By: Jonathan Gillard
Published: 6/07/2011
The Taxation (GST and Remedial Matters) Act 2010 (the “Act”) was enacted on 20 December 2010.  The Act introduces changes to the rules for Qualifying Companies (QC) and Loss Attributing Qualifying Companies (LAQC) and creates a new type of company, the Look-Through Company (LTC).
From the income year commencing on or after 1 April 2011:
  • companies can no longer elect to become a QC or LAQC
  • shareholders in existing QCs and LAQCs can no longer attribute losses
  • existing QCs and LAQCs are able to transition to a new business structure (LTC, partnership or sole trader) at no tax cost
  • existing QCs and LAQCs can continue to use the current QC rules (but can no longer attribute losses to shareholders).
If an LAQC does not elect to become an LTC within 6 months of the start of its income year it will not be able to attribute losses for the whole income year to its shareholders.  What this means is that if your company has a 31 March balance date it needs to elect to become an LTC by 30 September 2011 for the shareholders to be able to claim their share of the LTC losses against their income for the whole income year.

Look-through companies (LTC)
The new tax entity, the look-through company (LTC) can be used from the income year starting on or after 1 April 2011.

An LTC’s income, expenses, tax credits, gains and losses are passed on to its owners in an income tax treatment that is similar to partners in a partnership.  The difference between the income tax treatment for an LAQC and the income tax treatment of an LTC is that as well as being able to claim losses of the LTC against their personal income, the owners of an LTC are also taxed on the profit of the company.  This was not the case for owners of an LAQC.

If you are a shareholder in a company that prior to 1 April 2011 was a QC or LAQC you will need to look at how the QC and LTC reforms affect your company.  It is very important to note:
  • that the income year ending 31 March 2011 was the last year that an LAQC could attribute losses to its shareholders;
  • an existing LAQC with a 31 March balance date becomes a QC (and loses the ability to attribute losses to shareholders) from the start of the income year that begins on 1 April 2011 unless it has become an LTC by 30 September 2011.
If you have an existing ordinary company your last day to elect to become an LTC effective from 1 April 2011 was 31 March 2011.

The options for existing QCs or LAQCs:
  1. Remain a QC
If you own a company which is a QC or LAQC and you do nothing your company will become a QC without the ability to attribute losses to shareholders (pending a review by Inland Revenue of the dividend rules for closely held companies).
  1. You can transition into an LTC at no tax cost.
  • The transition into an LTC can take place in either one of the first two income years starting on or after 1 April 2011.  The year chosen is called the “transitional year”.
  • If the company chooses to transition in the second of the two possible transitional years it must have remained a QC for the previous years.
  • To transition into an LTC a company must complete a Look-through Company election (IR862) form and send it to Inland Revenue.  If the election is made within six months of the start of the transitional year then the company will be treated as an LTC from the start of that year.
  • Transitioning QCs can carry forward losses which may then be used by the owners of the entity when it has transitioned into an LTC.
  • After the second of the two income years starting on or after 1 April 2011 it will no longer be possible to transition into an LTC at no tax cost.  
  1. You can transition into a partnership, limited partnership or become a sole trader at no tax cost
  • The partnership or sole trader must be the same person or people who owned the QC or LAQC.
  • The transition into the new tax entity can take place in either one of the first two income years starting on or after 1 April 2011.  The year chosen is called the “transitional year”.
  • If the transition takes place during the second of the two possible transitional years the company must have remained a QC for the previous year.
  • To transition into a partnership, limited partnership or to become a sole trader a Qualifying Company and Loss Attributing Qualifying Company Transition (IR891) form must be completed and sent to Inland Revenue. 
  • All assets, liabilities and legal titles must be transferred fully by the end of the transitional year or the transition will be invalid and the QC or LAQC will become an ordinary (non qualifying) company from the start of the following income year.  A transition into a partnership, limited partnership or into becoming a sole trader will involve setting up the new business structure, consideration of the cost of the transfer of any assets, liabilities and legal title, carrying out those transfers from the QC to the new entity.  Plenty of time should be allowed to achieve this and advice should be obtained from your lawyer or accountant before making any decisions if you are uncertain about which business structure will suit you best.
  • After the second of the two income years starting on or after 1 April 2011 it will no longer be possible to transition into a partnership, limited partnership or sole trader at no cost.
  1. You can revoke your QC election
Existing QCs or LAQCs not wanting to remain a QC or become an LTC, partnership, limited partnership or sole trader can revoke their QC election and carry on as an ordinary company.
  • You will need to complete the Revocation of Qualifying Company or Loss Attributing Qualifying Company (IR437) form and send it to Inland Revenue to revoke the QC election.
When the changes to the QC and LAQC rules take effect
The changes to the QC and LAQC rules apply for the income years starting on or after 1 April 2011.  The income year that the rules will first apply to a QC or LAQC will depend on its balance date.
Balance Date First income year for the new QC and LAQC Rules
Standard 31 March balance date 2011 -12 income year
Early balance date (i.e. from 1 October to 30 March) 2012-13 income year
Late balance date (i.e. from 1 April to 30 September) 2011-12 income year

Critical Dates
If you have a QC or LAQC and want to transition to an LTC to enable losses to be attributed to shareholders from the start of the income year that you are making the election (the transitional year) then you must make the election within six months of the start of the transitional year.  For QCs and LAQCs with a standard 31 March balance date the last date that you can make the election to become at LTC for the 2011-12 income year will be 30 September 2011.  If you do not make the election by that date the company will not be considered to have been an LTC from the start of that year and will not be able to attribute losses from the 1 April 2011 - 31 March 2012 income year to the shareholders.

Important:
It is important that before you make a decision regarding whether your QC or LAQC should elect to transition to an LTC, sole trader, partnership, limited partnership or revoke your QC election you have taken all relevant considerations into account.  The information in this article is necessarily general in nature and is not intended to be a substitute for legal or accounting advice.  As individual circumstances vary considerably, professional advice should be obtained prior to making a decision regarding your QC or LAQC. 
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