Benefits of Look-Through Companies
A Look-Through Company (LTC) is a normal company for company law purposes, but one which has made a tax election to become tax transparent. This means all of its income, deductions, tax credits, assets and liabilities are deemed to be derived, incurred and held by the shareholders for income tax purposes.
The LTC regime is a very useful regime, which can offer numerous benefits and advantages including:
- Taxable income can flow through to shareholders on marginal tax rates of 10.5% (incomes between $0-$14,000) and 17.5% (incomes between $14,001 and $48,000), rather than being taxed at the company tax rate of 28%
- Tax losses can flow through to shareholders and be used by shareholders, rather than being trapped in the company
- Where shareholders are individuals in the safe harbour, the shareholders will not incur use of money interest whereas the company would.
- If the company trades overseas and pays overseas taxes, double taxation will not generally arise where the company elects to be an LTC. However, if the company does not make the LTC election, double taxation of overseas profits will arise where overseas tax is paid.
- In a restructuring, assets can be sold by an LTC to related parties without creating adverse income tax implications. Such a sale by a non-LTC company would likely create taxable associated person capital gain amounts.
If you are planning to make an investment, purchase a business or believe your existing company would benefit from the LTC regime, please contact us to discuss.
- If a capital asset or business is sold by an LTC, the capital gain can be distributed to shareholders without having to wind up the LTC company. A non-LTC company would usually have to wind up for the gains to be distributed tax-free.
Legislation has been passed which changes the taxation of higher-value assets used for both income-earning and private purposes (mixed-use assets). The changes include:
- The new rules will apply to boats and aircraft from 1 April 2014
- The new rules will apply to holiday houses/baches from 1 April 2013
- The new rules will only apply to houses, boats and aircraft
As the new rules are retrospective for holiday homes and baches, the tax deductions previously available for these assets in the current year will significantly reduce. If you have a holiday home or bach used for both income-earning and private purposes, you should consider the effect of the proposed rules on your 2013/2014 tax year. Please contact us if you would like to discuss this matter.
Are Your Interest Payments Tax Deductible?
A recent tax case has re-affirmed the importance of correctly structuring bank debt, when seeking to claim interest deductions on that debt. In the case, the taxpayer borrowed significant amounts from a bank and on-lent to related parties. The on-lending was on terms that interest was only payable if demanded by the lender. The lender did not demand interest. The Court held that the interest paid to the bank was non-deductible, as there was no income derived from the use of those borrowed funds.
This scenario is common in back-to-back loan situations, where an individual may borrow from a bank and on-lend to a company or trust which uses the funds to derive income. If interest is not charged on the on-lending arrangement, the bank interest is non-deductible.
For example, John and Julie borrow funds from a bank in their personal names. The funds are used in their company's business (the company is owned by their family trust). John and Julie do not document their loan to the company, and do not charge interest on that loan. In this situation, the interest would be non-deductible. John and Julie should have documented their loan to the company and charged interest on that loan.
Another common scenario which can lead to interest being non-deductible is where shareholders lend money to a company in proportion to their shareholding percentages and charge interest on those loans under a written loan agreement. The tax legislation generally deems these loans to be share capital rather than loan capital, with the consequence that the interest paid by the company is deemed to be non-deductible dividend payments, rather than interest payments. This is not a good outcome as the payments are non-deductible but the receipts remain taxable.
Other key points to note regarding interest deductibility:
- Most companies (not Qualifying Companies or Look-Through Companies) have an automatic deduction for interest. However, interest incurred on funds lent by shareholders relative to their shareholding percentages is likely to be non-deductible.
- For borrowers who are not companies, it is critical to show that the funds have been used by the borrower to generate income to the borrower, or in a business being carried on by the borrower.
Overseas Exchange Gains are Taxable
Most gains derived by NZ tax residents on the following foreign-denominated instruments are taxable in NZ:
- Overseas bank accounts
- Overseas term deposits
- Overseas bonds
- Overseas loans and mortgages e.g. borrowings from a foreign bank
The gains will either be taxable on an unrealised basis (based on exchange rate movements from year to year) or on a realised basis i.e. when the investment matures or loan is paid off.
