David Whitburn

Posts Tagged ‘LAQCs’

Changes to Qualifying Company rules and Look-Through Companies

Here is an important blog sourced from Inland Revenue in relation to the tax changes for LAQC owners.  The changes take effect from 1 April 2011.  Legislation passed in December 2010 made important changes to the rules for qualifying companies (“QCs”) and loss attributing qualifying companies (“LAQCs”).  These changes mean that LAQCs will no longer be able to attribute losses to shareholders.  The changes will affect all existing QCs and LAQCs, and also closed companies that may have wished to elect to use the qualifying company rules for income years starting on or after 1 April 2011. These changes also include the creation of a new tax entity known as a look-through company (“LTC”) to provide for a transparent form of tax treatment. This is to ensure that income and expenses are shared according to the owner’s effective interest in the LTC.

QCs and LAQCs (or their agents) will receive a letter late February advising them of the changes. Election forms and a factsheet will also be available in late February. A guide about look-through companies will be available in April.

Changes to the QC and LAQC rules

• The introduction of a new look-through company (LTC) tax entity for closely-held companies.
• Existing QCs and LAQCs will be able to transition into a LTC, or change to another business entity (such as a limited partnership or sole tradership) without a tax cost.
• Existing QCs and LAQCs will be able to continue to use the current QC rules without the ability to attribute losses.

The new look-through company rules

• The new rules create a new tax entity, called a look-through company (LTC).
• The new rules mean that the owners of a LTC will pay tax on the company’s profit and use the losses, subject to limitations.
• This is different from the existing LAQC rules because it is the owners of a LTC who will be taxed on the income of the company.
• A LTC’s income, expenses, tax credits, rebates, gains and losses are passed on to its owners, in accordance with their effective interest in the company.
• Shareholders of QCs and LAQCs will be able to elect to become an LTC.

A look-through company is still a company

• A LTC retains its identity as a registered company.
• A LTC will keep its corporate obligations and benefits under general company law, such as limited liability.
• The look-through treatment applies for income tax purposes only; the owners of an LTC are regarded as holding the LTC’s assets directly and carrying on the activities of the LTC personally.

Loss limitation for look-through company owners

• The LTC rules also have a loss-limitation rule, similar to that of limited partnerships.
• This will mean that owners can offset tax losses only to the extent that their losses reflect their economic loss.
• Any losses an owner cannot use are carried forward and may be used by the shareholder in later years.

Here’s what’s happening to current QC and LAQC rules

• The ability for LAQCs to attribute losses has been removed; this effectively means the LAQC rules have been abolished
• Existing LAQCs will default to QCs which may continue using the current QC rules.
• The current QC rules will remain while the Government reviews the tax rules for dividends, with a view to simplifying them for closely held companies.

Your options if you have an existing QC or LAQC

You have several options to choose from 1 April 2011. For instance, you can, without a tax cost:

• do nothing and continue as a qualifying company without the ability to attribute losses (the default option), or
• be taxed as an ordinary company by revoking your LAQC election, or
• elect to become a look-through company, or
• use the new transition rules to become a limited partnership, an ordinary partnership or a sole tradership. You will need to restructure your business and either make the company non-active or wind it up if you choose this option.

The new rules come into effect on 1 April 2011

• The legislation for these new rules was passed in December 2010 and comes into effect from 1 April 2011.
• The LTC regime will come into effect from 1 April 2011.
• LAQCs will no longer be able to attribute losses from the income year starting on or after 1 April 2011.
• The transition to a new entity can take place in either one of the first two income years starting on or after 1 April 2011
• QCs and LAQCs have six months from the start of their transitional year to advise us of their transition. The tax treatment for the entity they transition into (ie, LTC, partnership, or sole tradership) will then apply from the start of the transitional year.
• Provided the election to become a LTC or notification to become another entity is made within the first six months of the income year, the transition will be deemed to take effect from the start of the income year and will incur no tax cost.

Time to make an election

Elections must be received by the Commissioner before the start of the income year they apply to.  However, for the next two income years (starting from 1 April 2011 to 31 March 2013), existing QCs and LAQCs have a six-month extension period to elect to transition into a LTC, eg by 30 September 2011 if you have a standard balance date.  The LTC (look-through treatment) will apply from the start of the transitional year.

