How do they work?

From 1 April 2011 Loss Attributing Qualifying Companies (LAQCs) ceased to exist. The replacement loss attributing entity is a Look Through Company (LTC). Here we give some guidance as to how they work and some of the risks.

An LTC is a New Zealand company with look-through income tax treatment. LTC shareholders become liable for income tax on the LTC’s profits, whilst also being able to offset the LTC’s losses against their other income, subject to the loss limitation rules. Shareholders are treated as holding the LTC’s property in proportion to their shareholding. Therefore their liability for the company’s income tax, and their ability to offset the company’s losses against their personal income tax, are both in direct proportion to their LTC shareholding.

 LTC structure The company must be resident in New Zealand, and have no more than five shareholders (look-through counted owners). Only a natural person, trustee or another LTC can hold shares in an LTC. All the shares must be of the same class, and give the same rights and obligations to each shareholder. The look-through counted owner test determines the number of shareholders the company has for the purposes of the LTC rules. Related shareholders, for example, are counted as one shareholder.

 How to become an LTC The company director/s and all the shareholders must elect to make the company an LTC by completing a look-through company election form. The timing of the election is important; the date of election must be before the start of the income year. It will remain an LTC until either it no longer meets the eligibility criteria, or the election is revoked.

Loss rules Each shareholder can deduct their share of the company’s loss incurred against their personal income, subject to the loss limitation rule. The loss limitation rule is that the deduction a shareholder can use is limited to that shareholder’s contribution to the company. This rule ensures that shareholders can only offset tax losses up to the amount of their actual economic losses. Any contribution of $10,000 or more made by the shareholder within 60 days of the end of the LTC’s income year will not be included in the shareholder’s contribution to the company.

If the shareholder’s share of the LTC’s losses exceed their net contribution to the company, the loss can’t be claimed by the shareholder in that year. The unclaimed losses can, however, be carried forward to be deducted from income or loss in future years (subject to the loss limitation rule in those future years).

If the company ceases to be an LTC but carries on business as an ordinary company, any losses carried forward by a shareholder due to the loss limitation rules may continue to be used, but only against any future dividends they receive from the company.

Profits Each shareholder will be liable for the income tax payable on their share of the company’s net income at their personal tax rate. Whether this creates an increase or decrease of income tax liability for the shareholder will depend on the shareholder’s personal tax rate.

Risks When a company becomes an LTC, losses from all prior income years are written off. When a company ceases to be an LTC the shareholders are deemed to have disposed of all of the property owned by the company. When a shareholder sells their shares in an LTC that shareholder is deemed to have disposed of their share of the property owned by the company. Both deemed disposals are at the market value at the date of exit (regardless of actual consideration paid), and the shareholder/s will bear the tax consequences of disposal. This can have significant financial implications. (There are thresholds and exceptions to this rule.)

There may be tax avoidance issues if a shareholder lives in a property owned by LTC (whether temporarily or otherwise), and there are anti-avoidance provisions to prevent excessive use of the LTC structure.

Conclusion Compared with an LAQC, an LTC is a technical and difficult entity to use. Before deciding to establish an LTC, talk with all your professional advisers (us, your accountant and tax adviser) to ensure this is the right step for you and your particular circumstances.