There are many potential fish hooks which could be discussed. I have chosen three which I believe to be amongst the most risky.
Remembering this is a guide and if you want an assessment for your particular situation please give us a call and arrange a time to meet. Under the LAQC regime it did not matter how much equity you had in the company, if it made a loss then shareholders could access that loss. This is not necessarily the case with LTCs, which limit losses to the extent of an owners "economic risk".
Every year the extent of this economic risk has to be calculated in the form of an "Owners Basis" OB calculation. The calculation and maintenance of OB can be a complex exercise in itself and creates higher compliance costs.
In its most basic form the OB calculation considers contributions made to the company by owners against what they have taken out. If the expenses and drawings from the company exceed the amount invested then expense deductions are disallowed and ring fenced until the owner has sufficient investment to utilise them. An implication of this is that current account balances must be monitored and kept at reasonably healthy levels. Owners need to consider the impacts on their OB if they take drawings.
Excessive drawings can easily create a negative balance. In an LTC income and expenditure are treated independently. With no OB, deductions against LTC income will be disallowed and therefore owners could be left with a tax bill on the resulting income. This fish hook severely reduces the flexibility of owners to take drawings from the company. A company must meet certain criteria to be considered an LTC.
These criteria must be continually met at all times during the year. It is not difficult to breach these criteria and fall out of the regime. How to find the right property. How to negotiate successfully. Property management. Case studies and examples. Learn more Property by Matthew Gilligan. Property strategy meeting. Events and courses. Online tools. Accounting and tax structures.
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All our mentors are experienced, full-time property investors. Learn about us. The LTC election filing rules apply from 21 December Companies with an early balance date, for example, a company with a balance date of 31 December, can start using the LTC rules from their income year from 1 January to 31 December LAQCs with an early balance date of, for example, 31 December , choosing not to transition but to use the QC rules will have loss attribution for their income year ended 31 December but will no longer be able to attribute losses for their income year starting on 1 January Companies with a late balance date, for example, a company with a balance date of 31 May, can start using the LTC rules from their income year from 1 June to 31 May If transitioning in the second of the possible transitional years, they must also have met the QC criteria for the whole of the first possible transitional year.
It introduces the principle that LTCs are transparent for income tax purposes, and contains the LTC election requirements and rules on the tax treatment following an owner's disposal of interests in an LTC. Section YA 1 introduces several defined terms, including "LTC", "owner's interest", "look-through interest" and "working owner".
A company that elects to use the LTC rules must be a company that is a body corporate or entity with a legal existence separate from that of its members that is resident in New Zealand under domestic law and under any relevant double tax agreement.
The company residence rules in section YD 2 apply for these purposes; in other words, it is the residence of the company and not its shareholders that is determinative.
A company using the LTC rules must have only one class of shares. All the shares must have the same rights to vote concerning company distributions, the company constitution, capital variation and director appointments, and to receive distributions of profits and net assets.
This requirement prevents streaming of income or deductions under the LTC rules. The shareholders of a company using the LTC rules must be either natural persons or trustees including corporate trustees. An ordinary company cannot hold shares in an LTC. The sub-LTC's income and expenses will ultimately be attributed to the owners of the parent LTC, and it is these owners who are included in the look-through counted owner test.
To become an LTC, a company must meet all the eligibility criteria and must continue to meet it for the whole of the income year. If an LTC breaches the eligibility criteria its LTC status is lost from the first day of the income year in which the breach occurs. It cannot then use the LTC rules in the year in which the breach occurs or either of the following two income years.
A company that has elected to use the LTC rules is thereafter excluded from the definition of "company" in the Income Tax Act. This means that most of the rules that apply to companies, such as the requirement to keep memorandum accounts and the rules governing payments of dividends, do not apply to LTCs. However, for the following provisions there is no look-through treatment and the company, rather than its owners, is the relevant entity:.
An LTC must have five or fewer "look-through counted owners". This term applies for this count test only, and although related to shareholdings it is not always transposable with the term "owner" or "shareholder", such as when an LTC is the parent company of another LTC. For many LTCs it will be clear that they meet the count test, for example, if the company has only three individual shareholders it clearly has fewer than five shareholders and so fewer than five "look-through counted owners".
However, for companies that have more than five individual shareholders, or shareholders that include trustees, the look-through counted owner test needs to be considered.
The look-through counted owner test determines the number of look-through owners the company has for the purposes of the LTC rules by identifying the relationships between individual shareholders. Shareholders related by blood relationships second degree , marriage, civil union or de facto relationship, or adoption are counted as a single "owner" for the purposes of this test. Death or dissolution of marriage between the shareholders does not break the two-degree test, provided the company was an LTC and the shareholders were counted as "one" before the event.
In the example above, if Zeb, Esther, Benjamin, Mary, Jones and Curtis all held shares in a company they would be counted as a single look-through counted owner because they are related to each other via Mary within two degrees. If only Jones, Esther and Curtis held shares they would be counted as two look-through counted owners because although Jones, as his stepfather, is related to Curtis within two degrees, neither of them are related to Esther within two degrees, as she is Curtis's great grandmother and Jones's grandmother-in-law.
The look-through counted owner test must also be applied if a trustee holds shares in an LTC. Here the test will "look through" to the natural person beneficiaries of the trust which includes looking through any corporate beneficiaries to its natural person shareholders , if those beneficiaries are allocated income from the LTC as beneficiary income in that income year, or in any of the three preceding income years.
