A collection of Q & As on LTCs

Transcription

1 A collection of Q & As on LTCs The following have been adapted from questions asked by attendees of the NZICA webinars on the Look-Through Company regime presented by Frank Owen in February Disclaimer: The following is provided as an information service only. Accordingly, their contents are not intended as a substitute for specific professional advice on any matter and should not be relied on for that purpose. While every effort has been made by the New Zealand Institute of Chartered Accountants and the author and presenter of the Look-Through Company webinars to ensure the accuracy of the information provided in the presentations and the material below, neither the New Zealand Institute of Chartered Accountants, or the course author and presenter make any representations about the content and suitability of this information for any particular purpose. Count test 1. Do the associated persons rules apply to beneficiaries for the purposes of the five or fewer persons LTC count test? Yes, the associated persons rules do apply to beneficiaries to the extent that they are relatives. All associated persons in an LTC count as one owner. [Reference: s YA 1, definitions of look-through company, paragraph (d); relative, paragraph (a)(v). Tax Information Bulletin, Vol 23, No 1, February 2011, p 49]. 2. How many times do you count an individual who is a shareholder in the LTC in their own right and who is also a beneficiary of a trust which is also a shareholder? In this case the individual will be counted only once as the person does not hold the shares in the LTC in different capacities. [Reference: s YA 1, definition of look-through counted owner. Tax Information Bulletin, Vol 23, No 1, February 2011, p 49. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 6 7]. 3. If there is an individual who is a shareholder in his/her own right and is also a trustee of a shareholder trust do they get counted twice? Yes, because the person is holding shares in two separate capacities. [Reference: s YA 1, definitions of look-through company, look-through counted owner. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 7].

2 4. If Dad is a shareholder of the company, and Dad is a trustee of a shareholder-family trust (Mum, Dad and Kids as beneficiaries), is Dad counted once? As per question 3, assuming we have a valid trust, Dad is counted twice. Dad as a shareholder in his personal capacity counts as one and Dad as trustee of the shareholder-trust counts as one; that s two owners. [Reference: s YA 1, definitions of look-through company, look-through counted owner. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 7]. 5. Continuing on from question 4, is the Trust is a relative of Dad? No, Dad can t, separately as a trustee of the trust, be a relative of Dad. [Reference: s YA 1, definition of relative, paragraph (a)(v)]. 6. What if there are two LTC owners (individuals) related to the second degree? They count as one owner. [Reference: s YA 1, definitions of look-through company, relative. Tax Information Bulletin, Vol 23, No 1, February 2011, p 49. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 6]. 7. If a company has shareholders who are a couple in a relationship who count as one LTC owner, what if one of the parties in the relationship dies or the couple separates; does this alter the count for the number of owners in the LTC? No, a subsequent death or ending of the relationship does not break the two degree test when applying the count test. [Reference: s YA 1, definition of look-through company. Tax Information Bulletin, Vol 23, No 1, February 2011, p 49. IR 879 (April 2011) Look-through companies a guide to the lookthrough company rules, p 6]. 8. Do the associated persons rules apply to beneficiaries? Yes, the associated persons rules apply to beneficiaries to the extent they are relatives. If three beneficiaries are related to two degrees of relationship they will be counted as one owner. [Reference: s YA 1, definitions of look-through company, look-through counted owner, relative. Tax Information Bulletin, Vol 23, No 1, February 2011, p 49. IR 879 (April 2011) Lookthrough companies a guide to the look-through company rules, p 6 7].

