Welcome again to the McLean and Co. Newsletter in which we discuss current taxation and business matters. We trust you find it informative.  Any feedback would be welcomed.

McLean and Co. is a home based chartered accountancy practice based in Clive, Hawkes Bay.    Readers are invited to peruse the practice website www.mcleanandco.co.nz,  which lists services provided, gives contact details and indicates how to become a client, contains an extensive base of articles on business and taxation matters,  and has links to other websites that may assist your business.    Being a small firm itself,   McLean and Co. strives to provide a personal and professional service largely to a self employed person and small business client base.  Enquiries are welcomed.

We are happy to accept new clients.  Please contact ourselves at the contact points highlighted above if we can assist you in your accounting and taxation requirements. Our website lists information required for this in the following link:

INDEX

1. Inland Revenue and GST Number Range to be extended.

2. Lifestyle Farmers- Hobby or Lifestyle?

3. The Risks Associated with Property Develoment

4. How to Purchase an Existing Business

INLAND REVENUE AND GST NUMBER RANGE TO BE EXTENDED

The current stock of IR and GST numbers is beginning to run out and as a result IRD intend extend the number range. The new IR and GST number range will be 9 numbers long.

So why has this come about?

There are a number of reasons why the current range is coming to an end - such as new business creation, an ever expanding population (4,138,156 May 2006), family trusts, net immigration, government legislation changes such as family assistance changes and Working for Families, charities and other entities.

Why this solution?

The extension of the current number range will give continuity for taxpayers  and IRD's computer modelling has shown that the extended range will last until 2282.

How big is this change and what does it mean?

For most customers there is no change as you  will continue to use your current IR number. When the current number range runs out, all new taxpayers will be issued with IR/GST numbers that are 9 numbers long.     Employers, banks, financial institutions, software and payroll providers and IRD, however, will need to make changes to their systems and processes so that they can accept the new extended range.

IRD have also been consulting with payroll providers and software developers to make sure they have had enough time to make the necessary changes to their software packages.

From April 2007 IRD will be able to accept IR Numbers from both number ranges - 8 and 9 numbers long. Over time our forms/returns will show 9 boxes.

So what does it mean to you?

Current taxpayer- you do not need to do anything as IRD will continue to work with you using your current IRD/GST number.

Employers - if you deduct PAYE from Wages/Salary your systems will need to be able to accept the new extended range of IR numbers. You will need to check with your payroll software provider to ensure that their software is compliant. IRD are currently consulting with payroll software providers so they can update their products and make their software available to customers.

Payroll providers - your software/systems will need to become compliant. You can find out if you are compliant by viewing the specifications.

Resident Withholding Tax - your systems will need to be able to accept the extended range of IR numbers. The updated validation check will be available for year ended 31 March 2007 which will be available in December 2006.

Software developers - your software/systems will need to become compliant. You can find out if you are compliant by viewing the specifications.

LIFESTYLE FARMERS- HOBBY OR BUSINESS?

One of the difficult decisions for lifestyle farmers is whether to class their operation as a business or as a hobby.

Many lifestyle blocks are sold with the claim that owners will be eligible for GST refunds and tax deductions on expenditure, and that any tax losses can be streamed to offset tax paid on employment earnings.

Like most things in life, it is not that simple. To qualify for income tax deductibility, a ‘business’ must exist. The criteria is always a little vague, but depends on the nature of the activities, the period of time over which the activities occur, transaction volume, the commitment of time, money and effort, and the intentions of the taxpayer to make a pecuniary profit.

All too often, lifestyle farmers are left desperately trying to justify that their small holding is indeed a business.

The IRD just as doggedly argues that it is a lifestyle block and is wholly of a personal or domestic nature. The IRD aims to audit every business once in every five-year cycle. Defending the status of your lifestyle farm when that occurs, and the range of draconian penalties the IRD can impose if the status is overturned, can be daunting.

Even if you are successful in your claim, you are unlikely to be able to claim all of the deductions available to full time farmers.

The IRD will insist that expenses are apportioned between private and business use, and in many cases will allow no deduction at all. Apportionment may be difficult.   Inevitably, much of the produce is eaten or given away to friends, or livestock slaughtered for the owners own use. These are all trading stock, and their disposition for nil consideration is deemed to be gross income.

GST registration may appear an attractive option to claim GST input deductions, but it will lock you into the GST system. A few years down the track, most lifestyle farmers find that they have opened a Pandora’s box and regret ever getting their block caught up in the tax system.

What started out as a hobby and lifestyle choice with the added advantage of GST refunds and tax deductions and losses becomes an on-going burden of completing returns and paying accounting fees. The cost of getting out of the tax regime is prohibitive unless the block is sold, as full depreciation recoveries on all depreciated assets are taxable income, forestry trees may be considered a taxable disposition of standing timber, and GST has to paid back on the current value of land (which inevitably will increase markedly in value).

Think carefully before declaring your lifestyle farm to the IRD as a business. There may well be short-term benefits, but they come at the price of the on-going compliance burden.

In many cases it is usually much less stressful to acknowledge from day one that this is, after all, just a hobby or lifestyle choice. 