In some cases, exchange losses on these instruments may be tax deductible.
If you believe these issues may affect you, please contact us to discuss.
Foreign Superannuation & Pensions
The Government has issued a tax Bill proposing to make significant changes to the taxation of interests in foreign superannuation schemes and pensions held by New Zealand tax residents.
The key proposals are:
- From 1 April 2014, these interests will be taxed on a cash basis(*)
- From 1 April 2014, the FIF regime, company regime and trust regime will cease to apply to these interests(*)
- Regular pension payments will be taxed on a cash basis
- Lump sum withdrawals will also be taxed on a cash basis. There are two taxing methods that may apply, but the default method taxes a portion of the lump sum depending on how long the person has been in NZ. For example, if a person has been in NZ for 5 years, 23.07% of the lump sum is deemed to be income. If the person has been in NZ for 20 years, 82.28% of the lump sum is deemed to be income.
- The 4 year tax exemption for new migrants and certain returning ex-patriates will continue to apply, so any cash amounts paid from the overseas fund during that 4 year exemption period will not be taxable
- A concessionary measure is proposed which allows a person to either pay 15% on a lump sum withdrawal occurring before 1 April 2014, or apply the current rules
(*Unless the FIF regime has always been used and the taxpayer elects to keep using the FIF regime)
If you have an interest in an overseas superannuation or pension scheme, it is critical that you consider your NZ tax position and whether it is possible and tax effective to transfer the overseas fund to a NZ equivalent, given the tax cost of any transfers after 1 April 2014 is likely to be significantly higher than transfers occurring prior to 1 April 2014.
Land-Related Lease Payments
The Inland Revenue have released an Issues Paper proposing further changes to the taxation of land-related lease payments.
Under the new proposals:
- payments for leases or licences of land for a term of less than 50 years would be treated as deductible to the payer and taxable to the recipient.
- A separate timing rule would spread the income and deductions over the term of the land right
- Payments derived by tenants of residential premises are excluded from the proposals
- Lease modification payments made by commercial tenants that are currently non-deductible would become deductible
- Payments for a permanent easement would become non-taxable to the landowner (currently taxable)
- The timing rules for income from key money would also be rationalised and spread over the term of the lease rather than the current 6 year period.
Research & Development: Cash Back for Losses?
The Government has released an Issues Paper which proposes to allow certain companies to cash out R&D tax losses early, rather than having to wait for the business to generate taxable profits.
The suggested changes target R&D-intensive start-up companies. To be eligible, applicants would need to meet the following criteria:
- Company (and also group, if the company is part of a group) R&D expenditure on wages and salaries must be at least 20 percent of total expenditure on wages and salaries (the wage intensity threshold).
- The company (and also group, if the company is part of a group) must be in a tax-loss position for the applicable income year.
- The applicant must be a company resident in New Zealand. The company also cannot be a look-through company, listed company, qualifying company or special corporate entity.
The suggested R&D definition is based on the existing New Zealand equivalent to International Accounting Standard 38 (NZIAS 38), which is already used in the Income Tax Act 2007. Certain expenditure items and activities will be excluded from the proposed R&D wage intensity threshold of 20 percent of the total group wage and salary expenditure and/or qualifying R&D expenditure, to ensure the proposals are correctly targeted.
The amount of the loss that can be cashed out under the proposals will be the lesser of:
- 1.5 times the company's eligible R&D salary and wage expenditure in the relevant year;
- total qualifying R&D expenditure in the relevant year; and
- total tax losses in the relevant year.
Initially, the suggested maximum cap on eligible losses that can be cashed out will be $500,000, which equates to a cashed-out loss of $140,000 at the company tax rate (28%). This cap would rise incrementally each year up to a maximum cap on eligible losses of $2 million.
Loss recovery rules would be included, to recover the value of the cashed-out loss when a taxpayer derives a return from the sale of:
- intellectual property from R&D the company has performed;
- some of the shares in the R&D company; or
- the R&D company itself (all of its shares).