3 9. What if there are two-to-three beneficiaries of the shareholder trust who are related to the second degree of relationship, do they count as one person? Yes. Beneficiaries who are relatives count as one owner. [Reference: s YA 1, definitions of look-through company, look-through counted owner, relative. Tax Information Bulletin, Vol 23, No 1, February 2011, p 49. IR 879 (April 2011) Lookthrough companies a guide to the look-through company rules, p 6 7]. 10. What is the treatment of charities as beneficiaries of a shareholder-trust and the resulting shareholder count? Charities have not been specifically considered. The ordinary rules will apply. When considering these rules it is worthy to note that under trust law a charitable trust cannot distribute income as beneficiary income. Shareholder-trust A trustee of a trust is a look- through counted owner when the trust: has a look-through interest for the entity or has a direct or indirect beneficial interest in a look-through interest for the entity; and has not distributed, as beneficiary income, all income that arose from a direct or indirect beneficial interest in a look-through interest for the entity for the current income year and all of the last three income years. If the shareholder-trust has not distributed all of the LTC income as beneficiary income in the time frame referred to the trustees will be included in the shareholder count as one owner. Charitable trust as beneficiary If a charitable trust is a beneficiary of the shareholder-trust the trustees of the charitable trust will be a look-through counted owner as defined in paragraph (c) of the definition of lookthrough counted owner. Charitable company as beneficiary A natural person shareholder with a voting or market value interest in a company will be counted as a look-through owner if the company has derived, as beneficiary income, LTC income for the current income year or one of the last three income years.

4 Applying this test, it is possible that a natural person shareholder with a voting or market value interest in a charitable company that is a beneficiary of a trust that is a shareholder in a LTC will be counted as a look-through owner. This will be the case if the charitable company has derived, as beneficiary income, LTC income from the shareholder-trust for the current income year or one of the last three income years. [Reference: s YA 1, definition of look-through counted owner, paragraphs (b), (c) and (d)]. 11. How can a LTC be a look-through counted owner in another LTC it is not clear that an LTC meets the section YA 1 definition of look-through counted owner? The LTC rules specifically provide that an LTC can be a shareholder in another LTC. That was envisaged. For example, if an LTC has three shareholders two individuals and an LTC and the shareholder-ltc has two individual shareholders, the lower tier LTC will have four look-through counted owners (this being the two individual shareholders in the lower tier LTC and the two individual shareholders in the shareholder-ltc). [Reference: s YA 1, definitions of look-through company and look-through interest. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 48. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 7]. 12. Does a solicitor trust company acting as a corporate trustee need to be an LTC to hold shares in an LTC? No. Although an ordinary company cannot be a shareholder in an LTC there is a specific exception in the legislation for a corporate trustee. [Reference: s YA 1, definition of look-through interest paragraph (c). Tax Information Bulletin, Vol 23, No 1, February 2011, p 48. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 5].

5 Revocation of LTC status 13. Can a shareholder who writes to the CIR revoking LTC status subsequently write to withdraw the revocation notice before it takes effect? Yes, as long as it is done before the start of the income year in which the revocation was to come into force. Also, a revocation is ignored if the shareholder stops having a look-through interest in the LTC and the new owner reverses the revocation notice. The Commissioner must be given notice of the reversal before the start of the income year. [Reference: ss HB 1(1)(c), HB 1(3). Tax Information Bulletin, Vol 23, No 1, February 2011, p 50. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 10]. 14. If a revocation has been made by one of the shareholders how will the other shareholders know that this has happened? There is nothing in the law to provide that notice is required to be given to anyone but the Commissioner. However, the Inland Revenue Department Tax Information Bulletin states that a copy of the revocation notice should be sent to the director of the LTC. On the other hand Inland Revenue has stated in its Look-through Companies Guide it will advise the other shareholders in the LTC that an owner has revoked the LTC status and the income year the revocation comes into effect. [Reference: Tax Information Bulletin, Vol 23, No 1, February 2011, p 50. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 10]. ACC levies 15. How will the ACC levies apply to LTC income? If a natural person owner does not receive PAYE income payments from the LTC under a written contract for service but plays an active interest in generating the LTC income (i.e., the owner personally exerts themselves in the income generating activities of the LTC), they will be treated as self-employed and the income will be subject to self-employed ACC levies. Where an owner does not play an active part in the business and does not receive PAYE income payments from the LTC under a written contract for service, the owner is a passive investor so there will be no ACC levies payable on the LTC income.

