Companies weren’t common. The Companies Act 1993 changed that by simplifying the rules, making them much simpler to operate.
The abolishment of estate duties in 1992 and the increase in the top marginal tax rate for individuals in 2000 led to a significant increase in the use of trusts to protect assets and reduce the amount of tax payable.
These factors changed the face of the structures we use.
More recently the top effective tax rate for all common ownership structures became 33% for individuals, companies, and trusts, meaning tax savings are less of a consideration than in the past.
As a result the commercial objectives of the business owners have become more important.
Protecting assets from business risk has become a significant driver behind which business structure to use, particularly in light of recent changes to health and safety legislation.
More caution is being exercised in relation to company directorships where the director is not involved in the day-to-day operations of the company, because legislation and the courts continue to make directors personally liable when things don’t go to plan.
Trusts are falling out of favour because lawyers and accountants have become reluctant to take up trusteeships because of the personal risks involved, despite the New Zealand attitude of “she’ll be right” continuing to pervade many business structures.
When setting up a family-owned farming business, why choose a trust or a company over personal ownership in a partnership or as a sole trader?
Companies have many advantages over other business structures. They provide limited liability for shareholders, enabling them to separate private assets from the trading risks of the business.
Companies have many advantages over other business structures. They provide limited liability for shareholders, enabling them to separate private assets from the trading risks of the business.
Companies have a separate legal identity to their shareholders. They also provide flexibility of ownership, because shares can easily be bought and sold.
Taxing profits at a flat rate of 28% provides for the deferral, in the first instance, of 5% tax until a dividend is paid. It is essential the rules of engagement are clearly set out through the constitution and shareholders’ agreement.
Trusts, while continually under attack in the courts for varying reasons, continue to provide flexibility in the distribution of income and assets to a wide group of people (beneficiaries) who, for example, might otherwise not be shareholders in a company.
The effectiveness of trusts in protecting assets from spouses or new relationships, or to keep farming assets in the family has been steadily eroded by the courts in recent times.
Careful management is required for a trust to continue to provide all of the advantages historically associated with that structural choice.
The use of a trust as a trading entity is largely limited to single family businesses because of the discretionary nature of the deed and the flexibility surrounding the allocation of income.
Trading as a sole trader or through an ordinary partnership is commonly regarded as being a poor choice because of unlimited personal liability.
However, there will continue to be circumstances where a sole trader or partnership remains a useful business structure.
The simplicity and ease of setting up as a sole trader or partnership should always be tempered by the additional risk being taken on by the owners and the adverse consequences that can arise on death.
So what type of structure is appropriate for a farming business in 2016?
There’s no “one size fits all” answer but it’s difficult to go past a company as an appropriate structure for any farming business, whether a contract milker starting out, a sharemilker or a farm owner.
It’s how far you go with that structure that’s a key decision. The cost of putting a “Rolls Royce” structure in place at the outset can outweigh the immediate advantages.
This is where a company can come into its own, in that it can be relatively easy to change the shareholding and progress from a simple structure to the Rolls Royce structure over time.
Set and forget is not an option, however. The ownership structure should be reviewed annually to ensure it’s still fit for purpose.
For example, the shares in the company might be held personally but as equity grows it might be appropriate to transfer ownership to a trust so wealth accrues in the trust rather than personally.
For larger farming operations, more than one company might be appropriate – one for the farming activity and one to own the land or other assets.
While separating assets this way can provide an element of risk protection from creditors (other than your banker in most cases because of interlocking guarantees) it does come with additional compliance costs.
There was a time when land ownership by a trust was in vogue, and the land was leased to the farming entity, usually a company.
This type of structure worked well for asset protection and in some cases succession planning purposes but had a tendency to be inefficient from an income tax perspective and a compliance headache in practice.
In our view trusts are best used to hold passive assets earning dividend or interest income rather than business assets.
In our view trusts are best used to hold passive assets earning dividend or interest income rather than business assets.
A family farming business operated by a company, with the shares owned by a trust or trusts, would be the structure of choice, with variations depending on the objectives and requirements of the owners.
Using a trust as a shareholding vehicle rather than a business asset owner can allow for succession planning, where shares are transferred over time by the trust to the children coming through in the business.
The trust relationship would allow for value to be gifted, enabling the transfer of the shares as and when appropriate without cash changing hands.
Relationship property is often a key consideration at this point and while trusts can be effective in protecting assets from relationship property claims, the courts have frequently looked through the trust to ensure a fair and proper outcome.
There are certainly no guarantees that trust assets will remain outside the relationship property asset pool.
Careful consideration should be given to the business structure before setting it up. This should include consideration of the exit strategy because this will have a significant bearing on what type of structure is appropriate.
There are no wrong or right answers but owners should be prepared to adapt their structure as the business changes. Failure to do so could result in significant issues arising when change really is required.
Change will always come at a cost so it is important to carefully consider an appropriate structure at the beginning.
It’s also important you really understand the structure your accountant or lawyer is suggesting, and you’re prepared for the ongoing costs associated with operating that structure, whether it’s the cost of annual financial statements, separate bank accounts for all entities and so on.
Once you move beyond the traditional family farming business to equity partnerships the choice of appropriate structure changes.
As a trading entity a trust generally won’t be appropriate for the farming business of an equity partnership.
Companies and limited partnerships will often be the structures of choice, with the latter providing the ability to cater for the different tax profiles of the investors as well as potentially providing an easier exit strategy pathway.
Again, careful consideration and advice at the outset is essential to ensure the structure is fit for purpose. A constitution, shareholders’ agreement or limited partnership agreement are essential to govern the activities of the farming entity.
Whether your farming business is large or small, you’re just starting out, or you’re looking towards retirement, your choice of business structure is a key element that requires careful consideration and constant review.
A company will be the right structure for many but your individual circumstances will dictate whether it’s the right structure for you.
• For further information, contact Tony Marshall, tony.marshall@crowehorwath.co.nz, 03 474 5841, 021 978 079. About Crowe – Horwath Crowe Horwath New Zealand provides practical accounting, audit, tax and business advice to individuals and small and medium businesses from a comprehensive network of more than 20 offices around New Zealand. Disclaimer – This article provides general information only, current at the time of publication. The advice has been prepared without taking into account your personal circumstances. You should seek professional advice before acting on any material.
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