The end of financial year deadline

As the end of the financial year approaches, it always pays to spend a little extra time examining your financial records and considering ways to increase your after-tax income. There is a high chance that you will find a couple of extra savings from 2019-2020, which can add up to reduce your tax bill by a significant amount. It is also a good time of year to reflect on your financial position, and think about tax minimisation strategies and goals for 2020–21.

Top tax tips for preparing for the end of the financial year:

Write off bad debts

Businesses with outstanding amounts owed, no matter the size, that are unlikely to be recovered in full should consider writing these off as bad debts. Bad debts can be used as a tax deduction, effectively reducing your taxable income for the relevant year.

For a debt to be considered bad, you must have formally written the debt off in your accounts, and be able to prove to Inland Revenue that you have taken reasonable steps to recover the amount.

Pre-pay expenses

By pre-paying for tax-deductible expenses before March 31, you will be able to minimise your tax bill. Some categories of business expenses can be pre-paid without any limitations, meaning that you can claim as much as you like. Examples include stationery, vehicle registration, accounting and auditing fees and postal charges. Most other expense categories have caps that limit the amount that can be claimed in a year.

Split business income

In some circumstances, it may be possible to minimise your tax liability by redistributing the flow of income from your business. For example, if your partner is a low-income earner, it may be advisable for you to split the business income with them. It may also be possible for you to redirect some of your income towards your children.

However, if your family members are employed in your business as wage earners, you should be aware that Inland Revenue may elect to make tax adjustments if they consider the remuneration to be excessive.

Discount reserve

You can claim a deduction for a discount reserve. For example, a discount for speedy payments, if your debtors are traditionally entitled to this discount. In the years following on from the first year that you are allowed, you can claim a discount reserve deduction, adjustments will be made to maintain the discount level at a consistent level.

Trading stock valuation

Trading stock must be valued using a cost valuation method unless the market selling value is lower than the cost. Therefore, to lower the value of your stock before the end of the financial year, you should either physically dispose of it or sell it at market price (if the market price is lower than cost).

Work In Progress (WIP)

It is recommended that on 31 March you assess all the jobs in progress. Make a list of these jobs and add up the costs associated with these jobs (exclusive of GST). The costs will include any stock items used and employee/contractor time on these jobs. These costs are treated as closing Work In Progress as at 31 March and are costs yet to be billed to the customers. These won’t be deductible as an expense at the end of the financial year.

Fixed Asset Schedules

We suggest reviewing your fixed asset registers and assess whether any assets are no longer in use by the business, not working or stolen or disposed of during the year. By writing off these assets (only if they meet the write off criteria) a deduction will be allowed with respect to those assets.

Bonuses and holiday pay

It is possible to claim amounts payable to your employees as a deduction for the current financial year, so long as the full amount is paid to the employee within 63 days of the balance date. Amounts that are paid more than 63 days from the balance date can only be claimed in the following financial year.

Got a tricky tax problem? Call us now on 0800 758 766 to see what we can do to assist. Alternatively, you can email support@geca.co.nz.

Download a pdf of the 2020 year-end tax tips.

The post Year End Checklist 2020 appeared first on GECA Chartered Accountants.

Set expectations at the beginning

In New Zealand more than 60% of family owned businesses are transitioned to a second generation. However, this process can be fraught with difficulty and often lead to conflict between siblings and generations. Often this is due to the ‘expectations gap’ – that is differences in expectations between the various parties involved in the succession.

Often the expectations of each party when entering into an arrangement are not documented and so misunderstandings occur between the different parties. I recently worked with a client where this mismatch in expectations led to a severe breakdown in family relationships. Something that could easily have been avoided had these expectations been made clear from the outset of their business relationship.

Create a succession plan to document expectations as soon as possible

In this particular instance, the son had joined the family business ten years ago with a verbal understanding that he would succeed his father and take over the business in due course. This is a typical expectation for a family member entering a business even if they may not be the best person to succeed the parent.