6 If a natural person owner receives PAYE income payments from the LTC under a written contract for service this income will be subject to the employer levy and also the earners levy in the usual way. This treatment has been confirmed by the ACC. [Reference: Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 5]. Transition to LTC, partnership or sole trader 16. If the company remains a QC after 1 April 2011 or 1 April 2012 does the QC have the 6 month transition period to make changes without any tax consequences? Yes but see question below. [Reference: ss HZ 4B, HZ 4C, HZ 4D. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 19]. 17. If transitioning to a partnership, is it better to do the transfer on 1 April 2011 or 1 April 2012 rather than during the six month period following those dates? Although the legislation allows six months to transition to a partnership under the transitional rules the partnership is treated as having been in existence from the first day of the transitional income year. This is despite tax obligations and liabilities having been met by the QC in the first six months of the transitional income year. It would therefore be easier in practice to transition on the 1 st of April. [Reference: s HZ 4B. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 57 58]. 18. Transfer of assets to a partnership - are these assets transferred at book value so there is no tax liability? Yes, they are. However depreciation will be recovered when the assets are subsequently disposed of by the partnership. [Reference: s HZ 4B. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 57 58]. 19. Many LAQCs will owe their shareholders money. If you transfer to a partnership the company is left with the loans they can not repay. Is this going to be taxable income to the company, and therefore result in a tax liability or is there transition relief? Making the transition during the transitional period from an LAQC to an LTC, partnership or sole trader does not give rise to tax liabilities; so, on the transition there would not be any resulting

7 tax liability. The balance of the loan owing to the shareholder would become part of the partners current account and owed to the partner in the normal way. [Reference: s HZ 4B. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 57 58]. 20. Do you know of examples where shares should be transferred by shareholders before 31 March 2011? For example, individuals sell to trust before 31 March 2011, and then elect to become an LTC. Previously when an LAQC was set up the owners would have looked at where the shareholding best lay. When considering a transition from a QC to an LTC structure there would be a similar need to look at the composition of shareholders. This review may indicate that some restructuring will be required before transition to an LTC. It will be important to keep in mind that the QC/LAQC status must be kept in tact if any shareholding changes are made before the transition to an LTC. Once an election is made to become an LTC the company will cease to be a QC with effect from the beginning of the income year the LTC election is made. [Reference: ss HA 5(1B), (5), HA 7B, HA 30(3), HA 33B, HA 35, HA 37. Tax Information Bulletin, Vol 23, No 1, February 2011, p 56. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 4]. 21. Can an LAQC transition to an existing partnership? The legislation on the transitional rules is designed to transition a QC to a partnership. A QC can form a partnership with an existing partnership but this would form a new partnership entity. The legislation does not seem to prevent this. [Reference: s HZ 4B. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 4]. 22. Will an agency agreement between the existing LAQC and a new partnership be accepted by the IRD which would save having to transfer the property and bank loans into a partnership? The transitional rules require all assets and liabilities of the company to be transferred to the partnership. Therefore, the agreements will have to be redone. In what form the agreements will take is a legal issue. [Reference: s HZ 4B(7)(c)]. 23. Are there any GST issues if an LAQC transitions to a partnership? As no specific changes were made to the Goods and Services Tax Act 1985 the ordinary GST rules will apply; for example, going concern, zero-rating.

8 The partnership will need to register for GST and get a new GST number (assuming the partnership carries on a taxable activity). This also raises the question regarding the GST treatment of the transfer of the LAQC assets to the partnership. In our view there is a supply to the partnership so either the going concern rules or the new zero-rating rules will apply. GST input and output tax liabilities will also need to be determined. [Reference: Goods and Services Tax Act 1985, s 2(1), definition of person ; ss 5(3), 5(12), 11(1)(m)]. 24. If LTCs are able to distribute dividends tax fee (i.e.: are they exempt?), what happens to the opening balance of retained earnings when a company becomes an LTC; can this be distributed tax free also? Yes. This tax-free treatment of retained earnings carried forward applies only during the transitional period. If transition is made after the transitional income years (effectively after the 2013 income year) the LTC shareholders will be taxed on their share of the unimputed retained earnings brought forward. Distributions from an LTC are not a dividend because a dividend must be a distribution from a company. An LTC is not a company for tax purposes. [Reference: ss CB 32C(2), YA 1 definition of company. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 50, 57. IR 879 (April 2011) Look-through companies a guide to the lookthrough company rules, pp 5, 19]. 25. If a QC or LAQC becomes a partnership, are the assets treated at market value; therefore, depreciation recovered and tax payable? No, the legislation is quite specific. The transfer of assets during the transition period from the QC to the partnership or LTC will have no tax effect. Effectively the tax position of the QC/LAQC will be the opening tax position of the partnership. [Reference: ss HZ 4B, HZ 4C. Tax Information Bulletin, Vol 23, No 1, February 2011, p 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 19].

