Published: Sun, Mar 20th, 2011
In May 2010 the Government announced the introduction of flow-through treatment of profits and losses for closely held companies.
Government has implemented measures that prevent what is sometimes referred to as "Arbitrage", i.e, the retaining of profits in a company and therefore the utilisation of a company tax rate (28% as of 1 April 2011) that is lower than the top personal rate (33% as of the same date). Inland Revenue's policy division has completed legislation that implements far reaching changes to the Qualifying Company regime.
A General Overview of the changes and implications
- As of 1 April 2011, LAQC's will not be allowed to attribute losses to shareholders.
- The legislation creates a new entity called a "Look Through Company" (LTC).
- Companies will be allowed to transition across to become an LTC, or alternatively they can change to another business structure (e.g. a partnership), without any tax cost.
- An LTC's profits and losses will be passed on to its owners, according to each shareholder's effective interest in the company. This means that losses and profits will be deducted or taxed at the owner's marginal tax rate.
- Losses in LTC's will only flow through to owners to the extent that those losses reflect their economic loss. (Getting complicated now).
- Owners must elect to become an LTC by 1 October 2011. In other words, you will need to complete precise IRD forms to ensure an LTC election is valid.
- The shareholders of an LTC will be treated as holding the assets of that LTC directly. This raises complex issues where those assets are sold.
- Remember, this is all a tax fiction only – an LTC retains its identity as a registered company and therefore is still governed by The Companies Act.
For those clients with LAQC's, what are the options?
- Stay as a Qualifying Company (QC). This means you will not be able to allocate any company losses to shareholders. Losses will need to be used by the company, against other income. If your company makes regular losses and you want to use those losses against personal income (such as profits from another business, or wages from employment), this option may not work best for you.
- Be taxed as an ordinary company. Once again, you will not be able to allocate company losses to shareholders. Also, you will miss out on certain other benefits that QC's enjoy, such as the ability to distribute capital gains without winding up the company.
- Be taxed as a Look Through Company (LTC), as summarised above.
- Restructure to another type of entity, such as a partnership, a limited partnership, or a sole trader. As you can imagine, such a restructure is not necessarily a simple matter and although there is no tax cost there may well be legal costs involved.
Your company and the way forward.
You have until 30 September 2011 to complete the transition across to an LTC or to another type of entity. In the mean time, if you want to chat about the options and your circumstances do of course call or drop us an email.
This publication has been carefully prepared, but it has been written in general terms only. The publication should not be relied upon to provide specific information without also obtaining appropriate professional advice after detailed examination of your particular situation.