If you’re a commercial or residential property investor the stakes are about to get higher in the distinction between repairs and maintenance and capital expenditure.  Repairs and maintenance costs are typically tax deductible.  But from the start of the next tax year, no tax deduction will be possible for depreciating most capital expenditure on most buildings.

The line separating these two types of expenditure can be fine – and the costs of getting it wrong can be high no matter which way you err.  If building repairs and maintenance costs are wrongly treated as capital expenditure, these costs may fall into a black hole with no chance of a tax deduction.  And if during a routine risk assessment the IRD finds capital expenses wrongly claimed as repairs and maintenance, penalties, use of money interest and a full audit may follow.

On one end of the continuum, expenditure that restores the building to the condition when you purchased it is likely to be tax deductible repairs and maintenance.  At the other extreme, work that improves the building is likely to be capital in nature.  And from the next tax year, these capital costs will typically be unable to be depreciated.

Black and white on the face of it, right?

But between these extremes, this can get rather grey.  Property investors often solve maintenance problems during capital expenditure.  Or they may use improved materials for an enhanced result during routine repairs and maintenance.

 

How do you treat the cost of replacing the somewhat tired original roof on your 1960’s era building that has sprung a serious leak in a storm?

 

Is fitting a new kitchen capital expenditure or repairs and maintenance?  How about when the old chipboard cabinets have become so soft and musty that the kitchen is generally unhygienic after years of leaking taps and hard use by tenants?

 

What if you take the opportunity to replace rattling timber joinery with modern aluminium windows after complaints from your tenants about the draughts? 

 

How do you stand with replacing a stained old toilet bowl and a cistern that no longer flushes reliably with a crisp new water saving unit? 

 

Or replacing a timber floor that is showing signs of rot around a wet area with a new, waterproof tiled floor?

 

There is often no black and white answer.  The correct treatment often comes down to the particular facts and circumstances surrounding the expenditure.  Every situation will have its subtle differences that may affect the reasonableness of one position versus the other.

Check with us before assuming your building expenditure will or will not pass scrutiny as tax deductible repairs and maintenance.  A little bit of careful attention will go a long way towards clarifying the situation and maximizing your tax deductions without falling foul of the IRD.

 

 

We now know that LAQCs will no longer be able to attribute their losses to shareholders from 1 April 2011. 

Now that the draft legislation has been released, we have a much clearer view of how the new rules announced in the budget will look.  On the face of it, this seems a rather radical departure from the changes proposed in the budget, which included no such axing of the ability of shareholders to access an LAQC’s losses.

However the draft legislation also introduces the “Look Through Company” (LTC), which will allow allocation of the company’s losses to shareholders in proportion to their shareholding.

The new LTC seems likely to be the new preferred option for people who currently hold loss making businesses or investments in LAQCs.  Shareholders will be able to elect for their existing LAQC or newly incorporated company to become an LTC from 1 April 2011.

So what makes an LTC different to existing LAQCs?  There are many subtleties, but the top three changes that will affect most existing LAQCs are these:

 

Unlike existing LAQCs rules, shareholders of LTCs will be personally taxed on the company’s profit at their own marginal tax rate. This seems reasonable as it aligns the treatment of the company’s profits with the treatment of its losses.

Unlike existing LAQCs, any transfer of shares in an LTC will be treated as a sale of the underlying assets. This may trigger significant depreciation recovery issues creating a tax bill without the funds to pay the tax from an actual sale of the asset. Careful management will be needed here.

Shareholders will only be able to access LTC tax losses to the extent the losses reflect their own economic loss from the company’s activities. “Economic loss” will include share capital, shareholder loans and company debt guaranteed by the shareholder, so this is not as narrow a test as many people feared following the budget.

 

All those currently operating LAQCs will need to consider their options with their tax advisors. Options will include:

The default option which is unlikely to be the best option will be to continue as a QC without the ability to attribute losses to shareholders.

Revoking LAQC status and being taxed as an ordinary company.

Electing to become an LTC as detailed above.

Becoming a partnership or a sole trader. Special rules will allow this transition without a tax cost – although if property is involved there will be significant conveyancing, legal and bank costs.

 

If you hold property investments in an LAQC, I suggest you review this with your tax advisor.