9 26. If the option is taken to change the structure to a partnership does the partnership split of profits/losses remain the same as the shareholding ratio or must we apply to IRD for permission to deviate from the 50/50 split? If the shareholding in the QC was 50/50 and you move to a partnership the profits should remain on the same 50/50 basis. There may be a difficulty if the QC was paying a salary to one of the shareholders, the amount of which is determined at the end of the year and deducted before the profit split. Under the LTC rules the company will need to have an employment contract to pay the salary. [Reference: ss HZ 4B(7)(d). Tax Information Bulletin, Vol 23, No 1, February 2011, p 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 19]. 27. Do we need to get a valuer to evaluate the property/asset to obtain the market value when transitioning from an LAQC to an LTC? No, a formal valuation is not required for the transitional process. The LAQC and the LTC is the same entity so there is no transfer of property from one entity to another. However for the purposes of determining the owner s basis (see later questions) in the transitional year the legislation allows a market value to be used. If this option is chosen evidence will be required to support the value used. The market value of the asset comes into consideration if a shareholder sells their share(s) in the LTC. [Reference: ss HZ 4C(2), HB 11(3), HZ 4C]. 28. A QC has very large retained earnings. The company transitions to an LTC for one year and allocates all the retained earnings out as dividends that year. If it then exits the LTC regime and becomes a normal company in the next year is the effect that all the retained earnings have been allocated to the shareholders at the company s tax rate? Yes, effectively it has. The issue to be aware of is that despite there being no tax implications when the QC transitions to an LTC under the transitional rules, when the LTC becomes an ordinary company, all tax liabilities will crystallise and there will be a deemed sale of the owners interests in the LTC at market value. [Reference: ss CB 32C(2), HZ 4C, HB 4(6). Tax Information Bulletin, Vol 23, No 1, February 2011, pp 54, 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 18 19].

10 29. In the following situation is the best solution to transfer from LAQC to LTC: a residential rental property is purchased on 100% finance resulting in a loss every year regardless of building depreciation? Subject to the application of the loss limitation rule in section HB 11, the transition from an LAQC to an LTC structure will enable shareholders to continue to access losses. However it would be prudent to look at ownership issues (e.g., number of look through counted owners, etc) before doing so. If an LAQC transitions to a partnership, existing agreements will need to be replaced with agreements between individual partners and other parties. This may be difficult if there is 100% financing as different lending criteria may apply. Therefore a partnership structure may not be a viable option as a means to continue to access losses. [Reference: ss HB 1, HB 11, HZ 4C, DV 22, DV 23]. Losses 30. Why would you lose the losses after the election to become an LTC if you elect after the 2012 income year? If you are a QC (or a former L AQC) and you have losses carried forward they will move through to the LTC. However this applies only for elections in the transitional 2012 and 2013 income years. A company electing to be an LTC after the transitional income years will forfeit any tax losses carried forward. See also questions below. [Reference: ss DV 23, HB 3. Tax Information Bulletin, Vol 23, No 1, February 2011, pp 50, 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 9, 19]. 31. Can an LAQC with losses continue allocating losses through to 2014 before becoming an LTC? No. The last year an LAQC can allocate losses is the 2011 income year. In subsequent years, if no election has been made to become an LTC, the company will be taxed as a QC up until the time of the election. The election must be made no later than six months of the start of the company s 2013 income year to take advantage of the transitional rules. [Reference: ss HB 3, HB 13(3)(c), HZ 4C, HA 20 (repealed with application for income years beginning on or after 1 April 2011). Tax Information Bulletin, Vol 23, No 1, February 2011, p 56. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 4].

