EMAIL NEWSLETTER
JULY 2007
Welcome
again to the McLean
and Co. Newsletter
in which we discuss current taxation and business matters. We trust
you find it informative.
We
are happy to accept new clients. We would be happy to assist colleagues
and acquantances as new clients.
INDEX
-
Property
Tranactions- Questions and Answers
-
Tougher
Action on Property Speculation
-
How much should you Charge for your Product or
Service?
PROPERTY
TRANSACTIONS- QUESTIONS AND ANSWERS
The 2007 Budget included increased funding for Inland
Revenue Department to strengthen auditing of property transactions to ensure
people pay their fair share of tax.
The increase in funding will support and enable existing audit activity
to be strengthened in an area of risk that IRD have been actively pursuing for
a number of years. These questions and answers seek to answer most general
questions have on this area.
When is the sale of a property taxable?
Under current law, income tax may apply to profits made on property
sales in a range of circumstances:
- When land was bought with the intent to resell.
- When land has been developed or subdivided.
- When the seller is a dealer in land or a builder, or is associated
with a builder dealer or developer.
In these circumstances, tax should be paid on the profits, just as it
should on income from other kinds of investment.
How many houses can I buy and sell before I must
consider tax?
There is no set figure. When any property is purchased for the purposes
of resale, the profit may be taxable, depending on individual circumstances.
What if I'm not a developer, dealer or builder
(or associated with one) and I have not subdivided the land?
Your intent when you purchased the property will determine if the profit
from the sale of a property is taxable or not. If your main purpose was a
plan, desire or aspiration to sell the land when you purchased it, then it is
most likely that the profits made are taxable.
How does IRD determine my intent?
While your stated intent is considered, the evidence and patterns of
sales will also be a determining factor as intent is often verified by action.
To determine intent, we may look at statements you made to a bank manager or
advisor when you bought the property including any plans which may have been
made or discussed.
What if I lived in the property?
The sale of a family home is not normally subject to income tax. However
profits may be taxable if the homeowner has established a pattern of buying
and selling the properties in which they reside or the main intent when buying
was for profit.
What is the 10-year rule?
There are special rules for people involved in either the business of
developing or subdividing land, or people involved in the building industry.
These rules also apply when the property is held by an associated
person of a builder or developer.
Intent when a property is purchased is usually the determining factor in
whether profits from property sales are taxable. However in the case of
builders and developers, if the property is sold within 10 years the profit
may be taxable regardless of the original intention when it was purchased.
What are the penalties for not declaring profits
made from property sales?
The penalties range from 20% to 150% of the tax that should have been
paid depending on the circumstances leading to any omission. However they can
be significantly reduced by coming forward voluntarily. Find
out more about shortfall penalties.
I think I should have paid tax on my profits, but
didn't include them in my return. What should I do?
You should consider making a voluntary disclosure. You can find more
information in our booklet Putting your tax returns right (IR280). You can
read or download a copy at Forms and Guides on www.ird.govt.nz.
What are the benefits of this and how do I make a
voluntary disclosure?
Penalties are significantly reduced if you come forward before we
contact you. This is true of all disclosures not just those about property.
You may be entitled to a 75% reduction in the penalties that would be
applied if your activity is detected by us in some other manner.
There is also an amendment in a bill currently before Parliament that
reduces the penalties faced if you make a voluntary disclosure before being
advised that you are to be audited. The amendment means that if you make such
voluntary disclosures you will not attract a shortfall penalty if you have not
taken "reasonable care" or for having taken an "unacceptable
tax position". That change would take effect from 17 May 2007, the date
of introduction of the bill.
Find out more about not
taking reasonable care and unacceptable tax position.
How do I prevent penalties being applied?
You can prevent penalties by voluntarily complying with your tax
obligations and declaring and paying tax on all taxable sales. If you are
unsure then seek professional advice.
Am I supposed to pay tax on the property I have
just sold?
That largely depends on your intention when you purchased the property.
If you bought the property with the main intention of making a profit
then the answer is probably yes. If you purchased with the intent of residing
in the property as your home then the answer is probably no.
