In last month’s article I outlined the main types of business structure used by farmers in New Zealand. This month I will explain the factors you will need to consider when choosing the structure that is most suited to your circumstances.
Generally, you will be choosing between:
- A sole trader
- A partnership
- A company
- A trust.
There may be good reasons to choose a combination of these structures – for example, you may have a company carrying on the farming business and the shares in that company may be held by your family trust. Alternatively, you may have a trust that owns the land and leases it to your partnership that carries on the farming business.
Why Choose to be a Sole Trader?
Setting up business as a sole trader is simple. This structure is well suited to a small business where the owner also works in and manages the business. You don’t need to sign any documents to set up your business structure. Your accounts will be simple. However, you will be personally liable for all the business debts, it may be harder to raise money for the business and you may end up paying more tax than if you trade as a company or a trust.
Why Choose a Partnership?
A partnership is also relatively simple to set up and run. It is desirable to sign a partnership agreement, but it is not necessary to do so. You share responsibility for the business with the other partners. The downside of that is you have to get on with the other partners and make decisions together. Each partner is liable for all of the partnership debts.
A Limited Partnership (LP) under the Limited Partnerships Act 2008 is suited to larger joint venture type of business – for example, the purchase of a large farm. It enables one partner (the limited partner) to contribute capital and only be liable to the extent of that capital contribution. The limited partner must not be involved in running the business. The other partner (the general partner) is solely responsible for running the business and for the Limited Partnership’s debts.
As with a sole trader, the partners may end up paying more tax than if they trade as a company or trust.
Why Choose a Company?
A limited liability company is also relatively easy to set up. The major advantage of trading as a company is that the shareholders’ liability is limited to the amount of money they invest as share capital. The shareholders are not liable for the company’s debts.
It is easier to raise finance and to sell the business or a share in the business. A sale can be done by a sale of shares, rather than a sale of the company’s assets themselves.
The company may pay less tax than that paid by the individual shareholders, as the company tax rate is lower than the highest personal tax rate. The company will continue even if the directors or shareholders die, unlike a partnership or sole trader which ceases on the death of the sole trader or one of the partners.
On the downside, there will be costs and administration required to comply with the Companies Act 1993. Directors must be aware they can be personally liable if they don’t carry out the duties the law imposes on them.
Why Choose a Trust?
Trusts are valuable ownership structures to protect assets. Assets can be protected from relationship property and creditors’ claims and can be held for the benefit of family members who suffer disabilities or cannot handle assets responsibly. Assets can be transferred to beneficiaries without the need for them to be sold or gifted.
If you transfer assets to a trust, you will have more flexibility to provide unequally for family members in your Will because the assets are not taken into account if a family member brings a claim against your Will under the Family Protection Act. For this reason, trusts are particularly valuable for farmers who wish to pass on the family farm to one child and can only do this if that child receives a larger inheritance than other children.
There are also tax advantages as income can be allocated to beneficiaries on the lower tax rates and the trustees’ tax rate is lower than the highest personal tax rate. Trusts also continue if the trustees or beneficiaries die.
Disadvantages of a trust structure include the expense of setting it up and maintaining it. Also, trustees are personally liable for the trust debts unless they specifically agree otherwise.
Get it Right at the Start
When you are starting in business or purchasing business assets, it pays to work closely with your lawyer and accountant to choose the legal structure at the beginning that will be best for you in the long term. After you have been in business for some time, a re-structure can be expensive. If you decide to change your trading entity solely for tax reasons your re-structuring could be challenged by Inland Revenue.
Please email me at [email protected] with your ideas for future articles. Keep an eye out for next month’s column, where I will discuss another relevant rural legal issue.
Barbara McDermott is a partner of Norris Ward McKinnon, specialising in commercial and rural law. With offices in Hamilton and Huntly, we have friendly, expert legal advisors ready to help you with your business and personal legal matters.