11 32. What happens if a QC (not LAQC) with losses carried forward changes to the LTC regime; are these losses now available to distribute to shareholders? If the QC transitions to an LTC in the transitional period, the losses carried forward will be like a first charge against the future LTC income. In other words, the losses will be available for offset against the person s net LTC income derived. See also question 30. [Reference: s DV 23. Tax Information Bulletin, Vol 23, No 1, February 2011, p 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 19]. 33. A LTC is owned 99:1 by Mum and Dad, the loans are jointly guaranteed (i.e., 50:50). If the LTC incurs a loss are the losses allocated 99:1 or 50:50? They will be allocated on the basis of the shareholding 99:1. [Reference: s HB 1(5), definition of effective look-through interest. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 13 14]. 34. If a QC with losses transitions to a LTC (for the 2012 income year), and the company continues to make losses how are the losses allocated? For example, 2011 losses carried forward of $100, 000, 2012 loss of $20,000; is $120,000 distributed to shareholders? No. If you have QC losses going into an LTC, those losses can only be offset against future LTC income. The 2012 loss of $20,000 can be allocated to the shareholders. The QC losses of $100,000 will be available to LTC shareholders when they derive LTC income. [Reference: s DV 23. Tax Information Bulletin, Vol 23, No 1, February 2011, p 57. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 19]. 35. Are losses in an ordinary company lost if the company elects to be an LTC? Yes, they are. [Reference: s HB 3. Tax Information Bulletin, Vol 23, No 1, February 2011, p 50. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 9]. Loss limitation rule 36. Can you please give an overview of the loss limitation rule? The objective of the loss limitation rule is to ensure that the tax losses claimed do not exceed the owner s level of economic loss in the LTC at a particular point in time (their amount at risk). A person s amount at risk is measured by the owner s basis, a formula calculation provided in

12 the legislation. This calculation determines the adjusted tax value of the person s investment in the LTC. Broadly it takes into account a person s capital and security provided to the LTC, amounts paid to the person by the LTC (excluding salaries or wages paid to a working owner), the person s share of income and capital gains, and the person s share of deductions and capital losses. When carrying out the loss limitation calculation people need to be aware of how the secured amounts are determined. This is a lesser of test so in some circumstances it may exclude the amount of a guarantee that has been given. This is illustrated further below. [Reference: ss HB 11, HB 12. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 37. If a family trust owns property and this is used to secure borrowings of an LAQC which transitions to an LTC, how does this come within the loss limitation rule? If a natural person owner or an associate guarantees the debt, this is available to the natural person owner to be counted as economic contribution. However as the secured amount is a lesser of test the final answer may be less than the security given or even zero in some cases. To illustrate, say an LTC has borrowed $200,000 from a bank. A shareholder of the LTC has a family trust that owns property that cost $200,000. This property has a first ranking mortgage to the bank for $150,000. The family trust and the shareholder are associated persons. The family trust guarantees the $200,000 loan from the bank to the LTC. The market value of the trust property falls to $100,000. On the face of it the $200,000 loan to the LTC from the bank is included in the secured amounts calculation as it is a debt guaranteed by an associated person of the look-through owner. However, this is overridden by a subsequent test that requires the market value (which will also take into account any liabilities with priority on the property provided as security) of the property that secures the debt to be taken into account. This means in the above example the $100,000 market value of the property given for the loan to the LTC will be reduced by the $150,000 first ranking mortgage. Applying this test there is no amount at risk to the owner (because the amount of the first ranking mortgage exceeds the market value); accordingly, neither the loan to the LTC nor the security provided is counted as part of the LTC owner s amount at risk. [Reference: ss HB 11(12) paragraphs (a) and (c) of the definition of secured amounts, HZ 4C. Tax Information Bulletin, Vol 23, No 1, February 2011, p 57].

