Before April 1, 2011 a company set up as a loss attributing qualifying company ( LAQC) could pass losses to shareholders in proportion to shares held.
The option let taxpayers offset losses from their LAQC activity, with other income such as wages, and reduce income tax commitments.
In an attempt to reduce LAQC’s tax benefits, the Government introduced lookthrough company (LTC) legislation to apply from April 1, 2011.
The new LTC regime appeared to be a logical alternative to the repealed LAQC structure but ‘‘fish hooks’’ have surfaced and as advisers we need to deal with them while awaiting legislation changes.
Some of the issues we aware of include:
Previously share transfers did not trigger depreciation recovery and potential tax costs. In certain instances share transfers in LTC companies can cause taxation payable with depreciation recoveries. Also, any revocation of the LTC status in the future will cause depreciation recovery.
Loss of Corporate Tax Rate
LTC companies are good for passing losses out of the company to the shareholder, however profits are also distributed to the shareholders. Therefore the shareholder could end up paying 33 per cent tax in their own name instead of the company rate of 28 per cent.
Limitations of Losses
With losses limited to the shareholders economic loss, losses generated by the company will not always be available to the shareholder. A detailed calculation needs to be completed each year allowing for such factors as shareholding, funds invested in the company and guarantees made.
Care is needed with share transfers to ensure part- year losses are not forgone or tax triggered on depreciation recoveries.
Under an LTC, shareholder salaries need to be planned in advance and paid during the year.
If a non- shareholder guarantees the company, this potentially limits the loss allocation to shareholders.
Ceasing to be an LTC
The company will cease to be an LTC if the number of shareholders exceeds five.
Although all shareholders are required to approve a revocation, only one shareholder needs to elect with the IRD, therefore there is potential for one shareholder to revoke the LTC election without the knowledge of the other shareholders.
Forgiveness of Debt
Due to losses, many LTC companies are insolvent and owe money to shareholders. Although not intended in the legislation, there are concerns that IRD will treat any write-off of money owed to the shareholders as a taxable transaction, with the shareholders paying income tax on the debt.
To achieve the best outcome consider a strategy prior to exit.
Overall there are positives and negatives to LTC structure use but consideration needs to be given on the potential implications of the new LTC system as more is understood.
If you have any questions regarding the options under the LTC regime or how to manage your existing LTC please contact the team at CooperAitken.
– Grant Eddy is a director at CooperAitken Accountants.