Trading through a 'Company' structure - Tax obligation

Hi all,

As I understand it, if you trade through a company structure, your profit is taxed at a flat rate of 28%.

Now once you draw money from the company into your own account, do you have to pay a further income tax per your marginal rate on these withdrawals?

If you do, then I guess it would make more sense to trade as a sole trader.

Any thoughts?

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Originally Posted by hummerh40

Hi all,

As I understand it, if you trade through a company structure, your profit is taxed at a flat rate of 28%.

Now once you draw money from the company into your own account, do you have to pay a further income tax per your marginal rate on these withdrawals?

If you do, then I guess it would make more sense to trade as a sole trader.

Any thoughts?

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I would go and talk to an accountant...

What do you mean by "draw money into your own account"?? Either that would be a wage/salary (with PAYE deducted) loan or a dividend (imputed) or fraud (theft from the company) I guess....

Thanks for the reply blackcap. I just meant if you transferred the profits you have made through the company into your personal account (as a salary), would you then have to pay personal income tax on that?

For a single person run company, you would:
-have to pay 28% income tax through company
-would have to pay yourself in the form of wage or salary and thus would be required to pay a further personal income tax of say 33%

have I got it right? sorry for the confusion

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Originally Posted by hummerh40

Thanks for the reply blackcap. I just meant if you transferred the profits you have made through the company into your personal account (as a salary), would you then have to pay personal income tax on that?

For a single person run company, you would:
-have to pay 28% income tax through company
-would have to pay yourself in the form of wage or salary and thus would be required to pay a further personal income tax of say 33%

have I got it right? sorry for the confusion

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You would probably transfer those profits as a dividend which would then be fully imputed and passed onto the shareholder being you.
So you do not end up paying tax twice. The only thing extra you may end up paying is the difference between the 33% marginal tax rate and the company tax rate of 28%. Hope that helps.

Well your salary in that case would become a deductible expense for the company.

KISS is the best way to go.

Basically yes. Once you wish to draw funds out of the company you will need to pay either a shareholder salary or a dividend and thus the income will be taxed at your personal marginal rate.

You won't be paying tax twice. You either pay it through the company as profit or as wages.

For example: say you have $100,000 profit and you take $40k out for you, it would be classed as drawings and you would pay company tax on $100,000.

But if you have $100,000 profit and you take out $40,000 as a wage and pay paye as you go, then you only pay company tax on $60,000.

Inhuman is correct. Pipi is in error in his example. Salary can either be paid out direct or credited to your drawings account after personal tax is deducted. Then you can draw out from there. It could also be paid out as a dividend but tax still has to be calculated at your marginal rate. May be higher or lower than 28c/$.

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Originally Posted by unhuman

Basically yes. Once you wish to draw funds out of the company you will need to pay either a shareholder salary or a dividend and thus the income will be taxed at your personal marginal rate.

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what if that person is to sell those shares in that company to get the money out? - it may be a private company, but its still a share sale which are not capital gains taxed.

Also another question. If you set up an entity (company or trust) and that entity buys shares and sells them. It might be a mix of long term holds - which it would sell some of due to circumstance, and then short term opportunistic stuff, then does that entity have to pay capital gains tax?

I am asking because I know a lot of people would have companies of family trusts which would do a lot of share trading, but in a lot of cases these entities don't pay capital gains tax. It is a gray area with the IRD, so its kind of at what point is it "yes you are actively trading" and need to pay capital gains tax, or "we can see thats not what the entity was primarily set up to do"... all of this of course involves the IRD actually asking these questions of your entity, which usually means they are doing an audit of you, which is pretty rare....

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Originally Posted by alistar_mid

what if that person is to sell those shares in that company to get the money out? - it may be a private company, but its still a share sale which are not capital gains taxed.

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Whether the share sale is taxable or not is a different question and depends on many different factors. But ultimately if there is taxable income in the company, when the shareholder withdraws funds they will need to pay a salary or dividend. The dividend will have IC's attached thus 5% RWT will be payable bringing the ultimate tax rate to 33%, or a salary which will reduce the income in the company, while increasing the tax paid by the shareholder.

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Originally Posted by alistar_mid

Also another question. If you set up an entity (company or trust) and that entity buys shares and sells them. It might be a mix of long term holds - which it would sell some of due to circumstance, and then short term opportunistic stuff, then does that entity have to pay capital gains tax?

I am asking because I know a lot of people would have companies of family trusts which would do a lot of share trading, but in a lot of cases these entities don't pay capital gains tax. It is a gray area with the IRD, so its kind of at what point is it "yes you are actively trading" and need to pay capital gains tax, or "we can see thats not what the entity was primarily set up to do"... all of this of course involves the IRD actually asking these questions of your entity, which usually means they are doing an audit of you, which is pretty rare....

