January 19 2010
Can have tax advantages
If you have an investment making losses and you want to pay less income tax, an LAQC may be a useful investment vehicle for you. Despite some recent scrutiny by the Inland Revenue Department, LAQCs are still considered to be a robust and straightforward method to legally reduce your tax liability.
An LAQC is a regular New Zealand registered company that has made an election through the Inland Revenue Department to be a loss attributing qualifying company. To qualify to be an LAQC a company must not have more than five shareholders, the company must not receive more than $10,000 of income from foreign sources, and all the shares in the company must have the same rights attached to them.
The advantages and downsides of an LAQC
The main benefit of an LAQC is that losses made by the company can be allocated to the individual shareholders and offset against that individual’s personal income resulting in a decreased liability for income tax. With a company that is not an LAQC losses can only be offset against future profits.
Dividends from non-taxable reserves, eg: capital gains, are tax-free to LAQC shareholders.
Providing the shareholder is not an employee of the company, non-cash dividends distributed to LAQC shareholders are not subject to fringe benefit tax.
The shareholders must agree to become personally liable for a share of the company’s tax liability. This should not be an issue as an LAQC election is only appropriate for a company that is making losses, not profits. Furthermore, the company can exit the LAQC regime at any time within the tax year.
Qualifying Company Election Tax may be payable on entry into the LAQC regime on taxable reserves, this is currently set at 30%. The taxable reserves are all the retained income of the company. A newly formed company will not have any taxable reserves so the best time to elect to join the LAQC regime is at the time of incorporation. Understandably payment of qualifying company election tax is a strong deterrent to entry into the LAQC regime.
Any company losses from previous years which have been carried forward are forfeited on entry into the LAQC regime. Again, this will not be an issue for a newly formed company.
The LAQC regime is slightly more complex, for example, if you change the shareholding of the company you must file another LAQC election within 63 days of the change. There are also some increased compliance costs, for example, the costs of your annual accounts may increase.
Case study example
Mr & Mrs Jones are both employed, each earning annual salaries of $60,000 on which they each pay income tax of $13,809.67 pa. Mr & Mrs Jones own a rental property which is making annual rental losses of $20,000. If Mr & Mrs Jones transfer their rental property to an LAQC in which they each own 50% of the shares the losses can be attributed to Mr & Mrs Jones personally. The resulting tax benefits to Mr & Mrs Jones are that they should have paid income tax only on their salary less the losses which is $50,000 pa each. The tax refund they would each receive would be about $3,300. (Please note this calculation is based on some assumptions which may not apply to your particular circumstances.)
Using an LAQC to attribute losses earned in your company to you personally in order to reduce your income tax liability can be a useful tool. If you think you could benefit from an LAQC talk with us first to ascertain if an LAQC is the best method to use.
PS: Just as we went to press the Inland Revenue Department reported its success in a test case in relation to an individual who set up an LAQC for her private home in which she resided with a lease-back arrangement. This case confirms that LAQCs cannot be used to claim tax losses against the cost of living in your own home.