “It’ll cost you $16 to get in – and $6 to leave”.  I don’t know why I find that funny.

2:34pm

Here is the thrust of the government’s plan to end child poverty:  From 1 April next year, sole parent beneficiaries will have to be available for part-time work when their youngest child turns three, rather than five as it is now.

I’m sure this point will form the basis of much negative commentary on the budget over the next 24 hours.

2:38pm

So on 1 April next year Working for Families will increase for working families earning $36,350 or less a year – and it will decrease for families earning more than $88,000 a year.

2:39pm

Finally, the health, education and law enforcement announcements:  DHBs will have around $320 million available next year for extra services and to help meet cost pressures and population growth – and an extra $76 million is in the pot for hospices and 60 new palliative care nurse specialists.  An extra $63 million over four years will better assist children with special education  needs including funding for teacher aide support for 1,500 additional  students with special needs.  As well, additional funding for around 240  classrooms around the country.  And $164 million over four years for the Police and $8 million over four years for the Serious Fraud Office.

 All in all, rather predicable, right?  But that’s the budget ethos these days – no surprises on Budget Day.

For most businesses, the end of the financial year is fast approaching. Here are a few areas you may wish to look at now:

 

1. Inventory

If you carry inventory, you’ll be well accustomed to the annual stock take. Some effort at this time of year to dispose of obsolete stock or write it down to its realisable value will pay dividends at tax time. A general adjustment for obsolescence will not cut it – the written down stock must be separately identifiable. Remember, showing a stock value in excess of lower of cost or net realisable value of that stock equals paying too much tax.

2. Repairs and Maintenance

It may be worthwhile to bring forward repairs and maintenance. For example, if machinery or vehicles are due for a service, consider fitting this in before 31 March rather than leaving it until April – thus bringing the tax deduction forward by a year.

3. Retentions

If you’re a construction contractor, you need to be mindful of this at year end: Retentions on building contracts are generally taxable in the year the contractor becomes legally entitled to receive them.   If this entitlement falls in April rather than March, the associated tax bill is deferred by 12 months.

4. Employee Expenses

Bonuses and holiday pay are tax deductible in the year ended 31 March 2015 if they are physically paid by 2 June 2015. If you are considering paying bonuses in relation to this tax year, make sure these are paid before 2 June.

5. Business expenses paid privately

Business expenses paid privately often fall through the gaps – and the opportunity to claim a tax deduction is lost. Now is a good time to gather up tax invoices for expenses paid privately – and to reimburse yourself from the business bank account so there is a clear paper trail.

6. Bad debts

Where your business writes off a debt that has no reasonable expectation of being paid after taking all reasonable steps to recover it, this is tax deductible. The catch is that you must have physically written the debt off before the end of the financial year. Now is the time to write off any bad debts.

7. Fixed Assets

Now is a good time to review your asset schedule. Often obsolete assets have little or no value – and any loss on their sale below book value is typically tax deductible.   If you have business assets that are no longer used, get what you can for them now – or scrap them.   Think of that unused machine in the corner – or that old computer equipment under the desk.

8. Prepayment of expenses

Most expenses can’t be fully claimed as a tax deduction if you choose to prepay them. But there are some exceptions like stationery, postage, courier charges, vehicle registration, road user charges, rates, journal subscriptions or accounting fees. There may be some possibilities to pay these expenses in March thus capturing them in this financial year.