Changes to closely held company tax rules
In New Zealand, companies are often the preferred vehicle when setting up a new business. They are well understood, underpinned by well-functioning legislation, flexible, and liability is generally limited to the amount of a shareholder’s investment.
However, the tax rules surrounding companies can be complex and not well suited to small businesses. In acknowledgement of this, the Look Through Company (LTC) regime exists to provide the corporate benefits described above, while ignoring the corporate form for tax purposes. Instead, an LTC is treated as a partnership for tax purposes and profits or losses ‘flow through’ to the shareholders.
Unfortunately, the devil has been in the detail, as the LTC rules themselves are also complex resulting in few companies electing into the regime. The IRD have recognised this and released an Official Issues Paper that proposes to make the LTC rules more user-friendly. The paper also considers changes to the treatment of capital gains and dividends.
Proposed changes to the LTC rules
The major changes proposed to the LTC rules include:
Eliminating the requirement for most LTCs to complete the loss limitation calculation because it has limited practical application.
Changes to the eligibility requirements to allow more than one class of shares (provided all shares have uniform entitlements to income and deductions).
Tightening the entry requirements for LTCs with trust shareholders. For example, a beneficiary that has received a distribution in the last six years will be a ‘counted owner’.
Excluding charities and Maori authorities from being shareholders in LTCs.
Restricting the amount of foreign income earned to the greater of $10,000 or 20% of its gross income when more than 50% of the LTC’s shares are held by non-residents.
Clarification of the debt remission income rules, including a change that should mean no debt remission income arises when an amount owed to a shareholder by an LTC is remitted.
Overall, it is debateable whether the proposed changes simplify the LTC regime or not.
Generally, a company is able to distribute a capital gain tax-free when the company is liquidated. However, if a company makes a capital gain on the sale of an asset to an associated person, that gain is taxable on liquidation. It is pleasing to see that this rule may be relaxed to exclude sales to non-corporate purchasers and sales between companies that are 66% commonly owned.
Other simplification changes include removing the requirement for certain companies to withhold Resident Withholding Tax from fully imputed dividends and some interest payments.