QC and LAQC Reforms – New Announcement by the Minister of Revenue?
Most readers will know of the changes to the QC and LAQC regimes foreshadowed in the May 2010 Budget. The details announced in the the Budget were very brief.
However, a series of questions and answers on the upcoming changes have been released, as well as draft legislation encapsulating the changes. This article explores what these changes mean for those interested in QCs and LAQCs.
Have a look at our podcast discussion on the QC and LAQC changes with Craig Macalister from the Institute of Chartered Accountants of New Zealand.
What are the new developments in this area?
In October the Minister of Revenue released a questions and answer sheet on the future of the QC and LAQC provisions. You can view this at the following page: http://taxpolicy.ird.govt.nz/news/year/2010. The changes were signaled in the May Budget, but the extent of the changes has not been known until now. While the press release casts some clarity on the subject, draft legislation has also been released to clarify the treatment proposed.
Why are they making the changes to the rules?
- The QC and LAQC rules were added to the company tax rules in the 90s after changes to the tax system in 1985, that taxed the distribution of capital gains.
- Imputation taxes capital gains that are not distributed on liquidation. This is because capital gains are not generally taxable in New Zealand. Thus, they do not create any imputation credits. In the absence of the QC and LAQC regimes capital gains would be locked in till the companies are liquidated. The QC and LAQC regimes allow for capital gains to flow out without being taxed.
- However, when the imputation regime commenced the company tax rate and marginal tax rates were fairly much aligned. Thus, we suspect the thinking was that losses could flow through to shareholders, while profits could be taxed in the company.
- However, with the company tax rate now lower than the top marginal tax rate, the Government is missing out on tax by allowing income to be taxed at the lower company tax rate, but losses to flow through and offset income tax at higher personal marginal tax rates.
- As QCs and LAQCs increased dramatically over the previous property boom the Government has decided to move against them and the perverse incentives they create.
What are the changes being proposed?
There are three important changes:
- Losses will no longer be able to flow through LAQCs. However, the QC regime is maintained for the most part.
- A new type of company, a Look Through Company, or LTC, is being developed. This is to allow QCs and LAQCs the ability to transfer to a flow through world without changing legal form. Although the detail is rather light at the moment, it would appear that this is an attempt to maintain the “good” parts of the QC regime, such as flow through of profits, losses and capital gains, while at the same time limiting any abuse of the rules. If QCs or LAQC want to change to this new type of entity there will be no tax cost during the transitional period.
- A review of the dividend rules as they apply to closely held companies is currently being undertaken. Thus, no changes are proposed to these rules at present. It is likely that when these rules are finally reviewed that the QC and LAQC rules will be entirely phased out.
What does this mean for those with an LAQC or QC?
- LAQCs will not be as useful as they used to be. This, together with an impact on the depreciation that can be claimed is likely to have a significant impact on the return on your investment. This may deal a further blow to the already deflated investment property market.
- There is more certainty in the market. One thing markets despise is uncertainty, and with that now mostly gone, a damaging factor to the market will be removed.
- If you have a QC or LAQC you should get advice about your options. As there will be a transitional period you will need to take some action before the time runs out. My suggestion is to get onto this sooner rather than later. The new rules will apply from 1 April 2011, and there will be an initial six month period to make an election, and a further six months to put that election into practice.
There is going to be a tight timeframe to ensure you get the best planning in place, and there may be a short supply of advisors expert in the area.
Parry Field Lawyers provide legal advice on a range of tax matters and are able to assist you with any tax questions that you might have. Please contact Ken Lord at Parry Field’s Christchurch office (348 8480) for help with tax matters. Please note that this is only a high level overview of the rules, and there may be specific situations where a different outcome is reached. Therefore, please don’t rely on this as legal advice.