The business had several tough years and then a period of growth. During this time the son was employed as a CEO and after about five or six years began asking his father who acted as Managing Director what was happening with succession. Several discussions were held over the years, however, no firm agreement on the way forward was reached. Following increasing pressure from the son, two years ago the father finally engaged advisers to help structure a succession transaction with his son.

Communicate to keep all beneficiaries happy

It was important to both parents that their three children were treated equally. And so this precluded the gifting of shares in the company to the son. Instead, the father proposed the son buy 49.9% of the equity in the company based on an independent market appraisal, over a period of 5 years, and use dividends and a supporting loan from the family trust to enable this. His view was the family estate would be boosted by the amount received for the shares from the son. The son would then get a one-third entitlement to this value in his inheritance.

The proposal came as a great shock to the son. It was his expectation that he would be succeeding his father as owner of the business. He had not considered that his father would expect him to buy the company, especially not at a commercial valuation.  He believed that he had created the value during his ten years as a CEO and that by buying a company at commercial rates he would be rewarding his two siblings for his effort in creating value.

Plan for the unexpected

It was a classic case of mismatched expectations. And it was around this time that the father was diagnosed with a terminal illness with only two to three years to live. Suddenly, the succession process took on a new urgency.

Complicating the issue was the appointment of a sibling as a trustee to the family trust that held the shares in the family business. As an aside, this is a problematic issue for many New Zealand family trusts. While there is a desire for family members to support their parents in the event they become incapacitated. If they are beneficiaries as well as a trustee this places them in a difficult conflict of interest position anytime a distribution of trust proceeds is considered.

The sister was of the opinion that the brother was lucky to have a job and should not be given a company without paying for it. This led to a conflict between the brother and sister. In particular, because the original succession proposal provided for the trust to maintain a 50.1% shareholding, in other words, control of the company. As CEO and a part-owner as proposed, this was unacceptable to the brother.

Finding a solution that rewards success

The son rightly identified that if he wanted to game the proposal, as CEO he would manage the business value down in order to secure the remaining 50.1% at a reasonable price.  This would disadvantage his siblings in the process. He also had to consider whether he wanted to buy the company or use what would be a substantial inheritance to retire. He also recognised if he were to exit the business, there would have been a negative impact on business value in the short term.

The outcome

Ultimately, a succession transaction was structured. The son was given an option to buy 50.1% of the shares in the company each year at a set value. The set value was an agreed increase over prior year EBITDA, therefore, incentivising the son to exceed this in-order to achieve greater dividend return on his shareholding. The remaining 49.9% shareholding was to be valued in the event of his death and the son to buy the shareholdings from siblings at an agreed 10% discount to market value. This was to reflect the brokerage cost of selling a business and to incentivise the purchase of the business by the son from the family trust.

One of the crucial elements of the succession proposal was agreed and the proposal documented the dividend payment policy to enable the structuring of loan payments to pay for the shares.

The above example illustrates the need for documented agreements from the outset of any business relationship, and in particular between family members. The more informal nature of these working relationships often leads to mismatched expectations which can cause conflict and compromise the business performance.

In particular, the succession of a valuable asset such as a business needs to be managed carefully and with transparency amongst all family members to ensure harmonious family relations. Often family estates can be worth many millions of dollars. Claims on this can be wide and varied, ranging from partners family members to charitable causes. Documenting the succession plan and disseminating provides clarity and transparency to all involved parties and helps maintain the integrity of the family unit. 

Read more about Succession planning at GECA. If you need help with a family member succession process, feel free to get in touch with Giles on 0800 758 766.

The post Family Business Succession Planning appeared first on GECA Chartered Accountants.

Succession is a problem facing many New Zealand business owners and a common solution is to pass ownership to a son or daughter who is working in the business. However, while this solution may appeal for its simplicity and retention of business ownership within the family, it can come with a number of issues that need to be considered as part of the succession process. These issues include:

• Value of business versus value of other family assets such as property.
• Structure of a business sale to a family member and how to fund it.
• Timing and parity of distributions of assets from one generation to another.

