Inland Revenue has eliminated a couple of look through company (LTC) problems which should save you money and/or let you wind up LTCs you no longer need.
LTCs have been available since 1 April 2011 when they replaced LAQCs. They provide the benefits of a company, mainly limited liability, the ability to offset losses against shareholders’ other income and accessing tax free capital gains without winding up.
The rules contained provisions that were complex and which could give bizarre tax outcomes. These had the effect of deterring some small business from becoming LTCs and added compliance costs to those who did.
IRD have now changed the rules. These changes:
– Remove the deduction limitation rule, except for in very limited situations; and
– Reduce the liklihood of debt remission income when a LTC winds up owing its shareholders money.
There have been other changes to the rules, such as tightening the entry criteria and having to pay more tax when becoming a LTC.
Deduction limitation rule
The purpose of the deduction limitation rule was to limit tax deductions claimed by an LTC owner to their economic loss. Inland Revenue identified the deduction limitation rule applied to only a very small number of LTCs but made all LTCs perform the complex and expensive calculations.
From 1 April 2017, the deduction limitation rule will be restricted to LTCs in partnerships or joint ventures. Owners who previously had deductions restricted will be able to claim those in their 2018 income tax returns.
Debt remission income
When a company is no longer required it is usual to wind it up. However where a LTC had borrowed from its owners and couldn’t repay the loan, debt remission income could result.
In general, when a loan is forgiven, the borrower is deemed to have debt remission income. Due to LTCs being transparent for tax purposes, the LTC owners were deemed to derive this income, including LTC owners who remitted the debt. Owners were required to pay tax on their own money they had lent to their LTC and which hadn’t been repaid to them.
The new rule, which is backdated to 1 April 2011, ensures that remission income does not arise, where a LTC owner remits a debt owed to them by the LTC – termed self-remission. This change does not prevent debt remission income arising to other owners of the LTC, who have not remitted debt.
While this is an excellent change it’s not without its fishhooks. Say Mum and Dad lent their LTC $100,000. Debt remission income is triggered when the LTC winds up. If Mum and Dad own the LTC 50/50 there is no remission income. However if Mum and Dad owned the LTC 90/10, there is a mismatch between the shareholding and the debt which would still be taxed.
Now’s the time to consider winding up an LTC you’re no longer using, or to confirm you’re okay if you‘ve already closed an LTC.