The review of the taxation of closely held companies has been in the IR work program for some time and while the issues paper focuses largely on look through companies (LTCs) it also contains important proposals on how closely held companies and their shareholders should be taxed.
The document discusses reforms to:
- the entry criteria for becoming an LTC
- Restrictions on the use of LTCs by non-residents
- Simplification of the deduction limitation rule.
- Amendments to aspects of the dividend regime.
In addition Qualifying Companies (the predecessor to LTC’s) are expected to retain their status as QCs unless shares are sold for a windfall gain in which case QC status will be lost on the change of shareholding. There are also technical fixes proposed on entry into the LTC regime with pre-entry reserves to be taxed at marginal rates; and for debt remission where a debt owed to the shareholder by an LTC is remitted because the LTC cannot repay the debt.
The proposed changes to companies who are eligible to become LTC’s are significant particularly where the shares in the LTC are owned by trusts, charities or Maori Authroities.
For trusts it is proposed that
- A beneficiary that has received any distribution in the last six years should be a “counted owner”.
- A company should not be eligible for LTC status if a trust that is a shareholder makes a distribution to a corporate (non-LTC) beneficiary.
- The trustee should continue to be a single counted owner in the event that no distributions are made in the relevant period (last six years).
- Charities and Māori authorities would be precluded from being shareholders in LTCs or beneficiaries of trusts that own shares in LTCs. This would not impact on standard charitable donations.
More than One Class of Share
Officials propose to allow more than one class of share to be issued by an LTC without the LTC status being compromised. The different class of share can provide for different voting rights but all shares in the LTC must have uniform entitlements to income and deductions.
Non-residents and LTCs
The IR appear concerned at the use of a LTC as a conduit vehicle by non-resident shareholders to invest in foreign assets. A corporate structure that in some ways mirrors the foreing trust rules.
After careful consideration the officials accept that a hybrid entity such as an LTC should remain available for non-resident investing in NZ assets; and for NZ residented investing through an LTC in offshore investments.
However they propose to restrict the use of LTCs for offshore investments by limiting the foreign income an LTC can derive to the greater of $10,000 or 20 percent of its gross income when more than 50 percent of the LTC’s shares are held by non-residents if it wishes to retain its LTC status.
Deduction limitation rule
Since LTC’s were introduced to replace the Loss Attributing Qualifying Company (LAQC) regime there have been various quirks identified in the deduction limitation rule which was often referred to as the loss limitation rule.
There are a number of proposed changes and technical amendments to improve the ability of owners to get a deduction with a pleasing concession which would allow an immediate deduction against a shareholders’ other income in the 2017–18 income year for any deductions that have had to be carried forward due to the prior deduction limitation rule.
Initiatives to simplify and reduce the compliance and administration costs associated with closely held companies that are neither LTCs nor QCs include:
- Amending the restrictions around tainted capital gains to ensure that genuine capital gains made by small businesses do not become taxable on liquidation merely because there is a transaction involving an associated non-corporate party.
- Making the deduction of RWT from fully imputed dividends between companies optional rather than obligatory.
- Optional removal of resident withholding tax (RWT) obligations from small companies in respect of the dividends and interest they pay to their shareholders. This reform to be considered as part of a wider body of work on streamlining business tax processes.
- Streamlining RWT obligations when cash and non-cash dividends are paid concurrently so that they can be treated as a single dividend.
- Allowing shareholder salaries to be subject to a combination of PAYE and provisional tax provided the company maintains the approach consistently from year to year.