The trustees of a trust are counted as one look-through counted owner for an income year if any income the trust was allocated from the LTC in that income year, and in each of the preceding three income years, was retained by the trust and not paid out as beneficiary income. Walton Trust is managed by a corporate trustee. It distributes all of the income from Mountain Design Ltd to the following beneficiaries:. Because Mamie is Emily's sister a two-degree blood relative they are counted as one owner.
In 20X5 there are five look-through counted owners, because the test considers who received beneficiary income in the current income year 20X5 , and any of the three preceding income years 20X2, 20X3 and 20X4.
The look-through counted owners are:. If a company including a qualifying company is the beneficiary of a trust and has received income from the LTC as beneficiary income in that income year, or in any of the three preceding income years, then the company itself is not regarded as a look-through counted owner. Instead the test counts all natural persons who have a voting interest in relation to that company, whether directly or otherwise.
The LTC regime is elective. A company can only use the LTC rules if it continuously meets all the eligibility criteria, and has filed a valid election with Inland Revenue. A guardian or legal representative must sign for owners aged under 18, or any other owner without legal capacity. The director or other authorised company agent should send the election form to Inland Revenue, and confirm that all the owners have signed it.
An LTC election may also be signed by a person holding shares as a nominee or as a bare trustee for the beneficial owner, acting on instructions and on behalf of the beneficial owner under section YB Elections relate to the income year of the company electing to become an LTC; so the due date for the election depends upon its balance date.
Newly incorporated or non-active companies must file the LTC election by the date for filing their first income tax return. If an LTC election is received after the start of the year to which it was intended to apply, or if it is discovered to be invalid because, for example, not all the shareholders signed the election, it may still be accepted as a valid election.
However, the Commissioner's discretion will be exercised only if exceptional circumstances, such as a severe illness, caused the omission or lateness, and if any omission in the election is rectified in that income year. Any owner may revoke the LTC election.
It does not matter whether they were one of the initial owners who signed the election or not. The revocation notice must be received by Inland Revenue before the start of the income year to which it applies. A copy should be sent to the director of the LTC, to ensure that all owners are aware of the change in status. If a revocation notice is received after the start of the income year to which it relates, the Commissioner may still accept it, if it was late due to exceptional circumstances.
A revocation may be ignored if the owner issuing the revocation notice disposes of all their interests in the LTC, and the person s who acquire these interests advise Inland Revenue before the start of the relevant income year that the previous owner's revocation notice is to be reversed. To protect the integrity of the new rules, if an owner revokes the LTC election the company cannot use the LTC rules in the year for which the revocation is made, or in either of the following two income years.
If a company becomes an LTC after its first year of trading, its reserves are regarded as held by the owners in proportion to their look-through interest. So when a company first becomes an LTC, each owner will be deemed to have an amount of income arising on the first day of the income year the company becomes an LTC.
This is necessary because under the LTC rules these reserves may be distributed or drawn down upon without the owners being subject to tax upon distribution; this treatment is not intended to apply to previously accumulated company reserves. The amount of each owner's income is equal to their proportion based on look-through counted interests of the amount of the company's reserves that would be taxable if the company was liquidated and assets distributed to shareholders.
The formula to determine the amount of these reserves, which applied to the company immediately before it became an LTC, is:. This includes items such as depreciation recovered, bad debts and loss on sale of assets. Each owner is subject to tax on their proportion of these reserves, which are regarded as an income amount to them. This income amount is deemed to arise to owners in the income year the company becomes an LTC, and each owner pays income tax on the amount at their personal tax rate.
If a company ceases to be an LTC but continues in existence, it will be taxed as an ordinary company. Any retained revenue profits held by the company would have been previously allocated to owners who would have been subject to tax on this income in the year the income was derived. To prevent any double taxation of this income, dividends paid by the company in income years after it ceases to be an LTC will be regarded as paid firstly from this retained revenue profit until an amount of dividends equal to the amount of retained profit has been paid.
This applies whether the dividends are paid to the same shareholders that held shares while the company was an LTC or to new shareholders. Dividends regarded as paid from this retained revenue profit are excluded income in the hands of the shareholder recipients. The available subscribed capital formula is adjusted to reflect capital distributions made while the company is an LTC, taking into account both equity subscriptions and returns on that equity.
With some exceptions, for the purposes of the Income Tax Act, owners are generally treated as carrying on activities and having the status, intention and purpose of the LTC. While the LTC is treated as not carrying on these activities or having such an intention or purpose. Generally though, LTCs are transparent for income tax purposes. Owners are treated as holding property in proportion to their effective look-through interest, and as parties to an arrangement, and doing or being entitled to a thing, through their capacity as owner, unless the context requires otherwise.
An owner's effective look-through interest in an LTC is measured by the percentage of decision-making rights carried by their shares in the company in relation to dividends or other distributions, the company constitution, variation of the company's capital and director appointments or elections.
Income, expenses, tax credits, rebates, gains and losses are passed through to owners. These items are generally allocated in accordance with an owner's effective look-through interest in the company, and will usually be allocated according to their average yearly interests, as if each item occurred uniformly throughout the year. If the voting interest or market value interest varies during the year, owners may use the weighted average basis to determine their effective look-through interest, as shown in Example 3a.
If the company has a market value circumstance in the year, the owner's effective look-through interest is calculated as the average of their voting interest and the market value interest in the company for the income year.
On 31 December Caroline sells all her shares to Laura. Caroline and Laura have been shareholders for nine months days and three months 90 days respectively. The income and deductions are regarded as accruing evenly throughout the year, and are allocated to each shareholder based on their yearly average as follows:.
Alternatively, if the voting interest or market value interest varies during the year owners can use their actual look-through interest in each period during the income year.
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