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If you are considering starting your own business, you should think about which business structure will best suit your needs. Operating as a sole trader is one of the most common structures in New Zealand because it is easy and cheap to set up and run. Before choosing this structure, you should consider:

  • whether becoming a sole trader right for you;
  • your tax obligations as a sole trader; and
  • what is involved in setting yourself up as a sole trader.

This article explains the pros and cons of becoming a sole trader to help you decide whether it is the right business structure for you, including some legal and financial implications of this decision.

What Does it Mean to Operate as a Sole Trader?

As a sole trader, you go into business and trade on your own. This means that you do not need to share control of your business or split your profits with others as partners do. Likewise, you will not need to register with specific regulatory authorities as a company would. Meanwhile, you can still enjoy benefits like: 

The start-up costs to set up your new business as a sole trader are low. Importantly, you can offset your losses against other income sources. You may also be entitled to government benefits and other programmes to help you get your business off the ground. 

This flexibility appeals to many small business owners, especially if you are:

  • operating a trade, such as being a plumber, tiler, electrician, carpenter or hairdresser;
  • involved in creative crafts, such as being an artist, actor, model or journalist; and
  • in the service industry, such as being a consultant or gardener.

However, being a sole trader also has some drawbacks, including that:

  • you may be putting your personal assets at risk, unless you take steps to protect them;
  • it is harder to get a loan and raise capital;
  • there is no one else to share ideas or decisions with; and
  • it can be harder to grow or sell your business.  

If you think these factors will be problematic for your business, you might consider establishing a company or partnership instead. These options would allow you to operate your business as a separate legal entity.

Is Becoming a Sole Trader Right for You?

Before you set yourself up as a sole trader, you should consider whether you:

  • want to share the responsibilities of managing your business;
  • want to split the income and losses of your business with other people;
  • plan to sell your business in the future; and
  • will require any large loans or debts to expand your operations.

If you are not interested in pursuing any of these considerations, then a sole trader business structure is likely to suit your needs. This is because it: 

  • is a cost-effective and straightforward structure to set up and run; and 
  • has lower tax compliance compared to a company. 

If you are not sure, it may be a good idea to:

  • talk to someone who is already trading in your industry; or
  • get advice from a lawyer or accountant that specialises in this area.

What are Your Tax Obligations as a Sole Trader?

When setting up your business as a sole trader, you may need to set aside funds to cover your tax obligations. A tax agent can help you save you time and money.

Income Tax 

As a sole trader, you pay tax on the net profits (income minus expenses) that you earn from your business activities. It is crucial to maintain accurate financial records to make it easier to work out your tax liability at the end of the year. 

In New Zealand, sole traders are subject to the individual tax rates. These are progressive or gradual, which means they increase as your income increases. The top personal tax rate is 33% for income over $70,000. Sole traders file an IR3 tax return with Inland Revenue (IRD) at the end of the financial year.

You can reduce your tax liability during your first year in business as a sole trader by spreading your tax payments. If you make voluntary payments during your first year, you may be able to get an early payment discount of 6.7%. For example, if you owe $10,000 income tax at the end of the year, this discount can save you $670. 

Provisional Tax 

Provisional tax is not an additional tax. It is a way of managing your income tax by paying instalments during the year as opposed to a lump sum payment at the end of the year. This helps you avoid having to front a large tax bill all at once. 

There are four options available to calculate your provisional tax. Your accountant or tax agent can help you choose the easiest method depending on your circumstances. For example, the standard option is useful if your income is steady or increases over the next year. 

GST

Most goods and services (including imports) are subject to GST at a rate of 15% of the product price. If you supply goods or services (for example your labour) and you are expecting to earn more than $60,000 a year, you are required to register for GST. On the other hand, if you are expecting to earn less than $60,000 a year, you can voluntarily register for GST.

If you are registered, you must charge GST on the goods and services that you sell. Additionally, you can also claim back GST that you have paid on items that you purchased for your business.

Flat-Rate Tax on Schedular Payments 

Schedular payments are payments made to contractors who perform specific activities. For example: 

  • builders contracted to a labour-hire business; 
  • freelance journalists paid to write a magazine article; or 
  • contractors working in the horticulture or film sectors.

When you receive schedular payments, PAYE is not automatically deducted from your income, so you have to pay a flat-rate tax.

Expenses 

You can reduce your income tax liability at the end of the year by claiming back some of the expenses you incur while carrying out your business activities.

For example, you may be able to claim the costs of running: 

  • your vehicle for business purposes; or 
  • the area of your family home that you use for work. 

Record Keeping 

As a business, you must maintain tax records and keep these for seven years after filing your return. Whether you are managing your taxes yourself or getting help from an agent, keeping records makes it easier to work out your taxes, meet your employer obligations and confirm your accounts.

These requirements can change with updates to government policy. When deciding whether you need to register for GST, always refer to the IRD website or talk to your tax lawyer.

How to Set Yourself Up as a Sole Trader

There are a number of key tasks that you need to do to set yourself up as a sole trader. These include:

  • choosing a business name and protecting your IP (you can check if your business name, web domain, trademark and social media usernames are available with One Check);
  • applying for a New Zealand Business Number (NZBN) (there is no additional cost associated with this, you just need your IRD number and proof of identity);
  • setting aside funds to cover your tax obligations, including GST if you earn over $60,000 a year; 
  • registering with IRD as an employer if you hire staff (your spouse, de-facto partner or civil union partners will require further approval to work in the business);
  • registering with ACC (make sure to select the correct business type so that they correctly calculate your levy);
  • setting up a business bank account to avoid getting your personal and business expenses mixed up; and
  • deciding on the best system to manage your finances.  

Key Takeaways

Setting up and running your business as a sole trader in New Zealand is relatively easy and cost-effective. However, before you choose a structure, consider whether this is the best outcome for you by thinking about the legal and financial implications of your choice. Importantly, although a sole trader business structure can save you time and many, it can also have some drawbacks. You will need to plan ahead and consider your future needs to determine what the best way to set up your business may be. Finally, sole traders must follow a range of tax obligations. This means that you may need to set aside funds to pay your tax at the end of the year. If you need help deciding on your company structure or getting yourself set up, contact LegalVision’s business lawyers on 0800 005 570 or fill out the form on this page.

FAQs

What is the difference between sole trader and self employed?

Yes, many self employed people are also sole traders. This is because many people who are not employed by somebody else choose to register their business under a sole trader structure. For example, freelance writers or designers are often self employed under a sole trader structure. However, it is also possible to be self-employed without being a sole trader if you have registered your business as a company.

Is it better to be a sole trader or a company?

This will depend on your specific circumstances and business plans. Being a sole trader is beneficial because the start-up costs are low, you are entitled to many government benefits and you can offset any losses against other income streams. It is also easier to set up because you do not need to register with regulatory authorities like a company. However, unlike companies, as a sole trader you may be putting your personal assets at risk. It can also be harder to get a loan, raise capital or sell your business.

How much tax will I pay as a sole trader?

As a sole trader, you will pay personal income tax on the profits from your business. You can choose to pay this under the provisional tax system, which enables you to pay your income tax in regular instalments rather than as a lump sum at the end of the year. If you are registered or required to pay GST, you will also need to charge and pay GST on the goods and services that you sell.

How do I become a sole trader?

To become a sole trader, you need to choose a business name and apply for an NZBN. You will need to register with IRD and ACC, as well as set up a business bank account. Finally, you will need to let IRD know if you intend to hire any staff.

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