The 2010 budget signalled an overhaul of the QC regime – and although these changes have not yet been confirmed, they will likely take effect from 1 April 2011. While we have yet to see the proposed legislation, there have been clear signals of what we can expect to see.
By way of background, the QC (Qualifying Company) regime includes the popular LAQC (Loss Attributing Qualifying Company) form of company which allows any losses the company makes to be passed through to the shareholders in proportion to their shareholding. For example, if you hold 40% of the shares in an LAQC which makes a loss of $10,000, you are able to include a loss of $4,000 in your personal tax return thus reducing your own taxable income – and your own tax bill.
This form of structuring has become well known and a popular way of holding loss making business activities such as highly geared property investments or high risk entrepreneurial ventures. This popularity brought LAQCs to the attention of the Tax Working Group who recommended change in their December 2009 report – largely because they found that during the last housing boom, the number of active LAQCs doubled and the average tax loss claimed by investors increased by almost 50 per cent.
The term LAQC will be dropped, and both QCs and LAQCs will be known simply as QCs. More significantly than a mere change of terminology, we the following changes are likely to be included in the upcoming legislation – which treasury expects will generate additional revenue of $70 million in the 2012 year:
Losses will be limited to the amount that the shareholder has at risk in the LAQC / QC, which would impact on LAQC /QCs which are 100% geared. For example if a shareholder personally contributed say $5,000 to the QC with a much larger amount being borrowed from the bank, then on the face of it that shareholder’s losses will be limited to $5,000 rather than the much larger amount that may have previously been available. However it seems likely that personal guarantees for bank debt may satisfy the “at risk” requirement for claiming losses. Given that banks lending to QCs almost universally require personal guarantees from shareholders, this proviso would mean no practical impact for most people currently operating LAQC /QCs – unless they genuinely have no money at risk.
Where an LAQC /QC returns a profit, this will be passed through to the shareholders and taxed at their marginal tax rate which is likely to be 33% rather than the company tax rate of 28%. However this will not have an impact on the majority of LAQC /QCs which operate at a loss. There is already a significant incentive to drop out of the QC regime as soon as the venture begins to return a profit as one of the conditions of being in the QC regime is that the shareholders personally guarantee the LAQC /QCs income tax obligations – a requirement that does not apply to companies that are not in the QC regime.
Transferring LAQC /QC shares to existing or new shareholders will potentially trigger depreciation recovery income – as will dropping out of the QC regime. This depreciation recovery will be the same as if the LAQC /QC had physically sold the depreciated property to a third party – and I suspect this is where treasury expects to derive most of its $70 million additional revenue from these changes. This will require some careful management – but as the majority of depreciation recovery issues are with buildings, and as buildings can no longer be depreciated after 1 April 2011, this issue will become less pertinent as time goes on.
So in a nutshell, LAQC /QCs will certainly require more careful management – and probably more careful consideration up front as to whether they are indeed the most appropriate vehicle to conduct your business. However there is probably nothing too scary in the wind for most LAQC /QCs.
We will be reviewing all our LAQC /QC clients once we have seen the proposed legislation, but if you have any concerns call us any time.
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