Government to review tax rules on closely held companies

Tuesday 8th September 2015

The government is moving to tighten and simplify tax rules for closely held companies of five or fewer shareholders, one of most common vehicles used in New Zealand, and to simplify rules for non-corporate shareholders to receive tax-free capital gains.

Revenue Minister Todd McClay issued a discussion document on the proposals, which build on tax law changes announced in 2010 that ended the use of vehicles known as loss-adjusted qualifying companies (LAQCs) and replaced them with a look-through company (LTC) regime. The paper also suggests simplifications to rules

Those changes, which came into effect in 2011, were estimated at the time to be worth $190 million a year in previously unpaid tax and were aimed particularly at professional property investors. The LTC regime attributes company earnings to shareholders in proportion to their interests and imposes tax at the personal rather than the company income level.

The intended outcome was that LTCs would largely replace LAQCs and an associated qualifying company (QC) structure, but by the end of the 2014 income tax year, only about 50,000 LTCs existed and some 70,000 QCs continued to operate.

"A range of concerns have been raised about the workability of the LTC rules," says the discussion paper issued by the Inland Revenue Department today, which has an Oct. 16 deadline for submissions. "This may be deterring companies from becoming LTCs as well as imposing additional compliance costs on those that become LTCs," the paper said. "While there are a range of reasons for a company continuing to be a QC, it should not be because the LTC rules are hard to comply with."

In a statement, McClay said the LTC regime was intended to remove tax as a factor when small businesses chose whether to use a company structure.

"If the rules are not working as intended then they could be distorting business decisions as well as deterring more businesses from becoming LTCs," he said.

Among the most substantial changes being proposed are restricting the criteria that a company must meet to become an LTC, "most notably in relation to trusts, the use of LTCs as a vehicle for conduit investment by non-residents and the requirement that the LTC have only one class of share," the discussion paper says. "The changes would also narrow who would be covered by the restriction that limits an owner's LTC losses to the amount they have at risk."

The paper also proposes that anti-avoidance provisions that are intended to ensure that business partners' transactions occur at market value should be extended to LTCs. While existing QCs should be allowed to continue, "they would lose their QC status upon change of control" to prevent sales for windfall gains. When an LTC failed to repay a shareholder a loan, there would no longer be the ability to claim the unpaid sum as 'remittance income' for tax purposes.

Proposed simplifications include liberalising rules on 'tainted capital gains' - where a company sells a capital asset to a related party - "to ensure that genuine capital gains made by small businesses do not become taxable on liquidation merely because there is a transaction involving a related party."

BusinessDesk.co.nz

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