Future Ownership Options
Brown Glassford and Co Ltd,
Up to five years ago most farmer clients of mine would have been farming as sole traders or partnerships. These structures are generally well understood and relatively
inexpensive to administer.
The most significant factors that have bought about changes to the way my clients do business are:
? The Matrimonial Act and more recently the Relationship Act.
? Rest home subsidies and the fear of the reintroduction of death duties.
? Clients having the profitability to deal with succession requiring thought to be
given to moving forward with more appropriate ownership vehicles even if
this results in some short term financial cost.
? Better taxable incomes and a reluctance to pay higher rates of tax.
The Workshop held as part of this paper will focus on looking to move from a simple ownership structure (partnerships) to a structure that has more complex entities.
In order to do this it is helpful to summarise the major features, advantages and disadvantages of the options available.
? Partnerships and Sole Traders
? Trusts (Non-Trading)
? Trading Trusts
The following commentary summarises these features and is based on the Advanced
Business Structures papers given by Graham Brown of Brown Glassford andf Co at the SIDE in
Partnerships and Sole Traders
? Inexpensive to establish and administer
? Decision making and administration kept “in the family”.
? Control maintained by founding family members.
? The following aspects of The Income Tax Act do not apply to partnerships and sole ? traders;
? Fringe Benefit Tax relating to benefits provided to owners.
? Deemed Dividends.
? Issues relating to overdrawn Current Accounts.
? Carry forward rules regarding losses and imputation credits, which can be lost
with a change of shareholding in a company.
? Governance rules may not be adequate for multi owners particularly if they are not
related. For instance Shareholders Agreements are usually more comprehensive in
setting the rules for running the business, distributing profits and the future sale by
one or more owner.
? Owners may be exposed to higher marginal tax rates than would apply if taxable
income was spread between more taxpayers.
? Unable to “skip a generation” with the transfer of assets.
? Assets are owned personally, leaving the owners open to claims from creditors, and
to claims under the Relationship Property Act.
? Personal ownership of assets leads to higher value of Estates and potentially less
eligibility for government funded benefits, e.g. rest home care, government
superannuation, student allowances.
? Entry and exit of investors or family members requires the sale and purchase of the
assets themselves. This can lead to taxation consequences such as taxable
depreciation recovered on plant, vehicles and buildings, and taxable profit on the sale
? Future transfer of ownership of assets becomes easier – involves a share valuation,
then transfer of shares, rather than the transfer of assets themselves. This can lead to
tax savings relating to the transfer of the assets themselves.
? Liability of shareholders is limited to the value of unpaid capital. Main sources of
potential liability are trade creditors, third parties affected by the company’s actions
and environmentally related issues (e.g. pollution, fire, contamination, etc). This can
be severely undermined by personal guarantees being required by Banks and
? As businesses become larger and more complex, a more formal management and
governance structure may provide benefits.
? Corporate tax rate 33% - Australians now 30% - may fall further. But note salary to
shareholder employees must be commensurate with work done (may limit salary in
some cases). ? Easier for off farm investors to invest capital without being involved in day-to-day
? Avoids individual ownership for asset tested benefits.
? If a Loss Attributing Qualifying Company, can still offset losses against shareholders’
? Higher compliance costs - slightly higher than for Trusts.
? More complex to wind up.
? Losses and imputation credits can be lost if shareholding is changed.
? Companies Act requires a higher level of care by directors.
? Companies Act requires that companies do not trade whilst insolvent.
? Potentially more taxation related issues to consider, e.g.
? Fringe Benefit Tax because working shareholders become employees.
? Non cash dividends to shareholders where goods and services pass at less than
? Capital gains taxable unless made in the course of winding up (most cases) or
company is a qualifying company.
? Tax losses quarantined in company unless company is a Loss Attributing
? Loss Attributing Qualifying Companies can be a problem with Trusts as shareholders
because of need to distribute dividends in every circumstance.
Trusts (Non-Trading) [i.e. owns passive assets - usually land and buildings]
? A Trust separates ownership into legal ownership (the trustee) and beneficial
ownership (the beneficiaries).
? ACC levies are not payable on income received from a Trust. However, care should
be taken to arrange alternative accident insurance if it is required.
