Government confirms LAQC Changes

As we have highlighted in a previous email, substantial changes to the qualifying company (QC) regime were heralded by the Government in its May 2010 Budget. These changes are now confirmed as legislation. The need for changes arose out of concerns that taxpayers with loss attributing qualifying companies (LAQCs) were claiming losses at their higher individual tax rate (currently a maximum of $35.5%) and yet being taxed on any profits at the lower corporate rate (currently 30%). Following on from an issues paper (to which a large number of submissions were made) the Government has recently passed legislation making changes to the QC regime and introducing a new "look through" alternative structure.

This legislation will take effect from 1 April 2011. The new rules will apply to LAQCs from the income year starting on or after 1 April 2011 therefore for those with early balance dates (October 2010 to February 2011) any transition will not occur until the 2012 income year.

What should you be doing with your QC or LAQC prior to the changes in the QC regime?

There are four options, namely:

1. Do nothing and remain in the QC regime

2. Revoke the QC/LAQC elections and become an ordinary company

3. Transfer assets to a sole trader, ordinary partnership or limited liability partnership

4. Elect to become a "look-through company" (LTC).

We briefly examine the pros and cons of each option as follows:

1. Remain in the QC regime

Pros		Dividends which are not fully imputed will continue to be exempt from tax
		Capital gains can still be paid out to shareholders tax free without winding up the company

Cons		Losses will no longer be attributable to shareholders

Note: With the reduction in interest rates and the removal of depreciation on buildings from 1 April 2011 it could well be that a number of property owning LAQCs will no longer be making tax losses.

2. Revoke the QC/LAQC elections and become an ordinary company

Pros		Continuation of limited liability
		Income taxed at corporate rate

Cons		Losses can only be used by the company (subject to shareholding continuity)
		Distribution of capital gains are only tax free on the winding up of the company

3. Transfer assets to a sole trader, ordinary partnership or limited liability partnership

Pros			For a limited time period, shareholders of existing QC/LAQCs can elect to transition into any of the above structures with no tax cost.
			Choice of new structure can be tailored to your circumstances which may have changed since your QC/LAQC was set up.

Cons			A number of commercial issues are likely to arise from any transition including compliance issues such as conveyancing, renegotiation of contractual obligations or security arrangements and employment issues.

4. Elect to become a "look through company" (LTC)

The attributes of a LTC are as follows:

	A LTC is a company that is resident in New Zealand under domestic law or under a double tax agreement.

	The shareholders of a LTC (who are referred to as "owners") can be either individuals or trusts (but not companies).

	An LTC must be five or fewer "look-through counted owners". Special rules apply to this count test e.g. individuals are regarded as one look-through counted owner if they are relatives and trustees of a trust are regarded as one look-through subject to certain limitations.

	An LTC must have only one class of shares.

	All income,expenses, tax credits, rebates, gains and losses (subject to limitation rules) are passed on to the shareholders (owners) in accordance with their effective interest in the LTC.

	All owners must elect for the company to become an LTC. If the company subsequently breaches the eligibility criteria or the owner chooses to revoke the election, the company will revert to being taxed as an ordinary company.

Pros		Provides limited liability but allows shareholders to access losses (albeit limited to their financial risk in the company)
		Has less compliance cost than a limited liability partnership which has similar attributes
		Can transition from QC/LAQC to LTC with no tax cost

Cons		Use of losses by shareholders is limited to their shareholding and financial risk
		Need to ensure that eligibility is maintained with shareholder numbers, etc

The options need to be carefully considered to ensure that the action taken best suits your situation. The legislation provides for additional time beyond the start of the 2012 income year in which to make a decision. We recommend that you do not rush into a change. We will personally contact you about your LAQC or QC. We will tailor our advice as to what course of action should be taken that best suits your circumstances, so stay tuned. We anticipate being in contact around late Jan / early Feb 2011.

Kind Regards

Mark Greer B.Com(hons), CA

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