Date: 16th May 2011
In the May 2010 budget, the government announced it was going to make changes to LAQC’s. On the 15th of October, the government finally released the draft legislation for those changes.This article outlines those changes.
(1) There is a new tax entity called a Look-through company (LTC)
Rather than making lots of changes to the existing LAQC companies, the government has instead created a new company called a Look-through company.
(2) The end of the LAQC
The one and only major change to the LAQC rules is that any loss will no longer be attributed to the shareholders from 1 April 2011. This change means it will no longer be suitable to have a rental property that makes a loss owned by an LAQC.
If you have a rental property that makes a profit, you could leave your property in the LAQC to take advantage of the 28% company tax rate. However, the government is still reviewing the dividend rules so this may not be a good idea if the ability to pay any future capital gain as a tax-free dividend without liquidation is removed.
(3) Transition from a LAQC to a LTC
While LAQC’s will no longer be suitable for the vast majority of investors, there will be an easy transition to change an LAQC into a LTC. An election will be required to be signed by all shareholders by 30 September 2011.
(4) Transition from LAQC to Partnership or Sole Tradership
There are rules allowing an LAQC to be changed into a Partnership or Sole Tradership. However, a liquidation or legal transfer of the property is required to do this making this type of transition expensive.
(5)Loss Limitation Rule
Under a LTC, any loss allocated to the shareholders is now limited to the amount of that shareholders contributions. There’s no need to worry about this for the vast majority of property investors as the definition of shareholders contributions includes a share of the company debt to the extent to which it is personally guaranteed. So, the amount of the shareholders contributions should be vastly greater than any loss in most situations.
(6) Sale of Shares
Under an LAQC, shares could be sold to another person such as a spouse relatively easily. Sometimes an LAQC re-election was required and that was all. There was no impact on the underlying property owned by the LAQC.
Under a LTC, a sale of shares means a transfer of that portion of the underlying property owned by the LTC. So, if a person that owned 50% of the shares in a LTC sold their shares, they may also have to pay tax on 50% of any depreciation recovered at the same time.
There are two application exemptions for this:
(1) If the company owns a property that has a cost price of $200,000 or less; or
(2) If the sale proceeds do not exceed the shareholders share of the tax book value of the property less liabilities (net assets) by more than $50,000
So, the second exemption will apply where there hasn’t been a lot of unrealised capital growth in the properties owned by the LTC.
Let’s take a typical example of a LTC with a property with a tax book value of $350,000 and a bank loan of $320,000. A 50% shareholder’s net assets would be $15,000 ($350k – $320k x 50%). So, if the sale proceeds for the shares was less than $65,000, then there were be no tax implications for the existing shareholder.
While it has always been important to transfer shares between family members at an accurate market value to ensure the IRD couldn’t charge you with gift duty, it’s even more important now as you will need to calculate whether the exemption above applies to your sale of shares.
(7) Working Owners
Under an LAQC, if one shareholder earned significantly less than the other and that person managed the properties, the LAQC could pay them a shareholders salary to compensate them for their time. The benefit was that tax would be paid at the lower personal tax rate which would increase the other shareholders refund at a higher personal tax rate.
Doing the same thing under a LTC is much more difficult as there is no automatic deduction if the company engages in holding property, even if a written contract is present.
Thanks to Tony Thorne and the NZ Property Investors website.
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