Some of the issues that will need to be considered are:  How long do you intend to own the property?  Do you intend to introduce other shareholders in the future – or to transfer shares into your trust at any point?  Does the property generate losses?  How long might these losses continue given the changes to depreciation rules?  What is your actual economic investment in the LAQC and how might this change in the future?

Although the introduction of the LTC is a complicating factor since the original budget announcements back in May, the new LTC structure does broadly reflect the changes announced in the budget.

 

 

The phrase “new normal” has been circulating for a while now to describe the current state of affairs featuring a tougher banking environment and retrenchment of debt laden businesses and households.  The new normal envisages a future where the economy is powered by exports and business investment rather than by consumption, easy credit and rising asset prices.

Consumers are adapting to the new normal en masse by delaying gratification and repaying debt.  We are collectively holding off on buying big ticket items – and we are adopting the collective attitude that if something isn’t on sale and seriously discounted, then we won’t buy it until the vendor is willing to just about give it away.  We want to see some blood on the floor before we commit.

Tough for business owners who are hanging on in anticipation of a return to the “old normal”!

So how does your business thrive in the new normal environment?   Here are our top seven tips:

 

Continue to be lean.  Assume that boom times are not around the corner, so lock in those bootstrapping attitudes that have served you well through the past couple of years. Don’t relax vigilance with keeping overheads under strict control. 

Monitor your margins closely – for the full range of your goods and services.  There is still potential for costs to increase – and your ability to pass these on may be limited.  The new normal is not an environment where you can thrive on the average of profitable and unprofitable activities.

Use cash surpluses to pay down debts.  The new normal is no time for excessive leverage.

Take good care of your customers – and focus on adding value for them.  Those businesses that are able to provide significant value with superior service will be the ones that gain market share and thrive in the new normal.

Look for growth opportunity – and if you do expand, continue to bootstrap and try to keep your use of debt to a minimum.

More than ever – remember, cash is king. Focus on your debtors and cash management every day – and try to keep enough cash on hand – or enough headroom on your banking facility – to cover at least 30 days of expenses.  Preferably more.  

Deal with employee issues with an approach that is seen to make sense.  Despite relatively high unemployment, there is still a skills shortage – and you’re probably operating with a pared down team.  Make sure your crew appreciates and buys into the direction your business must take to thrive in the new normal – and make sure that in return you are adding value for your team on the way through.

 

The old normal is unlikely to return any time soon – if at all.  Those businesses that have survived the ressession in reasonable shape – and who focus on the seven points above will likely stay ahead of their industry averages, gain market share and thrive in the new normal environment.

 

 

 

A big thank you to the 40 or so business owners and managers in the construction trades who attended the “Building a Better Business in the Construction Trades” conference hosted by Webb Ross >>> on the past two Thursdays.  David Grindle – partner at Webb Ross – put this conference together, and his plan is to make this an annual event.  Great effort, David.

My contribution to the event was to discuss the behavious and habits that separate the excellent operators in the construction trades from the average operators.  We work closely with quite a number of clients in the construction trades, so we’re well placed to comment on this.

Here are our top seven behaviours and habits (in no particular order) that separate the excellent from the ordinary in the construction trades:

 

1.  Excellent operators manage cash closely

Resolve disputes quickly – especially those that are holding up payment.

Get paid retentions – don’t let those few minor tasks like painting manholes etc drag on and slow up receipt of retentions.

Make sure you issue valid payment claims under the Construction Contracts Act.

Don’t use IRD as a bank. Its easy to ease cashflow by paying GST and provisional tax late, but it’s expensive money.

Keep your bank in the loop. If you have banking covenants, honour them.

Get a variation agreed if the scope of a job creeps outside what has been contracted for.

Keep a cash reserve.  Preferably enough to cover 30 days of overheads.

 

2.  Excellent operators monitor profits closely

Back Cost most if not all jobs on completion.  Did they go as planned.  If not, why not?

Set KPIs – and monitor them monthly.

Set and monitor budgets.

Prepare monthly financial statements promptly, compare them with budget and understand variances.

 

3.  Excellent operators always use contracts

Although the Construction Contracts Act only requires written contracts for jobs over $20,000, we recommend written contracts for all jobs.

Know your payment milestones and manage the job around them.

Manage variations – and communicate these immediately.

Get the best from the claims process – follow the process laid out in the Construction Contracts Act to the letter.

Get paid retentions in a timely manner.

 

4.  Excellent operators are compliant

Comply with the legislation that applies specifically to your industry such as the Construction Contracts Act.