With acknowledgements to Inland Revenue

I am back from a cameo visit to Sydney today where I was a paid presenter for a six hour module on “Investing in New Zealand”.  I was very interested to see the announcement from the Government that LAQCs which I knew were going to be abolished but thought they had left the door open for some offsetting of losses against personal income.

The writing has been on the wall for a long time for property investors using Loss Attributing Qualifying Companies (“LAQCs”).  We know that the ultimate goal is to ring fence tax losses completely, so we property investors cannot use the LAQC ownership structure (our vehicle of choice) to offset rental property losses against or salary/wages.  Investors should not be surprised about this, although the hopes of many appear to have finally been dashed with the hope that there would still be the ability to deduct tax losses against income from personal exertion to the extent of capital contributed or even more hopefully against the amount of loans personally guaranteed.  Now the missing piece of the puzzle has been found – with the Minister of Revenue, the Honourable Peter Dunne saying this afternoon that “the Government would introduce new rules preventing loss attributing qualifying companies (LAQCs) from passing losses on to their shareholders.”

How did LAQCs become such a problem?

Lets look at this issue.  I don’t use LAQCs myself, instead preferring the asset protection (creditor protection, succession planning) benefits that well managed trusts bring along, with some incidental tax benefits, since I am not ‘normal’ and like to buy properties that make me money.  A lot of investors have bought on the rising market during the boom from 2003 – 2007 and fair few bought in 2008 thinking the market was just taking a short breathe before it would go up in value again.

The credit criteria for getting bank loans were very relaxed from 2004 until the Global Financial Crisis kicked into gear in New Zealand around September 2008.  Investor friends of mine were able to get their effective tax rates down from over 33% to below 15% through rental property losses being attributed via the LAQC against their salaries.  Instead of being net taxpayers, property investors (particularly residential property investors) became net taxrefundees! In 2003 before the last property boom kicked off there were $710 million of losses from LAQCs.  This more than tripled to a significant $2.256 billion by 2008.

The Tax Working Group made a big thing of this in 2009, and the information they had from Inland Revenue and Treasury showed the last two years that property investors were making big losses, despite control what they perceive to be well over $150 billion worth of property.

As a result of the financial crisis affecting companies, reducing consumption spending, rising unemployment and lets not forget the fact that we have many hundreds of thousands of New Zealanders not earning a single cent who have been in increasing numbers totally dependent on Government handouts, our Government has been suffering reduced income, yet facing increased expenditure pressures.  We are losing money to the tune of over $200 million per week.  This has to be borrowed at interest from abroad.  A few things had to give in the May 2010 Government budget.   One was the consumption tax that is Goods and Services Tax (“GST”) being raised to 15% with effect from 1 October 2011, another was building fit-out items being deemed to be fixtures and classified as part of the “building structure” eg. tiles and vinyl flooring is now depreciated at the building structure depreciation rate, and the building structure depreciation rate has been reduced to 0% (from 3% diminishing value, 2% straight line) with effect from 1 April 2011.  At that time the Minister of Revenue the Honourable Peter Dunne and the Honourable Bill English as Minister of Finance suggested that there would be tax changes to LAQCs.  We knew changes were coming – we had thought that LAQCs would be taxed as Limited Liability Partnerships and have to file IR7 returns, with LAQCs would be abolished to just be qualifying companies.  Now far more light has been shed with LAQCs and QCs being able to continue, just without the ability to attribute losses to their shareholders! So from 1 April 2011 LAQCs will lose their major benefit – being able to reduce their taxable income.  They called for submissions on this and wanted to work out the detail.  My previous blog contains the Press Release.

My Interpretation

If you have an LAQC you will need to take an extremely serious look at your structure and indeed portfolio and look for options on what to do with it.  The draft legislation will give full certainty, but one thing is for certain.  If you have an LAQC and make tax losses from which you have been offsetting your personal income – you will not be able to do this post 1 April 2011.  You will need to make changes, and before 31 March next year.

Follow the text of the draft legislation very carefully and look very carefully at your depreciation claims.  As Steve Tucker the owner of NZ’s leading chattels appraisal company Valu-it said in his address to APIA in July 2010, that depreciation claims are likely to be slashed by 60 – 85% depending on the type and nature of the property.  Older buildings with few valuable depreciable fit-out and chattels items would be amongst the hardest hit, as would commercial property as their is very little Landlord fitout or chattels.

