Legislation was recently enacted to establish new rules for closely held companies to be known as "Look-Through Companies" ("LTC") to be effective from 1 April 2011.
If the LAQC transitions to an LTC and the owners have sufficient contributions to the LTC, then they will be able to continue to get the benefit of the loss against other income.
LTCs will replace the previous Qualifying Company ("QC") and Loss Attributing Qualifying Company ("LAQC") regimes. Please refer to the separate article on changes to Qualifying Company Rules.
The new rules for LTCs are:
1. Must be New Zealand resident company.
2. Must have 5 or fewer shareholders referred to as look through counted owners ("owners"). Owners related to second degree (parents, children, grandchildren, grandparents, aunts, uncles, nieces and nephews), by marriage, civil union, de facto relationship or adoption are combined as one owner.
3. Only a natural person, trust or another LTC can be owners.
4. Trust owners are looked through to the beneficiaries for the owners test.
5. Care must be taken with trust owners. Where the income from the LTC for current and 3 preceding income years was allocated as trustees' income (i.e. not distributed to beneficiaries) then the trustees are counted as one owner rather than the beneficiaries. This will add another owner and may exceed the 5 owner count test.
6. Elections to become LTC must be made before commencement of income year in which it is to apply.
7. All owners must elect for the LTC rules to apply.
8. Cease to be LTC if any owner revokes status or company becomes ineligible.
9. If LTC status lost then cannot elect back in for 2 income years. Then taxed as ordinary company.
10. Only 1 class of company shares allowed.
11. An LTC is transparent for income tax purposes. The owners are treated as holding LTC property directly in proportion to their shareholding ("look through interest"). It is the owners who are deemed to be carrying on the activity and not the LTC itself. Despite that, LTC must still file an income tax return which specifies the amount of income and expenses allocated to each owner.
12. Company income and expenses are passed to the owners in proportion to their shareholding.
13. LTC losses are able to be claimed by each owner subject to the loss limitation rule.
14. The loss limitation rule ensures that the losses claimed reflect the level of the owner's economic loss. This means that an owner can only claim a loss to the extent of their contributions to the company.
15. Contributions to the company include any loans to the LTC, credit shareholders current account, and external debt guaranteed by owners.
16. Any LTC losses in the owner's tax return not able to be claimed against other income ("disallowed amounts") are carried forward to future income years. Disallowed amounts can only ever be claimed against income from that LTC. 17. If the owner disposes of their interest in the LTC any disallowed amounts are forfeited.
18. If the LTC ceases to be an LTC it reverts to an ordinary company, and any disallowed amounts can only be claimed against future dividend income from that company.
19. If an owner disposes of their shares in an LTC or the LTC ceases to be an LTC (by revocation or breaching owner count test) the owners are treated as disposing of their share of the underlying LTC property and will bear any tax consequence associated with the disposal only if it exceeds the following thresholds:
(a) Disposal of property not taxable unless proceeds exceed tax book value by $50,000;
(b) Trading stock not written up to market value unless annual turnover exceeds $3 million;
(c) No depreciation recovery except for assets with original cost price of more than $200,000;
(d) Further thresholds apply for investments and livestock.
20. The look through treatment applies for income tax purposes only. An LTC retains its limited liability and is still bound by the Companies Act.
21. LTC shareholders are not personally liable for the LTC's obligations for GST and PAYE.
22. Existing QCs and LAQCs can transition to an LTC with no tax cost.
23. New companies incorporated during year ended 31 March 2011 should elect to be a QC so they can transition to an LTC next year at no tax cost.
24. From 1 April 2011, newly incorporated companies can elect to be LTC from date of incorporation.
25. Ordinary companies that have been operational can elect to become an LTC from start of next income year. A calculation is required to ascertain what the company's taxable reserves would be if the company was liquidated the day before becoming an LTC and the assets distributed to the shareholders. Each owner is then taxed on their proportion of that taxable reserve as an entry tax to the regime.
26. Shareholder salaries (i.e. salary allocated at year end by credit to shareholders current account and tax paid by shareholder) not available in LTCs. Working owners must have written employment contract and have PAYE deducted. Must actively perform duties. If LTC is mainly engaged in investing or ownership of land, then cannot have working owner.
The LTC rules are more restrictive than its predecessors, QCs and LAQCs.
There was some conjecture that future losses in LAQCs would be trapped and unavailable to be offset against the shareholder's other income. If the LAQC transitions to an LTC and the owners have sufficient contributions to the LTC, then they will be able to continue to get the benefit of the loss against other income. As stated in 15 above, contributions include funds the owners have lent the company (loan or credit shareholder current account) as well as any external debt they have given a guarantee for. As most financiers require shareholders to guarantee company borrowings, it should be business as usual for getting the benefit of tax losses.
- This e-mail address is being protected from spambots. You need JavaScript enabled to view it is a Partner with Rodgers-Law in Dunedin and advises small and medium sized businesses on all aspects of commercial law.
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