For 99.9% of the time, New Zealand companies are incorporated to operate a business and derive income. On establishment, the focus tends to be on items such as:
- whether a company is the appropriate vehicle, e.g. does limited liability protection warrant it;
- who should own the shares, e.g. in personal names or in a Trust; and
- who should be appointed director.
Understandably, the initial focus is not necessarily on how business income will be extracted, or how the business will eventually be sold. However, with the difference between the company tax rate (28%) and the top personal and trust tax rates (39% from the 2024/25 year) increasing to 11%, a material barrier will exist to extracting taxable value from a company. This makes it important to ensure value is able to be extracted tax-free where possible.
In a simple sense, a company’s assets minus liabilities equals the ‘value’ or equity of a company. Equity is made up of available subscribed capital (ASC), accumulated taxable income, and/or capital gains (whether realised or unrealised).
ASC represents the cash put into a company by its shareholders. For example, if the shareholders paid $100,000 for 100,000 shares at $1 each, ASC of $100,000 exists.
ASC represents a pool of funds that is able to be paid to shareholders tax-free, subject to meeting specific criteria. For example, in the event of a pro-rata share repurchase and cancellation, the amount paid might be tax-free if it is at least 15% of the market value of all participating shares in the company (or 10% if approved by Inland Revenue). Another requirement is that the share purchase amount cannot be in lieu of a dividend.
Capital gains can only be extracted tax-free on liquidation. This often results in capital gains becoming trapped if a company can’t be struck off because it owns other assets. For this reason, land is sometimes held in separate, special purpose companies to enable easy extraction (by way of winding up the company) in the event the land is sold.
Finally, another option comes into play when it’s time to sell the business to a third party. If a company is ‘pregnant’ with taxable value, the company’s shares could be sold to another company. Assuming the shares are held on capital account, the exiting shareholder should derive a non-taxable capital gain. Future extraction of that value is not necessarily taxable to the purchaser.
A landscape will exist where the difference between the 28% rate and 39% rate is material and will inevitably lead to actions to mitigate the higher rate where possible, but it is also a complicated area that Inland Revenue will likely focus. Hence, with any tax mitigation strategy, risk versus reward will come into play.
