NZ Introduces Qualifying Company Reforms

by Mary Swire, Tax-News.com, Hong Kong

15 October 2010

Following public consultation on provisions announced in the 2010 budget, New Zealand’s Minister of Revenue, Peter Dunne, has said that the government would introduce new rules preventing loss attributing qualifying companies (LAQCs) from passing losses on to their shareholders.

The new rules will mean shareholders will pay tax on the company's profit, and use losses, at their marginal tax rate. This, it was said, 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 rules will also provide a flow-through income tax treatment for closely held companies who choose to use them. 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 structure.

A new tax entity will be created, called a look-through company (LTC). Shareholders of a closely-held company can elect to become an LTC. An LTC's income, expenses, tax credits, rebates, gains and losses are passed on to its shareholders, in accordance with their shareholdings in the company.

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 will apply 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 will be treated as a sale of the underlying assets.

The LTC rules will also include a loss limitation rule, similar to that of limited partnerships. This means owners can offset tax losses only to the extent the losses reflect their economic loss. However, any losses a shareholder cannot use are carried forward and may be used by the shareholder in later years.

"In response to feedback from small businesses, the government has also decided to review the tax rules for dividends, with a view to simplifying them for closely held companies" said Dunne. Until this review is undertaken, existing qualifying companies (QCs) and LAQCs can continue to use the current qualifying company rules, but without the ability to attribute losses.

Dunne confirmed that the new rules will allow existing QCs 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.

Existing QCs and LAQCs may also continue to use the current QC rules; income being taxed at the company level. Dividends will continue to be taxed as before, and 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 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. They will apply to LAQCs from the income year starting on or after April 1, 2011. The LTC regime will also be available from that date.

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