The huge cost of business failure – and paying the taxman.

By Bob Weir,  August 21, 2016

In recent months I have been doing some research into the reasons businesses fail, so we can learn from their mistakes.

My definition of “failure” is a business that was liquidated.  These are businesses who could no longer meet their financial obligations to others. They either chose to close their business or were forced to close and sell off their assets to pay those they owed money.

If a business is liquidated the liquidator’s report is a document that is available to anyone who wants to read it.  It includes the directors involved, who they owed money to, and if known, why the business failed (Refer to the Insolvency Watch website or the Companies Office website).

I reviewed a sample of 450 liquidations in 2015 to establish what trends arose. 

One thing that was very unclear was the root cause of the failures. Many directors could not be found to explain what happened.  Many made statements like “market conditions were difficult” or other generic statements that offered very little insight.

The one thing that was absolutely clear was how many businesses failed, still owing the IRD money. In the majority of cases it was the IRD whose warnings led to the owners voluntarily liquidating the business or it was the IRD who applied to the courts to have the business liquidated.

So how big is this issue?

Keep in mind that every tax dollar lost is a tax dollar the government has to find from somewhere else or a dollar they can’t spend on us, the taxpayer.

The IRD were very helpful in providing me with details on the issue, as scary as the numbers are.

Over the three financial years of 2013, 2014 and 2015 the total debt still owing to the IRD from liquidated businesses was $720 million dollars, or on average, $240 million per year.  When looking at the number of businesses that were liquidated in this period the average IRD loss was $129, 000 per business. 

You might think the larger business failures we have seen in recent years would be the main contributors to this (such as Solid Energy, Dick Smith, South Canterbury Finance, to name a few). 

Sorry, but it’s mainly small businesses causing the problem.

Of the 450 failed businesses I reviewed almost 75% of them had only one director and a further 20% only had two directors, most being husband and wife.  The money owed by these small businesses, including the IRD, the banks and other creditors, on average, was $240,000 per business.  Scary numbers!!

This blog is too short to attempt to explain why all these business failed (that’s the topic of my next book!).  However, I would like to highlight how businesses can avoid the huge IRD bills we seem to build up.  Here are some recommendations:

• Paying tax is a good thing. It means you are profitable and able to pay yourself something. Don’t get caught up in perverse, irrational business behaviours to avoid paying tax.
• When you employ people you will need to pay PAYE tax. If you take it off your employees pay the IRD. If you don’t, the IRD sees it being a bit like stealing money from your staff.
• If you start making more money (which is a good thing!!) you will probably need to pay GST. The 15% of your sales is not yours so put it aside. 
• If necessary, set up a bank account to put the tax you owe aside.
• As you become profitable you have to pay tax on your profits, namely provisional tax. This is based on past profits so they might hit you out of the blue. Talk to your accountant on how to predict what this will be and put the money aside.
• If you are not good at the book keeping, get someone who is. If you mess up your PAYE and GST, the price for a good book keeper will start to appear small compared to the tax mess you might be facing.
• DON’T use the cash you set aside to pay tax as your cash reserves. It’s not your money so don’t use it as your last cash option. Look elsewhere first.
• Manage your cash flow – it really is King. (If you want tips on this pop me a note as it’s a topic in itself).
• If you are unsure what tax you owe ask your accountant. The IRD will help if you call them, however, if you don’t get the right person on the phone and don’t know what to ask they may not give you your full tax picture.
• If you owe the IRD money and you are starting to struggle, PLEASE talk to them. Organise a meeting and walk through your situation.  If your business is viable and you take accountability to come up with a solution, they will help.
• If you ignore the problem it won’t go away - the IRD will step in and shut you down….if you doubt this, look at the statistics above one more time!!

I encourage further discussion on this issue so please send me your comments. I would love to hear your stories as we continue to explore this issue. 

If you want further tips on managing your way out of a tax issue please contact me.  

Please, let’s avoid further statistics if we can!!