? FBT may be avoided as this only applies where benefits are provided to employees.
Note however there is another school of thought which considers that provision of
services to the Trust constitutes an employer / employee relationship.
? The effective tax rates for income allocated from a Trust will be the tax rates for the
individual beneficiary - if an adult, subject to a minimum rate of 19.5%, or 33% if a
child under 16 for the full year. Alternatively, income retained in a Trust is taxed at
? Provides a mechanism for skipping a generation with the transfer of assets -
maximum life 80 years.
? An increase in the value of underlying assets and investments made from
retained profits will accrue to the Trust rather than individuals.
? If the Trust is discretionary, the trustees will have absolute control over
allocation of income and capital and beneficiaries can include children and
grandchildren. This potentially provides protection from claims by creditors
and spouses / partners.
? Transfer of assets may lead to potential avoidance of asset testing on benefits.
? Duties placed on trustees are onerous and include:
? Act personally, loyally and diligently in administering the Trust.
? Consider all beneficiaries when making decisions.
? Preserve the Trust property.
? Inform the beneficiaries of their entitlement. ? Complexity re bank securities - may mean personal guarantees needed, which dilutes
the asset protection objective to some extent.
? Also, trustees can be held personally liable for Trust liabilities. This is why
historically Trusts have not traded.
? Infant beneficiaries may accumulate significant Current Accounts which they can
demand to be paid out to them once they are no longer minors.
? The circumstances of all beneficiaries must be considered by trustees - potential for
claim/action by excluded beneficiaries?
? If Trusts are non-trading, there will be a limit to the amount of income which can be
transferred to the Trust - related to market rental of assets owned.
? Higher compliance costs than sole trade and partnership.
? “Modern” (post December 1992) Trusts with husband and wife as settlor, trustee and
discretionary beneficiaries would not have been effective under the old Estate Duty
rules (Estate Duty was abolished in December 1992). If such legislation becomes a
consideration again, these Trusts may have to be re-settled, although this can be
provided for in the Trust Deed. Care should be taken with the Trust Deed to avoid the
Trusts being treated as a sham (see below).
? In a similar vein, there is some concern that widespread use of Trusts, e.g. to own
family home, has potential to cause Government to legislate to protect the tax base
and reduce the opportunity for participants to qualify for state support. Accordingly,
if a Trust is used, I suggest it should be robust - for example, using a third non-
Care must be taken when a settlor (person putting assets into a Trust) is also a trustee and
a beneficiary. This applies to both trading and non-trading Trusts. In particular, I would
suggest firstly the use of a third independent (non-related) trustee (or in the case of a
corporate trustee, an independent director or shareholder). Secondly, I would suggest
that a person or persons who hold all three positions, do not also hold the power to hire
and fire trustees. This power should be held by an independent person as well.
Trading Trusts [ i.e. owns both fixed assets and trading assets]
The use of Trading Trusts in New Zealand is relatively uncommon. Advocates of Trading
Trusts argue that they combine the advantages of using ordinary passive asset owning Trusts
and a trading company, and overcome some of the disadvantages of both. In order to obtain
these advantages, Trading Trusts need to:
? Be discretionary with respect to the allocation of income and assets; and
? Use a corporate (company) as the trustee because potentially ordinary
individual trustees have personal liability for trading losses; or
? have the capacity for the corporate trustee to contract out of the potential
liability with creditors - this is probably not realistic.
Advocates for the use of Trading Trusts usually admit that they have potential problems
(from the point of view of protecting assets and minimising taxes and avoiding liability to
creditors and beneficiaries).
? Whereas the beneficial ownership of shares in a company is a matter of public record
(through Company Office records), the beneficiaries details / existence is not. 98
? If a corporate trustee is used, then creditors and customers may believe they are
dealing with a company rather than a Trust.
