Revenue Minister Peter Dunne says the Government is to introduce new rules preventing loss attributing qualifying companies (LAQCs) from passing losses on to their shareholders.
LAQCs have been used by property investors to claim tax losses and offset them against personal income. Investors' using LAQCs more than doubled their claimed tax losses to NZ$2 billion between 2003 and 2007, the height of the recent property bubble, data supplied to interest.co.nz by the IRD in 2008 showed.
Dunne says the move comes after public consultation on proposals for reforms to tax rules announced in this year's Budget for qualifying companies and LAQCs. The new rules will also provide a flow-through income tax treatment for closely held companies who choose to use them, says Dunne.
Business income and losses will be able to be passed to shareholders who will pay any tax due, but the rules will allow a business to still have the benefits of a company, such as limited liability.
Dunne says the Government will also review the tax rules for dividends, seeking to simplifying them for closely held companies.
"Until this review is undertaken, existing qualifying companies and LAQCs can continue to use the current qualifying company rules, but without the ability to attribute losses," Dunne says.
Draft legislation for the changes will be available from the Inland Revenue Department later in the week for feedback. See more detail here.
"The draft legislation will allow existing qualifying companies and LAQCs to transition into the new flow-through rules, or change to another business vehicle such as a limited partnership, without a tax cost," Dunne says. "The legislation for the new rules is expected to be enacted before the end of this year and will come into effect from April 1, 2011."
Meanwhile, the New Zealand Institute of Chartered Accountants said the Government had got the revision right. See its comments below.
New Zealand Institute of Chartered Accountants (NZICA) says the Government has got it right in the revision of laws which will see the end of Loss Attributing Qualifying Companies (LAQC) as we know them.
The Government today signalled it will change Qualifying Company (QC) and Loss Attributing Qualifying Company (LAQC) rules by:
· Allowing existing QC rules to remain pending a review of the company dividend rules; and
· Treating LAQCs as full flow-through entities from 1 April 2011, with the option to transfer at no tax cost to a QC or limited partnership.
NZICA tax director Craig Macalister said, “NZICA’s position was that full attribution of both profits and losses should be preferred over a full flow-through model because attribution is a lower compliance cost model than flow through.”
However, in the context of the Budget 2010 announcements to move to full flow through treatment for both QCs and LAQCs, the key policy priority for NZICA was to see the taxation of QCs remain as they are.
“The proposal to move QCs to a full flow-through model was entirely baseless,” Mr Macalister said. “It is pleasing to see the Government has taken this view on board. However, it does seem a little odd that only existing QCs will be grand-parented pending the review of the dividend rules.”
The announced policy change will force some people with LAQCs to reconsider whether they want to continue with the LAQC structure or move to a QC or limited partnership model.
However, the ability to do this with no tax cost will provide a seamless transfer. This allows people the opportunity to stay in the new flow-through model if they prefer, or opt out at no tax cost. This is a very sensible policy approach and will no doubt be welcomed.
Mr Macalister said that with the new rules set for enactment in April 2011 taxpayers affected should discuss their options with their Chartered Accountant as soon as possible.
Later, Dunne released a Question and Answer sheet on the changes:
1. What are the main changes?
i. Introduce new flow-through income tax rules for closely-held companies.
ii. Allow existing QCs and LAQCs to transition into the new flow-through tax rules or change to another business vehicle such as a limited partnership, without a tax cost.
iii. Allow existing qualifying companies (QCs) and LAQCs to continue to use the current QC rules without the ability to attribute losses (until a review of the dividend rules for closely-held companies has been completed).
2. What do the new flow-through rules mean?
These new rules mean shareholders will pay tax on the company's profit, and use losses, at their marginal tax rate. This is different from the existing LAQC rules because shareholders are being taxed on the income as well. This reduces arbitrage opportunities between the company tax rate and top personal tax rates.
The introduction of new flow-through income tax rules for closely held-companies who choose to use them was announced in Budget 2010.
The new rules create a new tax entity, called a look-through company (LTC). Shareholders of a closely-held company can elect to become an LTC.
A LTC's income, expenses, tax credits, rebates, gains and losses are passed on to its shareholders, in accordance with their shareholdings in the company.
3. Is an LTC still a company?
Yes. The LTC retains its identity as a registered company, and will keep its corporate obligations and benefits under general company law, such as limited liability.
Look-through treatment applies for income tax purposes only; the shareholders of an LTC are regarded as holding the LTCs assets directly, and carrying on the activities of the LTC personally. Thus, in general, a sale of shares in an LTC is treated as a sale of the underlying assets. There are de minimus rules that limit the application of this treatment. These will be closely modelled on the present partnership de minimus rules.
4. If I am a shareholder in a look-through company (LTC) can I claim all the company's losses against my other income?
Not always. The LTC rules also include a loss limitation rule, which is similar to that of limited partnerships. This means owners can offset tax losses only to the extent the losses reflect their economic loss.
Any losses a shareholder cannot use are carried forward and may be used by the shareholder in later years.
5. Why are the QC rules continuing in the interim?
As part of Budget earlier this year the Government announced reforms to the tax rules for qualifying companies, and sought feedback on the proposals.
Following this consultation, the Government is introducing new rules from 1 April 2011, providing flow-through income tax treatment for closely-held companies who choose to use them.
In response to feedback from small business the Government has also decided to review the tax rules for dividends, with a view to simplifying them for closely-held companies.
It is appropriate that while this review is being conducted, existing qualifying companies and LAQCs can continue to use the current qualifying company rules, but without the ability to attribute losses.
6. What is happening to the current qualifying company and LAQC rules?
Existing QC and LAQCs may continue to use the current QC rules.
The income is taxed at the company level. Dividends will continue to be taxed as before.
- Only dividends with imputation credits attached will be taxable to shareholders.
- Any capital gains can be distributed tax free without winding up the company.
However the ability to attribute losses will be removed; this effectively means that the LAQC rules will be abolished.
The current QC rules will remain while the Government reviews the tax rules for dividends, with a view to simplifying them for closely held companies.
7. I have an existing LAQC - what are my options?
If you already have an LAQC you have several options to choose from next year. You can, without a tax cost:
i. Continue as a qualifying company (QC), without the ability to attribute losses (which instead will be used at the company level)
- This is the 'default' option for all existing QCs and LAQCs.
- You will no longer be able to attribute losses to your shareholders.
- This applies until the Government has completed its review of the dividend rules for closely-held companies.
ii. Be taxed as an ordinary company.
- You will need to revoke your LAQC election.
- Any new losses will have to be used by the company, not the shareholders.
- And all dividends will be taxable to your shareholders, although imputation credits may be attached.
iii. Be taxed as a look-through company (LTC)
See answer to Question 2 above for details about being an LTC.
iv. Become a limited partnership, an ordinary partnership, or sole trader
- Special rules will enable you to transition into a limited partnership, partnership or sole trade, with no tax cost.
- You will need to restructure your business and either make the company non-active or wind it up. The transition rules provide extended time for this restructuring.
8. I have an existing QC - what are my options?
The options for an existing QC are the same as those for an LAQC. The default option is to continue as a QC.
9. When will the new LTC rules come into effect?
The legislation for the new rules is expected to be enacted before the end of this year. The LTC regime will be available from 1 April 2011.
10. When will the removal of the LAQC rules come into effect?
The legislation for the new rules is expected to be enacted before the end of this year and will come into effect from 1 April 2011. They will apply to LAQCs from the income year starting on or after 1 April 2011.
(Update 3 adds Q and A sheets.)