Keep proper accounting records.

Always use employment agreements for employees.

Pay people through the system – not in folding.

Deduct withholding tax from subcontractors where required.

File GST, PAYE and tax returns on time.

Comply with health and safety best practice.

 

5.  Excellent operators manage risk

Don’t rob the next job to pay for the last job as this creates huge financial risk if work slows down or stops.

Have proper insurance.

Get basic structuring right.  Operate through a limited liability company, always sign contracts as director rather than as an individual – and don’t accumulate valuable assets in your trading company.

 

6.  Excellent operators are organised

The construction trades require careful organisation – and the lack of it is a big predictor of failure!

 

7.  Excellent operators manage their brand

Appearance, apparel, vehicles, stationery and telephone manner are all important.  Be seen to be professional.

Know where your referrals come from and nurture referrers.

Network and get involved in the industry. 

 

It is my belief that the more ticks you can put beside the items listed above, the better your chances of excelling in the construction industry.  As you will know if you are interested enough to have read this far, the bar is much higher in this industry than it was a few years ago – and the ways of operating that were once acceptable just don’t cut it any more.

 

 

The upcoming increase in GST rate means some action for most businesses on the software front.  Typically if you’re using the latest version of your software, any upgrade to manage the change in GST will be reasonably painless.  But where you’re using an older version, you may find yourself needing to upgrade to the latest version before any patches or updates for the GST changes will work.

Here is a summary of what will be required for users of the more common software packages used by owner-managed Kiwi businesses.

 

MYOB

If you’re not using the most recent version of MYOB, you’ll need to upgrade.  Dig out your software serial number and key it into the box on the MYOB website >>> to check whether you need to upgrade.  MYOB will soon release a patch to registered users of the latest version which will create a new GST rate code and update debtors, creditors and recurring transactions.  It will also generate a transitional GST return and a new 101 GST return report.

 

Xero

As Xero is delivered as a service on a subscription basis and accessed online, there are no upgrades required at your end.  You have already paid for any upgrades at the Xero end as part of your monthly subscription.  Look out for the usual notification box when you log in explaining any changes Xero may make to the interface in response to the GST changes.

 

MoneyWorks

MoneyWorks already has a facility allowing a change in the GST rate from a particular date, so no upgrade is necessary – even if you are using a very old version of the software.  Users will need to change the GST rate in the MoneyWorks Tax Table in their software – and to set the appropriate date of 1 October and the software will automatically take effect on the date.  Step by step instructions are available on the Cognito Software website here >>>.

 

BankLink

BankLink also already allows for a change in the GST rate in “Other Functions”, “GST Setup”.  You can enter the new GST rate now along with the date (1 October) for the new rate to take effect.  Also expect a free patch to amend the 101 GST return report.  BankLink are running free 30 minute webinars to help users through this if they are having difficulties.  Upcoming webinar times are on their website here >>>.

 

QuickBooks

If you haven’t already done so, you’ll need to upgrade to the latest version (2010/11) or QuickBooks Online.  The distributors, Quicken, will release a patch on 24 September for these two versions only.  The patch will automatically change the “S” tax item to 15%.  You will be able to select the appropriate GST code after 1 October, while historical data will remain unchanged.  Instructions will be posted on the Quickbooks website here >>>  on 24 September – and they will detail the checks and action you will need to take.  Disks will also be made available on 1 October. 

If you’re running the 2008 / 09 version, it appears possible to bypass the 2010/11 upgrade and the upcoming patch by manually changing the GST rate – although we don’t recommend it.  If you want to go down that path, please do not manually change the S rate from 12.5% to 15%.  Rather create a new tax code and tax item for GST for the 15% rate which will report through to the Tax reports and the GST 101 report.

 

CashManager

Users will need to upgrade to CashManager 2010 if you haven’t already done so.  This latest version will allow the new GST rate to be entered and utilised throughout the package.  Instructions on how to change the GST rate in CashManager 2010 are on the Accomplish website here >>>.

 

Although some earlier versions of these packages allow you to manually change the GST rate in the setup menus – and it may seem tempting to stick with your existing version of the software if it is only couple of years old, we don’t recommend this.  The time, energy and cost of unravelling errors later will likely far exceed the cost of upgrading now to stay with the latest fully supported version of your software.

If you have any concerns or problems, just call us.