From 1 April 2011 new tax legislation introduces the Look-Through Company (LTC). This is the result of tax legislation passed in December 2010. From 1 April 2011, LAQCs, as we know them, will no longer be! This post provides a brief overview of the new entity and attempts to explain the new LTC loss limitation rule.
An LTC is a company and a tax entity, although for income tax purposes, the entity is not a taxpayer. As a company, the LTC will provide limited liability. To be able to enter the LTC regime a company must be tax resident in New Zealand and have a single class of shares. Also, the LTC may only have shareholders who are natural persons, corporate trustees, or another LTC, and all shareholders must elect for the company to be an LTC.
This new tax entity has been so named because, for income tax purposes, the entity is “looked-through”. The owners of a LTC are regarded as holding the LTC’s assets directly, and carrying on the activities of the LTC personally. The income and expenses of the LTC are shared according to the owner’s effective interest in the LTC. This concept focuses on the effective amount of equity that an owner has in the company, not the shareholding percentages.
Historically, LAQCs have been structured to ensure that rental losses flow through to the highest earning shareholder. For example, the shareholders of many LAQCs are 1% Mum and 99% Dad. Going forward, losses are allocated in proportion to an owner’s effective interest, not necessarily the owner’s shareholding. If owners maintain the 1:99 shareholding split, but their effective interest sits at 50:50, the 99% shareholder will not be able to access 99% of the deductions (or losses).
For example, Sarah and John Smith have a rental property in an LAQC which generates losses each year due to an interest-only loan over the property. Their respective shareholdings are 1% and 99%. As part of the loan ($10,000) is guaranteed equally by both, their effective interest in the company is split 50:50. During the 2012 income year, Sarah and John intend to elect that their rental company become a LTC for tax purposes.
They prepare an indicative budget for you as follows:-
Rental income $15,000
Expenditure $22,000
Loss $7,000
The shareholding percentage in the first instance dictates the proportion of income, deductions and credits which are allocated to each owner. John, the 99% shareholder would be allocated 99% of the income and expenditure.
However, the loss limitation rule then applies to determine how much of the expenditure allocated to a shareholder can be claimed in that year – which is based on each owner’s effective interest rather than the shareholding percentage.
The effect of this limitation is as follows:-
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Where does the ‘Restricted & carried forward’ calculation come from? Sorry, new to this – please explain.