The Comprehensive Guide to Tax Deductions for Sole Traders in New Zealand

“I think I should pay more taxes,” said no sole trader ever.

As a self-employed individual running your own business in New Zealand, you know the struggle of setting aside a significant portion of your hard-earned income for taxes. Perhaps you’ve found yourself wishing you could use those funds to grow your business or even take a well-deserved break.

Good news: there’s a legal way to reduce your annual tax burden!

Understanding Tax Deductions: The Smart Way to Keep More Money

The Inland Revenue Department (IRD) allows sole traders and small businesses to claim certain business expenses as tax deductions. This system essentially rewards you for investing in your business while allowing you to keep more of your money come tax day.

However, the tax deduction system isn’t as straightforward as simply buying something and paying less tax. Only specific business expenses qualify for deductions, eligible expenses vary by industry, and some purchases are only partially claimable.

In this comprehensive guide, we’ll explore:

• What tax deductions actually are
• Who can claim tax deductions
• What expenses qualify as tax deductible
• Different types of deductible expenses
• Record-keeping requirements for the IRD
• The 10 most common business expenses claimed by sole traders
• How Business Like NZ Ltd can simplify the expense claiming process

What Is a Tax Deduction?

Despite its name, a tax deduction isn’t money subtracted from your tax bill that you get to keep. Instead, it reduces the amount of income you’re taxed on, resulting in a lower tax bill and a reduced effective tax rate.

💡 Your effective tax rate is the average tax rate you pay on your income after applying all relevant tax rules.

When the IRD allows you to claim certain business expenses as tax deductions, you won’t pay tax on the claimed expense amount. This doesn’t mean you get this amount back as a refund.

Example: How Tax Deductions Work

Let’s consider Bridgette, a custom furniture maker:

• She receives an order requiring $7,000 worth of materials
• Her annual income from furniture sales is $75,000 (excluding GST)
• By claiming the materials as a tax deduction, she reduces her taxable income from $75,000 to $68,000
• At $75,000, her effective income tax rate would be 20.9%, requiring a payment of $15,670 to the IRD
• With the deduction reducing her taxable income to $68,000, her effective tax rate becomes 19.7%, lowering her tax bill to $13,420
• This single deduction saves Bridgette $2,250 in taxes!

Who Can Claim Tax Deductions?

In New Zealand, eligibility for claiming business expenses as tax deductions depends on your employment status:

PAYE Employees

People who aren’t in business (e.g., PAYE employees) generally can’t claim business expenses. They can only claim tax deductions for specific items like:

• Charitable donations
• Commission charged on earning interest or dividends
• Tax preparation fees
• Some income protection insurance
• Interest paid to the IRD for late tax payments

Companies typically cover work-related costs for PAYE employees, which is why they aren’t generally eligible to claim work-related expenses.

Sole Traders

As a sole trader, you can claim business expenses for costs directly related to your work. The general rule is that you can claim a tax deduction for a business expense if:

• The expense relates directly to earning income, OR
• The expense is necessary for running your business

Claiming eligible expenses is an excellent way to reduce your tax liability while investing in your business—a win-win situation!

💡 Important reminder: If an expense is used for both business and personal purposes, you can only claim the business portion.

What Expenses Are Tax Deductible?

It’s crucial to understand the difference between business expenses and tax deductions, as these terms are often used interchangeably but have distinct meanings.

Business Expenses vs. Tax Deductions

Business expenses are costs incurred as part of running your day-to-day business operations. If you need something to help you complete your work, that purchase is a business expense.

However, the IRD won’t automatically accept every expense as a tax deduction. They have specific criteria for what qualifies.

For example, work clothes are only deductible if they’re mandated uniforms, clothing with logos, or health and safety equipment. Even if you only use certain clothes for work, if they could reasonably be worn outside of work, they aren’t tax deductible.

Learn more: Tax Deductible Clothing

Tax deductions, on the other hand, reduce your taxable income. Most tax deductions are business expenses, but not all business expenses qualify as tax deductions.

