The Government recently announced changed tax rules that will force some company directors to rethink the tax status of their companies.
While the Government is calling for submissions on the proposed changes, it seems unlikely that any changes, apart from some cosmetic tinkering around the edges, will take place.
In the past, companies that were closely held - five or fewer shareholders - could elect to become a qualifying company (QC) or a loss attributing qualifying company (LAQC).
Deloitte Dunedin tax partner Peter Truman said that had provided some concessions from the tax rules that normally applied to companies.
The current rules had been in place since 1992.
LAQCs had been able to pass out tax losses to shareholders so they could offset those against other taxable income.
Dividends could be paid out as non-taxable income where the QC or LAQC had insufficient imputation credits.
The discussion document identified the current "mischief" with the current rules, he said.
They included.
• Tax arbitrage - tax losses of a LAQC could be passed out to shareholders to reduce tax payable at the top rate (38% currently but reducing to 33%) where profits were taxed at the company rate (30%, reducing to 28%).
• Access to tax losses greater than investment made by shareholder.
If the company lost more money than the amount the shareholder had invested, the losses made by the LAQC would still pass out to shareholders
• Ability to circumvent the personal liability shareholders had for income tax owing by a QC or LAQC by revoking the election to be either of those structures before the tax liability arose.
The changes would apply from April 1, next year, Mr Truman said.
He agreed that the main points of the proposed changes would be passed by the Government and that the only reason for submissions was to get some minor changes around the edges of the new rules.
The distinctions between QCs and LAQCs would be removed and both would be treated as partnerships for tax purposes.
That would affect both the rate at which income was taxed and on the nature of the investment held by the shareholder.
"Shareholders will only be able to access tax losses to the extent of their investment in the company.
Excess losses will carry forward to be used against income from the company."
The profit of a QC and LAQC would be taxed at the shareholder's marginal rate, he said.
If the shareholder was on the 33% tax rate, there was no ability to gain any advantage from the 28% company tax rate.
Tax would be saved if the shareholder's tax rate was less than 28% because their income was below $48,000.
The application of fringe benefit to vehicles owned by a QC or LAQC would change significantly.
Where the vehicle was used by a shareholder, in the future there would be an apportionment of costs between business and private use, with no FBT payable.
All shareholders in those two types of companies needed to consider whether they should elect to convert them to ordinary companies, Mr Truman said.
Previously, many shareholders had elected to join the QC regime, because there were potential benefits and little down side.
That logic might no longer be valid.
An example would be where shareholders were on the 33% tax rate and a significant part of the profit in the company was reinvested in the business, rather than paid out as a dividend.
Converting to an ordinary company would mean that the 28% company tax rate could be used, he said.
"The timing of any decision to change status is important.
Any change in status that occurs after the new rules come in will result in a deemed disposal of company assets, so this may give rise to tax implications."
A change in status in the year ended March 31, 2011 might be preferable in many cases.
Definitions
- Qualifying company: Maintains its company structure but receives the taxation benefits of a partnership. In a qualifying company, the shareholders will be personally liable for any income tax not paid by the company.
- Loss attributing qualifying company: A type of company structure that enables company losses to be allocated to individual shareholders to reduce their personal income and taxation.