However everyone's circumstances are different and all the facts need to
be considered on a case by case basis. You should look at the facts
surrounding your purchase and apply these to the question "What was my
main reason for buying the property?"
If you are still in any doubt after you have done that you should seek
professional advice.
What do I do if I might not be able to pay my
tax?
If you are unable to pay the full amount due on time, you should contact
IRD as soon as possible. IRD will discuss your current circumstances and help
you determine the best option for dealing with the amount due. You can also
read or download our booklet Debt options (IR582) at Forms and Guides on
www.ird.govt.nz
.
TOUGHER
ACTION ON PROPERTY SPECULATION
Inland Revenue will expand its audit activity to ensure property
speculators pay their fair share of tax, said Finance Minister Michael Cullen.
"Budget 2007 provides a further $14.6 million to Inland Revenue
over three years to strengthen its auditing of property transactions,"
said Dr Cullen.
"Clearly, the big increase in housing investment in recent years
has contributed to inflationary pressures with consequent flow-on effects for
interest rates and exchange rates. Speculative activity has played a part in
pushing up house prices and household debt levels.
"Giving Inland Revenue further resources to help it enforce
existing law more effectively will increase confidence in the tax system and
should help dampen the effects of property speculation on the housing market.
"There appears to be a growing risk from property transactions and
perhaps a perception that it is easy to avoid tax on them.
"Under current law, income tax may apply to gains on property sales
in a range of circumstances - such as when land was bought to resell or has
been developed or subdivided, or when the seller is a dealer in land. In these
circumstances, tax should be paid on the profits, just as it should on income
from other kinds of investment.
"Managing compliance risks around property transactions is a key
priority for Inland Revenue. It is important Inland Revenue has the resources
to ensure the tax rules relating to property transactions are enforced.
"The Commissioner has said that more resources in this area would
enable existing audit activity to be strengthened. Inland Revenue has targeted
property transactions in recent years. The revenue from property auditing
averaged $100 million between 2004 to 2006."
HOW
MUCH SHOULD YOU CHARGE FOR YOUR PRODUCT OR SERVICE?
One of the most difficult, yet important, issues you must decide as a
business owner is how much to charge for your product or service. While there
is no one single right way to determine your pricing strategy, fortunately
there are some guidelines that will help you with your decision.
Before we get to the actual pricing models, here are some of the factors
that you need to consider:
The next step is to determine your pricing objectives. What are you trying
to accomplish with your pricing?
- Short-term profit maximization - While this sounds great, it
may not actually be the optimal approach for long-term profits.
Tis is common among smaller companies
hoping to attract investment and funding by demonstrating profitability as soon
as possible.
- Short-term revenue maximization - This approach seeks to
maximize long-term profits by increasing market share and lowering costs
through economy of scale. Higher revenues at a slim profit, or even a loss,
show that the company is building market share and will likely reach
profitability. Amazon.com, for example, posted record-breaking revenues
for several years before ever showing a profit, and its market
capitalization reflected the high investor confidence those revenues
generated.
- Maximize quantity - There are a couple of possible reasons to
choose the strategy. It may be to focus on reducing long-term costs by
achieving economies of scale. Or it
may be to maximize market penetration - particularly appropriate when
you expect to have a lot repeat customers. The plan may be to increase
profits by reducing costs, or to upsell existing customers on
higher-profit products down the road.
- Maximize profit margin - This strategy is most appropriate when
the number of sales is either expected to be very low or sporadic and
unpredictable. Examples include custom jewelry, art, luxury cars and other luxury items.
- Differentiation - At one extreme, being the low-cost leader is
a form of differentiation from the competition. At the other end, a high
price signals high quality and/or a high level of service. Some people
really do order caviar just because it's the most expensive thing on
the menu.
- Survival - In certain situations, such as a price war, market
decline or market saturation, you must temporarily set a price that will
cover costs and allow you to continue operations.
Now that we have the information we need and are clear about what we're
trying to achieve, we're ready to take a look at specific pricing methods to
help us arrive at our actual numbers.
