LAQCs: Loss Attributing Qualifying Companies

What is an LAQC?

LAQC's are ordinary companies incorporated in New Zealand that allow the shareholders to have tax losses and capital gains incurred by the company 'flow through' to the shareholders tax returns.

What this means is that at the end of each financial year (typically 31 March in NZ), losses vest to the shareholders pro-rata based on their respective share of the company throughout the year.

Additionally in the event that the company makes a capital gain (for example a rental property is sold for a gain), such gain can be distributed tax exempt to the shareholders. Note that we do not have capital gains tax in New Zealand, so the distribution of such non taxable gains from companies is an issue if you are not a qualifying company in NZ.

How Can a Company Become an LAQC?

Entering the LAQC regime is done by the directors and shareholders of the company filling out the requisite IRD application form (IR436), and serving it on IRD for processing within 12 months of a company 's first tax return coming due. Many clients have issues with proving service and processing such forms, so we strongly recommend you follow up IRD and get confirmation in writing the election is accepted. You may wish to use a firm like GRA to process such application for you, so that you can hold them accountable for the losses if the election fails.

To enter the qualifying company regime, a company must have 5 or fewer shareholders, and have management vested to a New Zealand resident taxpayer, typically an NZ resident director.

Additionally foreign income derived must be kept below a threshold of NZ$10,000, ,making LAQC's unsuitable for investing off shore. Foreign income exceeding the threshold (such as rents from rental properties outside of NZ, or income from writing covered calls, or options trading ) would cause the company to fall out of the LAQC regime if it exceeds $10,000.

Who Uses LAQC's And Why?

Typically persons who expect to make a loss from a business activity in NZ tend to use LAQCs, as they wish to have the losses flow through to their personal tax returns to offset other income, such as salaries and wages.

Both self employed involved in business and property investors use LAQC's.

Perhaps the most common use of LAQCs though is a property investor. After deducting from rents the cash expenses and depreciation, typically investment properties are negative for tax for up to 10 years from acquisition. For this reason property investors utilise LAQC's, with the knowledge that when the property becomes breakeven for tax, they will transfer the shares to a trust to improve asset protection and trap capital growth inside the Trust. In the interim, they utilise the tax losses through offset with other income including salaries and wages.

As noted it is not only property investors that use LAQC's. They are also useful for businesses that are making losses. As many start up businesses initially make a loss, business people will often start a company as an LAQC, to ensure the losses are held personally. Later when the company has stable earnings, typically best practice is to move nearly all of the company to a trust for asset protection, and hold one share in each spouses name, to allow income splitting between the spouses. In such circumstances revocation in writing of withdrawal from the LAQC regime is advisable, to revoke the personal guarantee by shareholders over income tax to IRD.

Income Splitting For Self Employed

Income splitting is apportioning taxable income between the spouses, to remunerate them for their work done in the business. While this can be done via wages with PAYE being deducted at source, provision tax is more flexible with the declaration of a shareholders salary at year end to cover drawings through the year. This is helpful as often at the beginning of a year it is not possible to determine what the income of a company will be, and therefore what earnings are available to distribute. The one share to each spouse is required to allow shareholders salaries. You cannot have a shareholder's salary, without being a shareholder.

What are the pitfalls of LAQCs ?

Firstly, in the course of making an LAQC election, in return for gaining the flow through benefit of the LAQC election, the government requires the shareholders to personally guarantee the income tax position of the company.

This means personal liability to the shareholders for income taxes, but such guarantee is revocable in any year in which a taxpayer in writing gives notice of withdrawal from the LAQC regime.

It is important that you are able to prove service of such notice of withdrawal (likely all communication to IRD), so for this reason we recommend faxing the notice before posting it and keeping a copy of the fax and service confirmation.

A second pitfall is in the way that LAQC's interact with Trust structures. Generally Trusts have several classes of beneficiaries, and any beneficiary that receives a distribution from a LAQC is deemed to be in the count test for the number of shareholders.

If the recipient beneficiary is within one degree of blood relative to the other beneficiaries of the Trust, then such relationship will only count all of such persons within one degree as one person for the purposes of the count test. However, if the person or people fall outside of the class of beneficiary within one degree, then such person could potentially cause the company to fall outside of the 5 person limit for LAQCs and deemed revocation of the LAQC.

Change Of Shareholding - Re-election Required Within 63 Days Of Share Transfer

In the event that an LAQC changes shareholder to a person that is not elected as a party to the LAQC regime retrospectively to the beginning of the financial year in which the change of shareholding took place. To avoid this the new shareholder must elect within 63 days to be liable in the place of the exiting shareholder for their share of the guarantee provisions of the LAQC election to IRD, by signing an LAQC re-election form.

Failure to re-elect will mean that losses and capital gains are locked into the company and do not 'flow through' to shareholders until a subsequent LAQC election is made. Subsequent election will result in forfeiture of all losses to carry forward, meaning that the losses for that year incurred will be wasted. For this reason it is very important that a change of shareholding is accompanied by a re-election by shareholders within 63 days of the share transfer.

Change Of Shareholding / Death of A Shareholder

In the event of the death of a shareholder of an LAQC, the 63 day re-election rule has a 12 month re-election requirement, to provide relief for the beneficiaries to sort through the affairs of the deceased. Such 12 month period allows the affected parties to mull through the records of the deceased and gives time extension to sort matters out.

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Typical Salaried Property Investor Structure - Family Trusts & LAQC