13 38. If shares in an LTC are owned 99% by a trust and 1% by a natural person and liability for a bank debt is joint and several, does each person claim 100% of the bank borrowing? Each owner brings in their share of the debt guaranteed. Having joint and several liability for a debt means a person can be liable for the full amount of the debt. This suggests that each owner will be able to include in their owner s basis 100% of the bank borrowing. However as mentioned earlier the formula to calculate the owner s basis takes into account secured amounts which is determined under a lesser of test. Under one of these tests this liability is reduced to the owner s proportion of the security provided. Therefore the natural person would include only 1% of the bank borrowing. [Reference: s HB 11(12) definition of secured amounts. Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 39. Is the loss limitation rule calculated afresh each year or is it a cumulative limitation over the life of a company/investment? The loss limitation calculation must be carried out each year. It is a cumulative year by year test. [Reference: ss HB 11, HB 12. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 40. If the asset base is increasing in value is this taken into account within the loss limitation calculation? The loss limitation calculation in the initial year of transition from a QC to an LTC in the 2012 or 2013 income year allows an owner to use the market value or the accounting book value of the items in the formula. This choice is not available in calculations for subsequent years. However as illustrated in earlier questions if security has been provided under a guarantee the market value of the security will influence the owner s amount at risk. [Reference: ss HB 11, HZ 4C. Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 41. If a loan is taken from an associated person, is it taken as money at risk? It will depend on how the loan is taken. If the associated person lends the money to a look-through owner who then on-lends the funds to the LTC, this amount will be included in the look-through owner s amount at risk as part of the person s investments in the LTC.

14 If the associated person (not also a look-through owner) lends the money directly to the LTC the loan would not be included in the associated look-through owner s amount at risk as part of the person s investments. However if the associated person has provided a guarantee or indemnity in respect of a loan to the LTC this security may be included as part of the lookthrough owner s secured amounts. [Reference: s HB 11. Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 42. If a shareholder owns an LTC and personal assets are in a family trust, how is the secured amounts determined in the definition of investments in the owner s basis calculation? Are we expected to do a net asset calculation of shareholders to establish the base? Briefly, a look-through owner s investments in the LTC are the total of: the market value of the person s shares in the LTC at the time the person purchases or subscribes for them: the amounts that the LTC is a debtor for in relation to the person, including a loan to the LTC and a credit balance in a current account: secured amounts (not already included). If assets are in a trust the person does not have assets at stake (the trust assets are not secured amounts ). Therefore, trust assets will be excluded from the person s amount at risk. [Reference: s HB 11(5). Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17]. 43. If a shareholder of a LTC has no personal assets, does a guarantee provided by a family trust (of which the shareholder is a beneficiary) of a bank loan taken by the LTC qualify as a secured amount for the purposes of s HB 11(12)(a)? It appears that it would qualify as a guarantee provided by an associated person of the shareholder any thoughts? In the situation described the guarantee provided by the family trust will be included in the definition of secured amounts under section HB 11(12)(a). However it must be remembered that the secured amounts definition is a lesser of calculation so all parts of that definition must be worked through. As indicated in an earlier question this may result in the guarantee being excluded. [Reference: s HB 11(12) definition of secured amount. Tax Information Bulletin, Vol 23, No 1, February 2011, p 53. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, p 17].

15 44. If a Mum and Dad company (99:1) has a joint current account is the balance on the current account, for purposes of calculating the amount of loss limitation, split in the shareholder ratio or split 50/50 under the relationship property rules? A person s credit balance in a current account in an LTC is included in the person s investments. It is a question of fact as to what the level of a person s interest in the shareholder current account is. For example, the shareholders agreement may set out each shareholder s interest in a joint current account. This interest may not necessarily follow the person s shareholding ratio or the relationship property rules. [Reference: s HB 11(5)]. Tax liability 45. What taxes are LTC owners joint and severally liable for? Look-through owners are liable for tax on their share of the income from the LTC. The LTC itself is liable for PAYE, FBT, NRWT, RWT, ESCT and RSCT. [Reference: ss HB 1, YA 1 paragraph (abb) of the definition of company. Tax Information Bulletin, Vol 23, No 1, February 2011, p 48. IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 5, 12]. 46. If a LTC declares a dividend will they not then be subject to the RWT rules and therefore be required to pay 33% RWT? No. Distribution of LTC income is not a dividend because the LTC is not a company as defined. Therefore no RWT will be payable. [Reference: ss CB 32B, HB 1, YA 1 definition of company ]. 47. Is it correct that the FBT implications of the LTC providing shareholders with motor vehicles that are available for their private use will be eliminated? No. FBT still applies to an LTC. If a look-through owner is not an employee there will be no FBT liability. In the context of the LTC rules an employee includes an owner of an LTC who personally and actively performs duties as required by a contract of employment. If the person has a contract with the LTC as a working owner and a motor vehicle is provided to them in that capacity the LTC will have an FBT liability in relation to the provision of the vehicle. Note: The Taxation (Annual Rates, Returns Filing, and Remedial Matters) Bill 2011 proposes to amend the definitions of employee and employer to clarify that a working owner is not treated as an employee for FBT purposes. Therefore FBT will not apply to fringe benefits provided by the LTC to working owners. The cost of providing the fringe benefits will be a distribution of profit to the owner, to the extent of the private use element. The private costs