Interestingly, you can claim tax deductions for things other than business expenses. Charitable donations are a common example—donations to IRD-approved charities are 33.33% tax deductible, provided:

• The donation is $5 or more
• It doesn’t directly benefit you or your family
• It wasn’t made to forgive a debt

Types of Deductible Expenses

Industry-Specific Deductions

The IRD’s guidelines serve as a starting point, but deductible expenses vary between industries and contexts:

• A musician can claim specialized performance outfits
• A tradesperson can claim safety equipment like hard hats

This means you can’t automatically claim everything your friends or colleagues claim—their deductions might not apply to your industry.

Partially-Deductible Expenses

Some business expenses are only partially tax deductible:

• Only the business use portion of a work vehicle, not personal use
• Only the percentage of your internet bill used for business while working from home
• Only 50% of certain entertainment expenses

💡 Remember: You must be able to prove that an eligible expense was partly or solely for business use; otherwise, it might not be accepted by the IRD.

Depreciating Assets

Depreciating assets are claimed differently than regular expenses. These are assets worth more than $1,000 that decline in value over time with use (e.g., cars, tools, computers, smartphones).

With depreciating assets, you don’t claim the entire cost upfront. Instead, you claim the amount it decreases in value each year—the depreciation.

There are two methods for claiming depreciation as a tax deduction:

1. Straight-line method: Claim the same amount each year, calculated as a percentage of the asset’s original cost.
2. Diminishing value method: Calculate depreciation each year using a constant percentage of the asset’s current value. This method is more reflective of the actual value and allows you to claim more upfront but less in later years.

Both methods use rates and timelines set by the IRD. You can ensure accurate depreciation calculations using their depreciation calculator.

If you sell an asset during its depreciation period, stop using it for business, or cease being a sole trader, there will be tax and GST implications. Always inform your accountant promptly about any changes.

Learn more about depreciation: Understanding Depreciation: A Key to Maximizing Your Tax Benefits

Keeping Records for the IRD

Maintaining clear, organized records of purchases and sales is essential for stress-free tax filing. The IRD requires you to save expense records (receipts) for seven years after purchase, either physically or digitally.

Imagine seven years’ worth of receipts scattered across your office floor—you’ll appreciate the value of a good filing system! Alternatively, digital solutions can help you store and manage your receipts more efficiently.

10 Most Common Business Expenses for Sole Traders

Based on real-world data, here are the top 10 most commonly claimed expenses by sole traders:

1. Depreciation: For business assets purchased for over $1,000 that must be depreciated. Remember, only claim the business-use portion.
2. Subscription fees: Recurring costs for business-related products like software subscriptions, online magazines, newspaper subscriptions, and licensing fees.
3. Light, power, heating: If you work from home, you can claim the business percentage based on the proportion of your home dedicated to your home office.
4. Mobile phone bills: Only claim the percentage used for business purposes if the phone serves both business and personal needs.
5. Equipment purchases: Items needed to perform your job (mobile phones, software, camera equipment, tools). For equipment over $1,000, depreciation rules apply.
6. Internet bill: Like your mobile phone, only claim the business-use portion. Installation or setup costs aren’t deductible.
7. Mortgage interest: For home-based businesses, calculated based on your home office size relative to your entire home.
8. Professional insurance: Professional indemnity insurance is fully tax deductible.
9. Rent: Similar to mortgage interest, the deductible portion depends on your home office size. Or if you are renting a unit as part of your business, it’s all deductible.
10. ACC levies: Somewhat counterintuitively, your ACC levies are fully tax deductible.
11. Motor vehicle expenses: You can claim all vehicle costs as business expenses, but for vehicles with mixed use, only claim the business percentage.

Want to know more about claimable expenses? See our article: What expenses are tax-deductible in NZ?

How Business Like NZ Ltd Makes Claiming Expenses Easier

The most efficient way for sole traders to maximize their tax deductions legally is to partner with a specialized service like Business Like NZ Ltd.

With Business Like NZ Ltd, we’ll:

• Automatically deduct all relevant tax payments and levies with each payment you receive
• File your annual tax return
• Simplify expense claims
• Manage and claim your expenses so you receive tax relief earlier

Get your tax deductions in order by joining Business Like NZ Ltd today!

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DISCLAIMER: The information in this article is for general educational purposes only. It doesn’t cover all situations and circumstances and shouldn’t be taken as direct tax advice. For specific guidance tailored to your business needs, please consult with our team of experts at Business Like NZ Ltd.