Look at your latest set of financial accounts and analyse what is likely to happen to you post 1 April 2011.  If you need to make changes I would strongly suggest that you talk to me and we can look together at all of the fantastic benefits that trusts can provide you with.  Having worked at both leading chartered accountancy firm Deloitte, leading law firm Russell McVeagh, being a successful property investor myself, and having worked with property investors on ownership structures for a number of years, I can work with you to balance tax optimisation and asset protection objectives in this challenging political climate.  Contact me at david@davidwhitburn.com or on direct dial (+64 9) 528 5533.

Today has been an Interesting day. Seen a house burning down. Had a fantastic feast of a lunch whilst sharing ideas with property investor & developer and former mortgage broker Ammon Acarapi, and Lease Options guru and and property investment superstar Steve McMenemy.

Steve’s been busy buying property – making himself a few more hundred dollars a week positive cashflow from Lease Options, doing some super do ups and quick flicks, and basically anything he can to maximise his lifestyle and quality time with his lovely life wife Kelly and their two kids. Steve’s an inspiration to me as well as a long time friend of mine. It is just so fantastic to see his and Kelly’s continued personal and portfolio growth. Keep it up mate.

He is a fine example to many younger New Zealanders that you don’t have to join what seems like the majority and do an OE. When we live in the most beautiful country in the world, have plenty of financial opportunties to make for ourselves, own Businesses to grow – there is not such a need.

The burning house of Kemp Road & insurance protection

In the same street as our Fuzo showoffice today I saw and smelt a house burning down. Not very pleasant at all. The firefighters were super and got there very quickly – sadly the house inside was gutted. The second house within the past 9 days on the street to be gutted by fire. Suspected electrical fault again at this early stage – guys old wiring is dodgy. No one was injured or hurt fortunately. However this got me thinking. For properties you are keeping you can lose a substantial asset if a current insurance policy is not in place and income from not having a rental house in place. My suggestion is to get insurance policy extensions to cover loss of rental income from fires too. It happens far too often.

A Fuzo client has even had their house burn down (the older one not the new house we built for them). Fortunately they had insurance to cover the rental income whilst the assessors did their work, demolished the old home, got building consent to erect a new building, insurance company approval to built it and then getting it built. This takes many months, possibly a year – can you survive without that cashflow? If not get insurance to cover it. I know some successful investors don’t insure all their properties, but until you achieve massive success and have 40 plus properties in your conservatively geared portfolio – you are not ready to do the same.

Asset protection

I often get asked about what structures I use. Today I helped guide a couple of trading and development clients re just what is the best structure for their property investment activities today. So for those that I have promised this information to and to be useful to others here’s what I do and recommend.

Because I am a Business owner, property developer, trader, investor and own home owner trusts are the best structure to have. I value asset protection extremely highly, more highly than total tax optimisation so I have 3 core trusts:

1) A trading trust – for all properties I buy with an intention for resale
2) A buy/hold trust – for all properties I hold and buy for the long term (with no plans to resell at the time I buy it)
3) A family trust – for my own home in central Auckland, my wife and my life insurance policies, some ungeared passive investment (shares, managed funds, bonds, mutual funds and term deposits).

I have 3 other trusts, but these are for my business interests, joint venture entities, and I am a trustee of some of my family members and a couple of close friends trusts too.

I highly recommend the use of professional trustees in your trusts (not so for trading trusts). So I am not a trustee of my buy/hold trust, nor my family trust. Rather leave my lawyers to run it and let me focus on my core activities.

A structure like this gives me true asset protection in the sense that I get creditor protection, a clear and simple ownership structure, smart savings structure, in built succession plan, flexible structure, tax effective for me, no need to enter into gifting programmes, option to get around means testing (eg for medical, pharmaceutical and nursing costs).

In my opinion everyone should own their own home in a family trust. And also every property trader (that I define similarly to the Income Tax Act 2004 – as a person that purchases a property with a purpose of resale at the time of acquisition) should buy that property in a trading trust. However for some salaried people it may be better to purchase long term buy/holds in a Loss Attributing Qualifying Company where they get massive tax advantages for doing so. In my opinion business owners should be using the tri-trust structure I have recommended.