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Correct, basically answered your own question. This is generally why it is important to get an accountant or advisor of some sort involved early on so they can set up structures and do the right things that will demonstrate intention if the IRD were to come looking.

I agree there are probably many small time investors that would have issues between long term holds and short term trading if the IRD where to do a review or audit, leading to income tax risks. To be fair from my experience this is largely through ignorance - the "capital gain" concept for shares is not a black white issue which most people don't understand on a common law basis. There are however a couple of simply steps to minimise risk; i.e. keeping investing and trading in separate entities.

Audits are rare, but you would want your cards to be in order if you were on the receiving end of one as they can last decades...

Ultimately it is piece of mind.

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Originally Posted by alistar_mid

I am asking because I know a lot of people would have companies of family trusts which would do a lot of share trading, but in a lot of cases these entities don't pay capital gains tax. It is a gray area with the IRD, so its kind of at what point is it "yes you are actively trading" and need to pay capital gains tax, .

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I think you need to change the terminology. There is no capital gains tax in NZ for shares. if you were to be taxed on gains from shares then I think it is "trading profits" you are going to be taxed on. So if you are "actively trading" then you will have to pay "income" tax on the gains made and deducting the losses of course.
Whether it is a company doing the "trading" or a individual or a trust is a moot point.

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Originally Posted by blackcap

I think you need to change the terminology. There is no capital gains tax in NZ for shares. if you were to be taxed on gains from shares then I think it is "trading profits" you are going to be taxed on. So if you are "actively trading" then you will have to pay "income" tax on the gains made and deducting the losses of course.
Whether it is a company doing the "trading" or a individual or a trust is a moot point.

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hmm so it comes down to the definition of actively trading?

The reason is I am looking up to set up a private investment fund, I have enough interest and would be able to start the fund off in the 6 figure mark. The only problem is what entity to set it up in. I originally thought a company / trust would not work because of capital gains tax, but seeing as the definition of what is actively trading is very grey, and the threshold for what constitutes actively trading is probably far in excess of the number of trades I would be making, I now think a company is the way to go.

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Originally Posted by alistar_mid

hmm so it comes down to the definition of actively trading?

The reason is I am looking up to set up a private investment fund, I have enough interest and would be able to start the fund off in the 6 figure mark. The only problem is what entity to set it up in. I originally thought a company / trust would not work because of capital gains tax, but seeing as the definition of what is actively trading is very grey, and the threshold for what constitutes actively trading is probably far in excess of the number of trades I would be making, I now think a company is the way to go.

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Enough interest. Is that using other people as investors with you and you making all the investing decisions?

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Originally Posted by unhuman

Whether the share sale is taxable or not is a different question and depends on many different factors. But ultimately if there is taxable income in the company, when the shareholder withdraws funds they will need to pay a salary or dividend. The dividend will have IC's attached thus 5% RWT will be payable bringing the ultimate tax rate to 33%, or a salary which will reduce the income in the company, while increasing the tax paid by the shareholder.

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Hold up. If the Company is not actively trading, then it is not paying tax on those capital gains. When you come to distribute those capital gains, you will have no IC's so any distribution will be fully taxed - not ideal (assuming you dont have IC's from other taxed activities). The only way to get untaxed gains out tax free is to liquidate the company.

In the good old days of qualifying companies, this wasn't an issue (note. from memory, legacy QC can still do this).

^ Correct, but my interpretation when applied to a situation if a company was not actively trading then capital gains on sales during the life of the company would presumably be rare as they would be holding the shares long term.

If there were sales then one would think that the gains would be reinvested in other shares etc rather than withdrawn to the shareholders, provided all shares weren't being sold and withdrawn. In which case preparing a capital dividend on liquidation wouldn't be an issue as the company would no longer have any purpose.

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Originally Posted by 777

Enough interest. Is that using other people as investors with you and you making all the investing decisions?

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Yep, still sorting through the legalities of setting it up, but it would be me making all the investment decisions. It won't just be shares I plan to have some in Harmoney, in some snowball effect stuff etc

It came about as i now make more income off investing than my 9-5, alot my friends are aware of it but don't have the time / effort to get started in investing, nor the patience for the admin. So this idea came about to help them out, to do more of what i like doing. Not taking any fees either.

Nothing finalised yet. still need to sort out how to protect both parties.

Interesting. Sort of a share club with a difference. Best of luck and I hope you don't lose any friends.