? If the corporate trustee owns no assets and has a low level of authorised capital,
protection of claims from creditors may be achieved. Even though a director has a
fiduciary duty to the corporate trustee (i.e. duty to act in the best interests of the
company), and the corporate trustee has a duty to act in the best interests of the
beneficiaries, arguably the directors of the corporate trustee as individuals do not
have a fiduciary duty to the beneficiaries. However, this line of argument is not
without its critics who argue that, whilst this lack of liability to beneficiaries may be
correct from the point of view of Trustee and Corporate Law, it may not be correct
from the point of view of the Law of Tort (where one person owes a duty of care to
another). There has been precedent for the Courts to look through a company to the
directors, who can then be treated as if they were the trustees.
? Capital gains can be distributed tax free. In a company this can only be done if the
capital gains made in the course of winding up or the company is a Qualifying
Company (5 or fewer shareholders).
? With companies tax losses and imputation credits (tax credits which can be allocated
with dividends), can be lost if shareholding changes above certain thresholds. ? Non-residents of New Zealand don’t suffer the loss of imputation credits which are
usually attached to dividends paid by companies from revenue profits.
Disadvantages [of a Trading Trust]
? The need to use a corporate trustee makes establishment, operation and understanding
more complex for owners. Other parties such as banks may require more complex
? Multiple ownership within a family is not well catered for - normally have to use
multiple Trusts, i.e. one for each family member.
? Passive assets, e.g. property, should be held separately from trading assets - to avoid /
minimise claims against passive assets from creditors, spouses and financiers. This
may require the use of more than one Trust.
? A build up of balances owing to beneficiaries should be avoided. These come when
the allocation of income exceeds the application or vestment of funds for the
beneficiary. In a practical sense this may limit the amount of income allocated each
year - particularly to infant beneficiaries. Accordingly, the tax saving benefits will
also be restricted. Note for all Trust payments for / to beneficiaries that these should
not be for necessities of life, e.g. food, clothing and shelter.
Note also that to qualify as beneficiary income, payments must either be made to or
on behalf of the beneficiary during the year, or vested in them (by Trustees Resolution)
within 6 months of the Trust’s balance date.
? Trading Trusts are likely to attract more IRD scrutiny than Non-Trading Trusts.
? In Australia, Trading Trusts have been taxed as companies since July 2000. In other
words, the Trusts pay tax on income, then distribute income to beneficiaries with tax
credits attached. If beneficiaries have lower income, they cannot utilise all the tax
credits. Our legislation could follow that in Australia.
How do I know if I need to change my existing structure?
? You need to identify the problems with the existing structure.
? This can itself be a problem as without the input of your professional advisers you
may not be in a position to identify the problems or quantify the financial benefit of
? In most cases changes in structure take time and are relatively expensive. Will it be
? Changes to structure need to be considered in relation to personal and financial
Considerations when moving to a new structure
1. Decide on name for new company or trust.
2. Decide on settlor, trustees, and beneficiaries if Trust.
3. Decide on Directors, Shareholders and Registered Office if Company.
4. Establish estimates for legal, accountancy and valuation costs. Make sure bank aware
of planning as securities may need to be transferred and there may be existing fixed
interest rate loans to consider regarding early repayment penalties. A new trading
cheque account may be required.
5. Agree on most appropriate date for transfer to the new entity.
Consider: (a) Annual Balance Date of existing entities
(b) Potential benefits of transferring before existing Balance Date
re current year’s income.
(c) GST Return periods for existing entities which may be
st(d) Deferral of tax payment if transfer left to 1 day of the next
6. Decide on the assets to be transferred after considering potential taxation
consequences, for example, with respect to profit on the sale of livestock and taxable
depreciation recovered on the transfer of assets (including buildings). Consider
leaving expensive items of vehicles and plant, some / all livestock and buildings (if
on separate title) with current owners. Any fixed assets left would be leased to new
trading entity. Any livestock left would be made available to the new entity. Bailors
cannot use NSC. Therefore, a bailment (rental) could be used only if existing owners
are using Herd Scheme or Market Value. If the existing owners are using NSC, a
Profit Sharing Agreement must be used rather than a bailment. Some commentators
consider that a disappearing bailment can be used.
7. Discuss which farm related shares will be transferred to the new trading entity, e.g.
fertiliser company shares, meat company shares, dairy company shares, trading
society shares, etc.
Write to Share Registrars re transfer.