If not dealt with appropriately, consequences can be serious including wealth erosion and damaged family relationships.

Example Situation

Consider the following situation which represents a typical New Zealand family owned business.

The father founded the business 15 years ago and is the sole Shareholder and Director. His son joined the business 8 years ago and has worked his way up to General Manager over that time.  The business currently has 20 staff, a $5m turnover and budgeted EBITof $1m.

The son would like to succeed his father owning the business and has asked his father what his plans are for exit and succession.

To answer this, the father worked with his business adviser to create a Succession Plan with the following objectives:

• Sale of the business within five years, achieving an exit value of $6m, being a $2.5m increase above its current $3.5m value.
• Confidence his son would be able to meet the requirements and responsibilities of being both owner and CEO.
• Maintaining amicable family relations and parity of distributions between the parents and siblings in the event the ownership did transfer to one child.
• Positioning the business for sale to a third party in the event the succession to the son did not work out.

These objectives ensures the parents will have funds available to meet their future lifestyle requirements, provide their son with a business succession opportunity and provide for an alternate exit pathway if required.

Ownership Transfer Transaction Structure

Once a decision has been made to pass on some or all of the ownership in the business to a family member, it is necessary to consider how to structure the transaction to meet the needs of the both the Owner and the Successor. Consideration needs to be given to the following:

• The percentage of ownership that will be transferred, the timing of this and if it will be way of instalments.
• The valuation of the business at the time of share transfers.
• Whether the shares will be paid for or gifted.

One of the biggest issues present in a succession to a family member is how to fund the transaction.

Often the shares are gifted to the child, however, this creates issues of fairness with other family members who may question why someone is receiving a valuable asset when they are not. To maintain equity and fairness, this approach is often recognised by way of inheritance offset so the value of shares gifted to the child working in the business is offset against the amount other family members receive from the inheritance pool at the time of the parents passing. Again, this approach does present issues, primarily around asset valuation. A business asset may increase or decrease at markedly different rates than a property asset investment and the final amounts received by beneficiaries may differ as a result.

Selling Shares

A better approach to the issue of share transfers to a new generation is sell the shares to the family member at an agreed value.

To do this the business is valued by an independent valuer and this is used as the basis of structuring an ownership transfer.

In this situation above, it was decided to sell the son a 50% shareholding over 4 years subject to meeting various performance hurdles including year on year profit increases to achieve the exit value required by the owner. The transaction was structured as a loan that allowed the son to buy the shares in tranches with loan repayments funded by offset against his dividend entitlements.

So far so good. However, the sale of the remaining 50% ownership stake became contentious when a value was placed on it. The son proposed he should buy the remaining 50% at the original value placed on the business at the time of original valuation. However this meant the capital gain of approximately $2.5m in the business value would go to the son at the expense of the other siblings as part of an inheritance pool.

The alternative approach of valuing the remaining 50% stake at the time of sale in five years’ time led to adverse outcomes in that it the de-motivated the son to increase the value of the business as he would then have to pay for half of it, even if he would ultimately recovered a third of this value back through his inheritance entitlement.

A third approach was considered which was for the father to hold on to the 50% stake and have this as part of the inheritance assets. However, this would have led to the same situation as above where the son would have to pay market value to buy shares of his siblings if he wanted to maintain full ownership. Keeping the siblings on as minority owners typically creates issues managing the business and should be avoided where possible.

So as you can see, succession to a family member may appear to be the easiest option to exit your business but has a number of issues that need to be addressed to ensure a successful ownership transition and maintaining amicable family relations.

The most successful ownership transitions benefit from the experience and skills of a trusted business adviser who understands your circumstances and the nuances of various family relationships.  If you need advice to plan your succession and exit, call Giles now on 0800 758 766.

The post How to structure Business Succession to a family member appeared first on GECA Chartered Accountants.