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Originally Posted by unhuman

If there were sales then one would think that the gains would be reinvested in other shares etc rather than withdrawn to the shareholders, provided all shares weren't being sold and withdrawn. In which case preparing a capital dividend on liquidation wouldn't be an issue as the company would no longer have any purpose.

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So you have created a successful investing company and you want some cash out to enjoy, but you have to liquidate the whole thing to do it tax free? That might be true but I expect at some stage, you may want to take only part of the cash out and it will be trapped, due to tax inefficiency.

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Originally Posted by alistar_mid

Yep, still sorting through the legalities of setting it up, but it would be me making all the investment decisions. It won't just be shares I plan to have some in Harmoney, in some snowball effect stuff etc

It came about as i now make more income off investing than my 9-5, alot my friends are aware of it but don't have the time / effort to get started in investing, nor the patience for the admin. So this idea came about to help them out, to do more of what i like doing. Not taking any fees either.

Nothing finalised yet. still need to sort out how to protect both parties.

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Investing money on behalf of others. Have you check the legal requirements of this? Pretty sure there are a whole lot of rules to stop you being the next David Ross/Hubbard/Bernie Maddoff (not that they helped in those situations).

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Originally Posted by Harvey Specter

Investing money on behalf of others. Have you check the legal requirements of this? Pretty sure there are a whole lot of rules to stop you being the next David Ross/Hubbard/Bernie Maddoff (not that they helped in those situations).

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currently doing this (checking the legal requirements).

and at the moment its only open to very close friends (who known me 20+ years, know where I live etc lol) and part of how its going to work is with total transparency with the ability for investors to cash out at any time.

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Originally Posted by alistar_mid

currently doing this (checking the legal requirements).

and at the moment its only open to very close friends (who known me 20+ years, know where I live etc lol) and part of how its going to work is with total transparency with the ability for investors to cash out at any time.

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Great way to lose friends , go into business with them . Cash out at any time..... going to get ugly after a GFC type event - "You can checkout anytime you like but you can never leave "

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Originally Posted by alistar_mid

Yep, still sorting through the legalities of setting it up, but it would be me making all the investment decisions. It won't just be shares I plan to have some in Harmoney, in some snowball effect stuff etc

It came about as i now make more income off investing than my 9-5, alot my friends are aware of it but don't have the time / effort to get started in investing, nor the patience for the admin. So this idea came about to help them out, to do more of what i like doing. Not taking any fees either.

Nothing finalised yet. still need to sort out how to protect both parties.

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You should find out more about the tax side of things before even considering this. You may want to seek paid professional advice also before going ahead. This looks like a potential disaster at face value, there is a reason why you don't mix business and pleasure and having the ability to cash out at any time doesn't make sense with the types of investments you will be making (Harmoney, Shares).

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Originally Posted by Investor

You should find out more about the tax side of things before even considering this. You may want to seek paid professional advice also before going ahead. This looks like a potential disaster at face value, there is a reason why you don't mix business and pleasure and having the ability to cash out at any time doesn't make sense with the types of investments you will be making (Harmoney, Shares).

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lol, there will be a unit price which will be comprised off the value of the shares, cash, harmoney, private equity. Everything except the private equity has an up to the minute value, and I have already talked to snowball effect people about this, they updated every 3 months.

When I say my investors can cash out at any time, I don't mean this would be implemented by me selling off investments for them to get their cash out lol. thats amatuer as. I mean I would just buy their share holding. This whole thing might be only $300k max. I have multiples of that in liquidity. If all my investors sold out, I would just take over the whole thing - I already invest in all this myself

Already met with the lawyers, the accountants. I wouldn't be doing this if I wasn't confident in my ability or experience to pull it off. Most of the logistics etc are allready sorted. Just need to lock down the definition of what constitutes trading, and what form / level of legal agreement I need to provide for my investors when they sign up.

Still not 100%, if i don't think i can get it to work, then I won't do it.

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Originally Posted by alistar_mid

lol, there will be a unit price which will be comprised off the value of the shares, cash, harmoney, private equity. Everything except the private equity has an up to the minute value, and I have already talked to snowball effect people about this, they updated every 3 months.

When I say my investors can cash out at any time, I don't mean this would be implemented by me selling off investments for them to get their cash out lol. thats amatuer as. I mean I would just buy their share holding. This whole thing might be only $300k max. I have multiples of that in liquidity. If all my investors sold out, I would just take over the whole thing - I already invest in all this myself

Already met with the lawyers, the accountants. I wouldn't be doing this if I wasn't confident in my ability or experience to pull it off. Most of the logistics etc are allready sorted. Just need to lock down the definition of what constitutes trading, and what form / level of legal agreement I need to provide for my investors when they sign up.

Still not 100%, if i don't think i can get it to work, then I won't do it.

