Now that the draft legislation has been released, we have a much clearer view of how the new rules announced in the budget will look. On the face of it, this seems a rather radical departure from the changes proposed in the budget, which included no such axing of the ability of shareholders to access an LAQC’s losses.
However the draft legislation also introduces the “Look Through Company” (LTC), which will allow allocation of the company’s losses to shareholders in proportion to their shareholding.
The new LTC seems likely to be the new preferred option for people who currently hold loss making businesses or investments in LAQCs. Shareholders will be able to elect for their existing LAQC or newly incorporated company to become an LTC from 1 April 2011.
So what makes an LTC different to existing LAQCs? There are many subtleties, but the top three changes that will affect most existing LAQCs are these:
Unlike existing LAQCs rules, shareholders of LTCs will be personally taxed on the company’s profit at their own marginal tax rate. This seems reasonable as it aligns the treatment of the company’s profits with the treatment of its losses.
Unlike existing LAQCs, any transfer of shares in an LTC will be treated as a sale of the underlying assets. This may trigger significant depreciation recovery issues creating a tax bill without the funds to pay the tax from an actual sale of the asset. Careful management will be needed here.
Shareholders will only be able to access LTC tax losses to the extent the losses reflect their own economic loss from the company’s activities. “Economic loss” will include share capital, shareholder loans and company debt guaranteed by the shareholder, so this is not as narrow a test as many people feared following the budget.
All those currently operating LAQCs will need to consider their options with their tax advisors. Options will include:
The default option which is unlikely to be the best option will be to continue as a QC without the ability to attribute losses to shareholders.
Revoking LAQC status and being taxed as an ordinary company.
Electing to become an LTC as detailed above.
Becoming a partnership or a sole trader. Special rules will allow this transition without a tax cost – although if property is involved there will be significant conveyancing, legal and bank costs.
If you hold property investments in an LAQC, I suggest you review this with your tax advisor.
Some of the issues that will need to be considered are: How long do you intend to own the property? Do you intend to introduce other shareholders in the future – or to transfer shares into your trust at any point? Does the property generate losses? How long might these losses continue given the changes to depreciation rules? What is your actual economic investment in the LAQC and how might this change in the future?
Although the introduction of the LTC is a complicating factor since the original budget announcements back in May, the new LTC structure does broadly reflect the changes announced in the budget.