In New Zealand, most companies are set up with the primary goal of conducting business and generating income. During the establishment phase, attention is typically focused on aspects like the company’s structure, ownership of shares, and director appointments.
Often overlooked, however, is how business income will be extracted or how the business might eventually be sold. Yet, with the growing disparity between the company tax rate (28%) and personal/trust tax rates (reaching 39% by 2024/25), it’s crucial to explore avenues for extracting taxable value from a company tax-free whenever possible.
In simple terms, a company’s equity is the value derived from its assets minus liabilities. This equity comprises subscribed capital, accumulated taxable income, and/or capital gains.
Subscribed capital (ASC) represents the cash injected into a company by its shareholders. It forms a pool of funds that can be distributed to shareholders tax-free, subject to specific conditions. For instance, if a pro-rata share repurchase and cancellation occur, the amount paid might be tax-free under certain criteria, such as being at least 15% of the market value of all participating shares.
Capital gains, on the other hand, can typically be extracted tax-free only upon liquidation. To facilitate easy extraction, land is sometimes held in separate companies, allowing for straightforward winding up if the land is sold.
Another option arises when selling the business to a third party. By selling the company’s shares, assuming they are held on capital account, exiting shareholders can potentially realize a non-taxable capital gain. Future extraction of this value by the purchaser may also remain non-taxable.
As the disparity between tax rates grows, businesses are likely to seek ways to mitigate the higher tax rate. However, it’s essential to consider the complexity of tax mitigation strategies and weigh the associated risks against potential rewards. With tax planning, striking the right balance between risk and reward is paramount.
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