New look through company rules offer simplification, but with pitfalls
The tax rules for closely held companies - companies that only have a few shareholders – are changing. The changes stem from Inland Revenue’s September 2015 issues paper. They aim to align the tax treatment of closely held companies to direct owners in order to simplify the rules and reduce compliance costs.
Closely held companies comprise a significant portion of New Zealand’s business landscape, so these changes are sure to affect many.
Most of the changes apply from the 2017-18 income year.
We are disappointed that Māori authorities and charities will be barred from look-through company (LTC) ownership. We also see issues with the operation of some rules in the close company group context.
Removal of deduction limitation rule for most LTCs a welcome change
The deduction limitation rule essentially limits the LTC deductions that can be taken by the owner of a LTC to the amount of their economic risk. From the 2017-18 income year, the deduction limitation rule will not apply for most LTC owners, unless the LTC is in partnership or joint venture.
The removal of the deduction limitation rule for most LTCs is welcome. It will do away with an onerous and redundant process for many LTCs.
Changes to eligibility criteria see Māori authorities and charities miss out
A number of changes have been made to the LTC eligibility criteria. One of the changes provides that Māori authorities and charities can no longer own LTCs. This change is disappointing, as alternative structures tend to be more costly, complex, and riskier than LTCs.
There is a silver lining for Māori authorities and charities with existing ownership interests in LTCs – those who held their interests before 3 May 2016 will be able to benefit from grand-parenting provisions and remain eligible for LTC ownership.
Relief from debt remission rules omits trusts and individuals
LTC owners, as well as partners of a partnership, who remit debt owed to them by the LTC or partnership (including a limited partnership) will no longer derive debt remission income as a result of new “self-remission” rules. These new rules are backdated to 1 April 2011, being the start of the LTC rules.
While the new rules make sense, we are disappointed that the change will only apply to debt remission between corporate entities (including LTCs), and not to debt remission between a trust or individual and a wholly owned subsidiary.
Other main changes to the closely held company rules not covered here relate to:
- LTC entry tax
- New continuity of ownership test for “qualifying companies”
- Tainted capital gains
- Resident withholding tax on dividends
- PAYE on shareholder-employee salaries
For further information on the closely held company changes, see Inland Revenue’s Special Report. If you would like to talk about the closely held company changes and how they could apply to you or your business, please get in touch.