A new tax vehicle to replace loss attributing qualifying companies could prove attractive to a range of small to medium enterprises, a leading tax practitioner says.
LAQCs became popular particularly with owners of residential investment property because they allow tax losses, which may arise if the investment is heavily geared, to flow through to the shareholders and be used to offset other taxable income.
Landlords would gain the same tax benefit if they owned the property directly, but a LAQC also caps the tax on any profit the company makes at the company tax rate and provides the advantages of limited liability.
Removing that asymmetry, where profits are taxed at the company rate but losses can be used at the shareholder's marginal rate, is the main object of the planned reform.
It creates a new tax entity called a look-through company or LTC, which closely held companies with up to five owners can elect to become.
Shareholders will pay tax on the company's profits, or use losses, as their marginal rate.
This eliminates any arbitrage opportunity between the company tax rate, 28c in the dollar from next April, and the top personal rate, now 33c.
Deloitte's managing tax partner Thomas Pippos said rental property owners with an LAQC were likely to take the option of switching to an LTC.
"For those taxpayers it will largely be business as usual," he said.
"They will still be able to access their tax losses - assuming they still have tax losses now that they are no longer allowed to claim depreciation on their buildings."
Many small business taxpayers could also benefit from the new LTC regime, Pippos said, as they would be able to access lower tax rates as if they traded in their own name, but still have the benefit of limited liability.
The lower tax rate arises because of the difference between marginal and average rates of tax in a progressive tax scale like the income tax.
A taxpayer earning more than $70,000 pays 33c in the dollar for every dollar over that threshold but only $14,000, or an average of 20c in the dollar, on the first $70,000.
The taxpayer needs to earn close to $180,000 before his or her average income tax rate exceeds the company tax rate of 28c on every dollar.
Inland Revenue said that, for income tax purposes, the shareholders in an LTC would be regarded as holding the LTC's assets directly and carrying on the activities of the LTC personally.
"Thus in general a sale of shares in an LTC is treated as a sale of the underlying assets."
Pippos said that complicated matters for forest owners. The sale of a forest was seen as a revenue matter, and subject to income tax, while the sale of shares in an LAQC was on capital account and untaxed.
"For existing forests where minimal tax losses are being generated, owners may choose to revert back to a normal company taxation model, enabling them to sell their shares outside of the tax base."
Revenue Minister Peter Dunne said the draft legislation would allow existing qualifying companies and LAQCs to transition to the new flow-through rules, or change to another business vehicle such as a limited partnership, without tax costs.
In response to feedback from small businesses the Government had decided to review the tax rules for dividend with a view to simplifying them for closely held companies.
The legislation is expected to be enacted before the end of the year and come into effect from April 1 next year.
CHANGE OF VEHICLE
LAQC: Loss attributing qualifying company. Profit taxed at company rate.
LTC: Look-through company. Profit taxed at shareholders' marginal rate.