16 will be non-deductible to the other owners. It is proposed that the amendment will apply retrospectively from 1 April [Reference: ss HB 1, DC 3B, YA 1 paragraph (db) of the definition of employee, paragraph (b)(iib) of the definition of employer, definition of working owner and definition of contract of employment. Commentary to the Taxation (Annual Rates, Returns Filing, and Remedial Matters) Bill 2011, p 100]. 48. It is common practice for a debit entry to be made to a shareholder-employee s current account to eliminate or reduce the FBT liability on the shareholder-employee s private use of a company motor vehicle. Would there be a need for this practice to continue if an owner of an LTC has the use of a company motor vehicle? Yes, if the look-through owner is a working owner and the motor vehicle is provided to them in that capacity under their contract of employment. See also question 47 and proposed amendment to legislation. [Reference: ss HB 1, DC 3B, YA 1 paragraph (db) of the definition of employee, definition of employer, definition of working owner, definition of contract of employment ]. Interest deductibility 49. When an LAQC was used previously to achieve an interest deduction (e.g. acquiring ex family home as a rental or refinancing the shareholder current account) can interest remain deductible if an LTC is used? Yes, provided the property is used to derive assessable income by the LTC. The interest deductibility test is satisfied where there is a sufficient connection between the interest incurred and assessable income derived (the nexus test). It is how the funds are used by the borrower that determines deductibility. Under the LTC rules in section HB 1(4) the individual, in their capacity as owner of the LTC, is treated as having borrowed the money to acquire the rental property. The interest on the borrowing would therefore satisfy the nexus test and the individual would be entitled to the deduction for the interest paid. The use to which the individual, as the original seller of the asset, puts the sales proceeds they receive is not relevant to the issue of interest deductibility on the borrowing by the LTC to acquire the rental property. The above also applies in the case of an LAQC with a rental property that elects to become an LTC.

17 As for any loss that may arise, it is subject to the loss limitation rule. The loss will still pass through to the shareholders (owners of the LTC) but the shareholders may not be able to use them in that year. This is something that should be considered. [Reference: ss DA 1, DB 6, HB 11, HB 12]. Imputation credits 50. Are there any implications regarding retained earnings carried forward from 31 March 2010 with imputation credits and declaring tax paid dividends on post-ltc income (with tax paid by shareholders) - do we have bench mark dividend issues or can we declare dividends as we see fit? There are no bench mark dividend issues for an LTC because an LTC is not a company for tax purposes; therefore, it cannot be an ICA company. Accordingly an LTC is not subject to the imputation rules. Directors can still declare dividends for company law purposes. [Reference: ss HZ 4C, YA 1 definitions of company, ICA company ]. 51. When you enter the LTC regime, do you effectively lose any imputation credit balance held? Yes, effectively they disappear because the company will no longer meet the tax definitions of company and ICA company, so an imputation debit will arise on the day the company becomes an LTC. There are no taxable dividends subsequently as tax is already paid on the income by the shareholders as look-through owners. [Reference: ss OB 56, YA 1 definitions of company, ICA company ]. 52. Does the imputation credit account balance become nil on entry to the LTC regime and therefore all retained earnings allocated as exempt dividends; or do we still have to attach imputation credits to the extent they existed in the company? No. As explained in an earlier question the imputation credit account balance will disappear when a company becomes an LTC. Under the ordinary company rules if dividends have been paid with imputation credits attached any shortfall of tax payable by the shareholder would have been picked up by the shareholder. If a company is an LTC the imputation credit account balance has disappeared, dividends can be distributed tax free from the LTC and there will be no extra tax impost for the shareholder (lookthrough owner). [Reference: ss CB 32B, CB 32C, OB 56, YA 1 definitions of company, ICA company ].