8. Consider income tax consequences if land being subdivided, particularly if within ten
years of purchase, and remember that the clock starts again on the ten year rule for
the new owner regarding possible future subdivision of the land.
9. Avoid a sale and lease back of land where there is unamortised development, as
amortisation can only be claimed by a farming business (not a landlord).
10. Discuss Fringe Benefit Tax issues where using a company.
Will apply re cars, electricity and any other expenses paid on behalf of an employee
(including a shareholder, unless the company is a Qualifying Company and the
shareholder is not a shareholder employee - unusual).
Note recent increase in complexity of FBT regime and increase in effective rates
unless benefits are attributed to individual employees. General recommendation
would be to increase salary and ask employees to pay their own accounts, and
prohibit private use of motor vehicles owned by the company.
FBT on cars can be expensive. If relatively high business running may be better to
leave out of company and reimburse owner for the business running proportion.
11. Consider key person insurance for farm manager and key staff - mainly applicable for
Joint Venture Companies. Policy should be owned by the company
1. Arrange for valuation of assets to be transferred. Must be at market values, i.e.
livestock, plant and land. Consider proximity to last rating’s valuation - can
generally use if less than six months old.
2. Prepare final estimate of cost of income tax payable on transfer of assets.
3. Apply for IRD number and GST registration once Certificate of Incorporation (for
company) or Deed of Trust (for Trust) has been received.
? Consider Group GST Registration. To get this one party must control all
members. Not permitted where trusts are involved.
? Consider whether GST going concern rules apply which would mean the
transaction could be zero rated.
? Consider making company a Qualifying Company and possibly a Loss
Attributing Company. This can only be done if no more than five shareholders.
4. Register the new trading entity as an employer. De-register existing trading entity
5. Revise Wills of all parties as appropriate. Consider appointment of replacement
Directors or Trustees. Consider transfer of controlling shareholding on death or
incapacity of founding controlling shareholder(s).
6. Set up gifting programme re residual debts.
Consider making initial gifts of more than $27 000 at lower duty rates.
For example: Gift of $36 000 - duty equals $ 450
Gift of $50 000 - duty equals $ 2250
7. Arrange insurance.
Income tax planning ? Income tax benefits must be seen (and documented) as an ancillary benefit and not
the main purpose of the restructuring. The potential tax savings can be worthwhile
with the current tax rate regime.
? Take care in correspondence and documentation. Transfer assets at valuation. Use
Sale and Purchase Agreements. Prepare Employment Contracts for employees of
company or Trust.
? Suggest a couple need to have a taxable income of between $150 000 and $180 000
before tax savings equate to compliance and set up costs of alternative ownership
For example: Husband and Wife Partnerships Taxable Income, say $140 000
equals $70 000 each
Potential tax saving to shareholders if income above $60 000 salary,
taxed in the company, will be: 2 x $10 000 x 6% = $1200 p.a.
Compare with savings which can be made by paying wages to children who are doing
the required work. i.e. marginal tax rate for income from wages up to $9500 equals
For example: 2 children x $5000 wages per annum x 24% (39%-15%) saving equals
$2400, and no set up costs and minimal additional compliance costs.
Note that the wages become the property of the child - requires care. Normal
requirements re deducting PAYE and maintaining wage records will apply.
? Husband and wife partnership - both in forties.
? Owned their property which was a new conversion in 1996.
? Currently milking 600 cows on 170 ha [229 000 kg of solids]
? Partnership owns all livestock, plant and land and buildings.
? Two children 14 and 16.
1. Land, buildings and Fonterra shares - Estimated Value $3 800 000
2. Accumulated Depreciation
Buildings $ 70 000
Plant $128 000
Motor Vehicles $ 32 000
3. Livestock Av Book Value Market Value
125 R1yr heifers $619 $ 620
120 R2yr heifers $800 $ 1120
480 MA cows $900 $ 1300
725 _______ _______
TOTAL VALUE $605 375 $842 556 Difference $230 525
====== ====== ======
Taxable income 2001 $280 000
5. Unamortised Development $230 000
1. No succession plan in place - do they need one:
2. No structure to limit relationship claims.
3. Some potential to increase income by intensification or buying additional land.