tax on side income and expenses in new zealand

Question

Got a couple of really basic tax questions.

I'm looking to register as sole trader to sell some woodworking projects and to have a small side income trading under a trading name. I also have a full time job on which i already pay PAYE.

I understand that i'm going to have to declare any extra income and file an IR3 at the end of the tax year to pay tax on that income, but i've got two main questions;

a) Am i required to declare all expenses related to that side income ? It's quite likely to be as much or more than the actual income if i claim everything (like a % of my house power due to working from home, raw materials, and etc). I understand that'll make it a loss for tax purposes and i'll pay zero tax on the income, but do i have to claim everything anyway, or can i just claim enough expenses to cover the amount i'd have been taxed ? I'm ok with this business coming out as break-even.

b) Would this affect my PAYE tax that i've already paid at all ? I've read in some places that you should declare all expenses from a side income (i think it was due to otherwise possibly representing the business as more profitable than it was if you came to sell the business), but if i do that and it turns out i've had more expenses than income, does that affect my PAYE tax ? I'm hoping the answer is no, otherwise surely they'll be angry that a side income is taking their tax away again, and classify it as a hobby.

Regarding the hobby bit, the issue is that while to me it's something i enjoy doing and i'll probably not even break even, i'd definitely like to make a profit if i can and the 'intention to make a profit' is generally what they classify as being a business.... But realistically i'll probably make a loss after expenses :) However after registering a domain name, putting out a bit of advertising etc wouldn't it be hard to classify as a hobby any more ?

Or am i overthinking this entirely ? At what point does lost tax become an issue ? $100/pa ? $1000/pa?

Answer 1

Your accountant would be able to best advise you based on your situation but there are a few general principles:

1. In general, a business activity is with a view to making a profit. If you are not breaking even based on your costs, then it becomes an exercise that can lower your overall taxes (you could potentially get back some of the tax you paid through PAYE), but tax authorities generally take a dim view of deductions from loss-making businesses as it is a method people some people try to use to avoid taxes.

2. If you did deduct expenses (and they were all applicable and valid) you could potentially carry them over to your next tax year.

IRD might also be able to offer some guidance if you contact them.

a) Am i required to declare all expenses related to that side income ?

No. Deductions are optional for the purposes of lowering your tax rate.

b) Would this affect my PAYE tax that i've already paid at all ?

Potentially. I don't know how PAYE works in New Zealand, but you might be able to get a credit from your PAYE if you had a loss. You might need to make additional payments of tax if you make a profit. You might be able to get that collected through the PAYE system by increasing your tax rate.

One thing you might want to consider is setting up a limited liability company (e.g. Ltd.). That will probably have its own separate tax return, and some administrative overhead, but will limit your liability if something goes wrong. All of this however is additional work, which probably makes sense if you're bringing in more than enough income to more than cover the costs of the overheads. It does however provide a clean separation of you from the company which can have some benefits, and potentially more room for deductions.

Answer 2

You'll need to file an IR10 as well as an IR3. If you track your income and expenses carefully they can easily be filled out online without needing to pay an accountant.

I would go ahead and include all your expenses. It's common enough for new businesses to run in the red for the first couple of years (my wife's first business definitely did). I've heard of a guideline that the IRD expect two profitable years in the first five, but I have no direct experience of that.

Any loss on your side business will reduce your tax liability from your regular job, so you should be due a refund.

As to how much of a loss you're allowed, I lost NZ$50,000 on a "side" business last year. The IRD queried it, but I had statements to back it up so they accepted it after only a few extra days.