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So what price are you going to buy someone out in the example of GFC where "assets" are not able to be valued , or shares were suspended ....
You will have your price and the seller another ....hence a lost "friend "
If you have multiples of this $$ why bother with the possibility of losing some good friends. Just point them in the direction of a stable managed fund imo.

Cheers

S/L

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Originally Posted by stoploss

So what price are you going to buy someone out in the example of GFC where "assets" are not able to be valued , or shares were suspended ....
You will have your price and the seller another ....hence a lost "friend "
If you have multiples of this $$ why bother with the possibility of losing some good friends. Just point them in the direction of a stable managed fund imo.

Cheers

S/L

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part of it is I like doing this stuff - more than my day job, and see this as a way of getting (somewhat) "formal" experience.
My friends are all smart people and would understand the implications of a recession.

Also i don't imagine there would be a time when I could never value the fund. Sure a small portion (one stock) might go on a trading halt, but that its not going to make it so I can't define the value of the fund.

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Originally Posted by alistar_mid

I have already talked to snowball effect people about this, they updated every 3 months.

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Really - every three months? Not sure how they do this given there is no way to value those companies unless they are going by the last round price, in which case there are only a few that have had a follow on round (normally privately).

If the legalities prove too difficult, why not form a 'share club'. Never been part of one my self so cant really comment but it would also give the benefit of educating your friends (give a man a fish vs teach a man to fish and all that stuff). Otherwise, they free load of you in the good times and blame you in the bad times.

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Originally Posted by Harvey Specter

Really - every three months? Not sure how they do this given there is no way to value those companies unless they are going by the last round price, in which case there are only a few that have had a follow on round (normally privately).

If the legalities prove too difficult, why not form a 'share club'. Never been part of one my self so cant really comment but it would also give the benefit of educating your friends (give a man a fish vs teach a man to fish and all that stuff). Otherwise, they free load of you in the good times and blame you in the bad times.

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additionally to answering your PM, I guess they can give you a value, but i don't know if it means a whole lot, its only indicative. Businesses in their early stages could be valued in any number of ways, and you could arrive at any number of values.

I thought about a share club. But easiest way to put it is I want this to operate like a mini version of a managed fund, without the $ millions in FMA set up costs.

The first round of investors are really close friends who I trust and I assume they trust me. If there's any chance of spoiling friendships then I would be hesitant to do it. They are all smart people, they could do it themselves its not an issue of ability its more they don't have the time of the admin.

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Originally Posted by alistar_mid

additionally to answering your PM, I guess they can give you a value, but i don't know if it means a whole lot, its only indicative. Businesses in their early stages could be valued in any number of ways, and you could arrive at any number of values.

I thought about a share club. But easiest way to put it is I want this to operate like a mini version of a managed fund, without the $ millions in FMA set up costs.

The first round of investors are really close friends who I trust and I assume they trust me. If there's any chance of spoiling friendships then I would be hesitant to do it. They are all smart people, they could do it themselves its not an issue of ability its more they don't have the time of the admin.

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I would seriously consider getting legal advice. If in a company structure then I presume you will be a director. That comes with a whole host of responsibilities as well. And trading with other people's money can get you quickly into strife with the SFO. I am not even sure its legal in NZ to do so without a prospectus.

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Originally Posted by alistar_mid

additionally to answering your PM, I guess they can give you a value, but i don't know if it means a whole lot, its only indicative. Businesses in their early stages could be valued in any number of ways, and you could arrive at any number of values.

I thought about a share club. But easiest way to put it is I want this to operate like a mini version of a managed fund, without the $ millions in FMA set up costs.

The first round of investors are really close friends who I trust and I assume they trust me. If there's any chance of spoiling friendships then I would be hesitant to do it. They are all smart people, they could do it themselves its not an issue of ability its more they don't have the time of the admin.

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have a look at what Lance did with Punakaiki then. Close friends is an exemption from the wholesale investor requirement.

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Originally Posted by blackcap

I would seriously consider getting legal advice. If in a company structure then I presume you will be a director. That comes with a whole host of responsibilities as well. And trading with other people's money can get you quickly into strife with the SFO. I am not even sure its legal in NZ to do so without a prospectus.

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I will get legal advice.

wouldn't I only get in to strife with the SFO if I plan to be dodgy with my friends money?

I wouldn't be doing this if I wasn't sure of it. I have already ran it past people in the industry who are good friends / family (they are obviously unable to invest). These guys are very experienced, head of research at one of NZ's main fund managers and head of investments at another fund manager. I sat down and talked it through with both these people to see if it was even feasible. No major red flags came up. Its going to be a private fund. Not public.