18 Other 53. What form is required to be completed and filed to elect LTC status? IR 862 Look-through company election. This form must also be completed if transitioning from a QC/LAQC to an LTC. [Reference: s HB 13(3)(c). IR 879 (April 2011) Look-through companies a guide to the lookthrough company rules, p 8]. 54. With an LTC, as shareholder salaries cannot be credited to current accounts, the current accounts will become overdrawn. How should this be dealt with? From a company point of view, declare a dividend. If you have two shareholders (look-through owners) each owning 50% of the company, the company can pay a dividend that is not subject to tax because the tax has been paid by the shareholders. [Reference: none]. 55. If you change shareholding between shareholders after 1 April 2011, will this trigger depreciation recovered? Is it correct that if the shareholding change is done before 1 April 2011 there will be no depreciation recovered? Yes, depreciation recovered may be triggered depending on the circumstances. If the company is an LAQC it will become a QC from 1 April If an election is made to be an LTC and if a lookthrough owner sells their shares in the LTC, they are deemed to sell their share of the underlying assets in the LTC. The selling look-through owner is taxed at this point. There are specific exclusions from tax if the disposal proceeds do not exceed the total net tax book value of the look-through owner s share of the LTC property by more than $50,000, or if the disposing owner s interest included an interest in an item of depreciable tangible property with a historic cost of $200,000 or less. Any shareholding changes prior to 1 April 2011 will not give rise to depreciation recovered as the ordinary company rules apply. But note shareholder election requirements will need to be satisfied if QC status is to be retained. [Reference: ss HB 4, HB 5, HB 7. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 5, 18].

19 56. If you changed the LAQC to a partnership (not registered for GST), and then combined with an existing partnership that is registered for GST, what would be the implications? No transitional rules were enacted in the Goods and Services Tax Act 1985 so the usual GST rules will apply. In a GST context there would be an associated supply from an unregistered partnership to a registered partnership and the associated persons rules may apply. [Reference: Goods and Services Tax Act 1985, s 2(1), definition of associated supply ; s 2A]. 57. All LAQCs will become QCs from 1 April 2011 any GST issues? No. The same legal entity owns the same assets. The same answer applies if an LAQC transitions to an LTC. [Reference: Goods and Services Tax Act 1985, s 2(1), definition of person ]. 58. Can you feasibly set up an LTC to own a rental property with child shareholders, profits flowing through to them and taxed at marginal rates? Or if there was a bank loan that mum and dad who are not shareholders have guaranteed does this affect their look through interests? There can be infant shareholders in a LTC. If so the LTC income can flow through to them and it will be taxed at the infant shareholder s marginal rates. Mum and Dad will be associated with the child shareholders so presumably the guarantee provided by them would count toward each of the child owner s amount at risk. However the full calculation of secured amounts must be carried out. It would be prudent to keep in mind the anti-avoidance rules. [Reference: ss HB 13(2), GB 23, GB 25B]. 59. In the future when an ordinary company makes a capital profit, say upon the sale of a building, what mechanism is available to distribute that profit tax free especially where the company is to continue operating? Previously we would have used the QC regime to do this. QCs will remain in the meantime. The Policy Advice Division is looking at the distribution rules of closely held companies. This review may result in the abolition of QCs and closely held companies (ordinary companies) may be able to distribute capital profits tax free. [Reference: Media statement, the Hon Peter Dunne, Minister of Revenue, 11 October 2010].

20 60. Say an ordinary company has unimputed retained earnings at 1 April 2011, can it elect to be an LTC and then distribute those retained earnings tax exempt? No. If you are an ordinary company now and you want to become a LTC there is tax to pay similar to Qualifying Company Election Tax. [Reference: s CB 32C. Tax Information Bulletin, Vol 23, No 1, February 2011, pp IR 879 (April 2011) Look-through companies a guide to the look-through company rules, pp 8, 16].