Traps for the unwary in qualifying company changes

Since the Budget there has been plenty of discussion regarding changes in tax rates, loss of building depreciation claims and the increase in the GST rate.  What seems to have slipped under the radar is the proposed changes to the Qualifying Company (QC) and Loss Attributing Qualifying Company (LAQC) rules. 

The Government has proposed a substantial overhaul to the QC/LAQC rules to stop what it believes are a number of tax advantages of LAQCs, which will apply to most LAQCs from 1 April 2011.  These types of entities are now very common throughout New Zealand, being used for property investment, farming, manufacturing, tourism and retail.

In simple terms, the proposed changes will combine the LAQC and QC regime into one ‘QC regime' and will treat these companies the same as partnerships for tax purposes while retaining the benefits of limited liability for non-income tax purposes under company law.  However, the changes do go deeper; although all of the detail has not yet been confirmed.

• Losses will be limited to the amount that the shareholder has at risk in the QC, meaning a possible restructure of shareholder advances to share capital may be required. Alternatively a personal guarantee for bank debt may satisfy the at risk requirement for claiming losses. Losses unable to be offset immediately will carry forward and offset against future taxable income from the QC.
• QC income will flow through to shareholders - the same as losses flow through -, meaning that income will be taxed at the shareholders personal tax rate (soon to be 33%) compared to the company tax rate (soon to be 28%).
• For property investors, transferring QC shares to existing or new shareholders will potentially trigger depreciation recovery income as the shareholder will be deemed to sell their share of the underlying QC assets. This will also occur if a QC ceases to be a QC, which will increase the tax risk of inadvertently falling out of the QC rules. There will be special disposal concessions but these may not apply to the majority of the QCs that operate.