(Acknowledgement- substantially copied from an article by Peter Sibbald, Chartered Accountant)

THE RISKS ASSOCIATED WITH PROPERTY DEVELOPMENT

Over the years many property developers have gone broke What  are the risks involved in property development?

Some of the significant risks I have come across include:-

HOW TO PURCHASE AN EXISTING BUSINESS

Building your own business is hard work. That's why many entrepreneurs choose to buy an existing business rather than starting from scratch.  But how can you avoid sinking all your resources into a business that is sure to fail?   What should you look for?  What should you avoid?

This article will help you evaluate the advantages and disadvantages of buying an existing business, as well as provide you with some tips that should help guide you as you make what is bound to be one of the most important decisions you will ever make.

Good Reasons to Buy

There are several advantages to buying an existing business as opposed to starting your own.  Most obviously, you save time.  Suppose you want to start a retail business.  It may take months for you to build an adequate inventory.  Opening your own restaurant means creating your own recipes and menus; building a manufacturing business from scratch can take years. But when you purchase an existing business, the "dirty work" has already been done.

If the business you want to buy offers a product or a service, you can evaluate the operating history and better understand the demonstrated market.  Are people buying the product or service?  What are they willing to pay?  What type of advertising has been most effective?  When you start your own business, it can take many years of trial and error to establish your market.  Purchasing a business can alleviate this process.

Buying an existing business will allow you to evaluate its cash flow and operating expenses, giving you a better idea of how much investment capital you will need.  When you start your own business, these numbers are much more difficult to estimate, and investors consider start-up businesses higher risk than existing ones with operating histories and proven track records.

Perhaps the biggest advantage to buying over starting a business is the existing business's potential.  You may see growth opportunities the current owner doesn't, or maybe you have a superior business plan.  Your enthusiasm and excitement for the business can revive it and help it to grow, and often relatively minor changes in advertising, personnel, or procedure can greatly improve profitability.

But, there is a downside …

Of course, there are disadvantages to buying a business, and you must weigh them seriously against the advantages. For example, unless you plan to replace all of the existing staff, you will have employees working for you whom you did not hire and whom you do not know. They may be resistant to the changes that you make. You may find it difficult to motivate employees who have become complacent under the old management or that there are personality conflicts between new and existing employees.

Evaluating the current operations of any business can be a daunting task, and when you consider buying you must do this thoroughly and with diligence.  Health inspections, building inspections, financial analysis -- the list goes on, and you must be prepared to do it all before you sign the dotted line. This can become costly, especially if you are comparison shopping.

Remember, the seller may try to downplay any business problems.  He or she may not be honest about operating cost or profits, and there is the possibility that the "books are cooked."  That is why you must have a capable financial expert explore all records thoroughly.

Additionally, make sure you understand the current customer base.  Financial records indicate only the number of sales or clients, not the level of customer satisfaction.  What if you inherit a dissatisfied customer base?  Or, conversely, what if the customer base purchases the product or uses the service simply because they have a relationship with the current owner? This problem can present itself particularly if the business you purchase is a family business, a small-town business, or in many cases, both.

Then, there is the issue of lower potential for returns.  Whenever you invest in anything, regardless of what it is, the general rule is less risk equals lower returns.  Buying versus starting your own business is no different, and although every situation is unique, typically buying a business brings a lower return on your initial investment than starting one from scratch.

And last but not least, buying a business means you miss out on all the excitement that comes with starting a business of your own.  Depending on your personality, you may want to create something unique, unlike anything the world has every seen. When you purchase an existing business, you have to ask yourself if you are willing to take on something someone else has created.  Will you be satisfied taking the reins?  Or do you want to buy your own horse, build your own carriage, and be in control from the get-go?

Should you Buy a Franchise?

Franchises offer their own set of advantages and disadvantages. When you buy a franchise, you are purchasing a recognized brand name without an existing customer base in the area.  So, unless you purchase a franchise that is already up and running, you are dealing with a mixture of issues.

Buying a franchise can be a lot like starting your own business.  You will likely have construction or, at least, remodeling costs.  However, unlike starting your own business, you are not on your own.  You will have a parent company to instruct you through the start-up process, and later to guide you in your operating procedures.  But ask yourself: Are you willing to take direction and to follow procedures you did not create?  Oftentimes, entrepreneurs are entrepreneurs because they want to be independent and will resent not being in total control.

However, some business owners find franchises offer the best of both worlds -- the independence of running your own business without jumping into the complete unknown. Frequently, the brand name recognition and the lower wholesale purchasing costs associated with running a franchise appeal to new business owners. 

Tips for Moving Forward

If you've already decided that purchasing a business is the right choice for you, you may still have questions. Namely, how do you proceed? Here are some suggestions to help you start on your path to profits and success:

You bought the Business, Now what?

Make sure you disclose the transfer of ownership to all the business's creditors.  If possible, try to arrange for an article to be published in the local paper.  This will accomplish the two-fold task of making the transfer of ownership public and can serve as free advertising for the business itself.  Inform employees of your business plan, but take time to implement major changes.

Last but not least, try to keep in touch with the prior owner. You never know when you might have a question or even need advice.

Buying a business is hard work, but with patience and good legal advice, the hard work should go hand in hand with satisfaction and success.