Four Models for Calculating your Pricing
As was said earlier, there is no "one right way" to calculate
your pricing. Once you've considered the various factors involved and
determined your objectives for your pricing strategy, now you need some
way to crunch the actual numbers. Here are four ways to calculate prices:
- Cost-plus pricing - Set the price at your production cost,
including both cost of goods and fixed costs at your current volume,
plus a certain profit margin. For example, your widgets cost $20 in
raw materials and production costs, and at current sales volume (or
anticipated initial sales volume), your fixed costs come to $30 per
unit. Your total cost is $50 per unit. You decide that you want to
operate at a 20% markup, so you add $10 (20% x $50) to the cost and
come up with a price of $60 per unit.
So long as you have your costs calculated correctly and have
accurately predicted your sales volume, you will always be operating
at a profit.
- Target return pricing - Set your price to achieve a target
return-on-investment (ROI). For example, let's use the same situation
as above, and assume that you have $10,000 invested in the company.
Your expected sales volume is 1,000 units in the first year. You want
to recoup all your investment in the first year, so you need to make
$10,000 profit on 1,000 units, or $10 profit per unit, giving you
again a price of $60 per unit.
- Value-based pricing - Price your product based on the value
it creates for the customer. This is usually the most profitable form
of pricing, if you can achieve it. The most extreme variation on this
is "pay for performance" pricing for services, in which you
charge on a variable scale according to the results you achieve. Let's
say that your widget above saves the typical customer $1,000 a year
in, say, energy costs. In that case, $60 seems like a bargain - maybe
even too cheap. If your product reliably produced that kind of
cost savings, you could easily charge $200, $300 or more for it, and
customers would gladly pay it, since they would get their money back
in a matter of months. However, there is one more major factor that
must be considered.
- Psychological pricing - Ultimately, you must take into
consideration the consumer's perception of your price, figuring things
like:
- Positioning - If you want to be the "low-cost
leader", you must be priced lower than your competition. If
you want to signal high quality, you should probably be priced
higher than most of your competition.
- Popular price points - There are certain "price
points" (specific prices) at which people become much more
willing to buy a certain type of product. For example, "under
$100" is a popular price point.- notice how many items
have $0.99 price. Dropping your price to a popular
price point might mean a lower margin, but more than enough
increase in sales to offset it.
- Fair pricing - Sometimes it simply doesn't matter what
the value of the product is, even if you don't have any direct
competition. There is simply a limit to what consumers perceive as
"fair". If it's obvious that your product only cost $20
to manufacture, even if it delivered $10,000 in value, you'd have
a hard time charging two or three thousand dollars for it --
people would just feel like they were being robbed.
Now, how do you combine all of these calculations to come up with a price?
Here are some basic guidelines:
- Your price must be enough higher than costs to cover reasonable
variations in sales volume. If your sales forecast is inaccurate,
how far off can you be and still be profitable? Ideally, you want to
be able to be off by a factor of two or more (your sales are half of
your forecast) and still be profitable.
- You have to make a living. Have you figured salary for
yourself in your costs? If not, your profit has to be enough for you
to live on and still have money to reinvest in the company.
- Your price should almost never be lower than your costs or higher
than what most consumers consider "fair". This may seem
obvious, but many business owners seem to miss this simple concept,
either by miscalculating costs or by inadequate market research to
determine fair pricing. Simply put, if people won't readily pay enough
more than your cost to make you a fair profit, you need to reconsider
your business model entirely. How can you cut your costs
substantially? Or change your product positioning to justify higher
pricing?
Pricing is a tricky business. You're certainly entitled to make a fair
profit on your product, and even a substantial one if you create value for
your customers. But remember, something is ultimately worth only what
someone is willing to pay for it.
The information
provided in this email newsletter is for informational purposes only.
McLean and Co. accept no responsibility for the opinions and information
expressed in the information provided and it is provided "as
is" without warranty of any kind. The user
assumes the entire risk as to the accuracy and use of this document.
Readers are asked to seek professional advice pertaining to their
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