Changes to taxation of LAQCs have not been finalized yet. These are expected to be finalized in coming months and will be implemented effective from tax year 2011-12.
An Issues paper on implementation to changes is available on Policy Advice Division of IRD.
There are two changes proposed which are related to property investors.
The first one is whether there is a loss or there is a profit to LAQC, it will pass through to shareholders. At present losses are allocated to shareholders whereas the profits are taxed in the hands of the company. So if proposed changes are implemented, the profit will be added to personal income and taxed at the marginal tax rate of the shareholders.
At present the maximum marginal rate of individuals is 38% whereas the company tax rate is 30%. In the coming 12 months, these rates will change to 33% and 28% respectively.
According to current situation, if an investor is holding a property through an LAQC and the property is negatively geared, the individual who is in 38% marginal rate tax bracket will gain tax advantages to the extent of 38% of loss attributed to him. The same property, if becomes positively geared (for any reason, may be due to reduction of debt, decrease in interest rates, increase in rent etc.) will attract tax at the rate of 30% in the hands of the company. This is what the Government proposes to change.
The second change relevant to property investors will be that of restriction on losses that can be set off against their personal income. According to Issues paper on IRD website-
“A shareholder of a qualifying company will only be able to offset allocated losses to the extent of their investment in the company. To measure a shareholder’s level of investment in the company, officials propose to adopt a qualifying company membership basis similar to the “partner’s basis” in section HG 11 which applies for limited partners. This would include the share of any debt guaranteed by the shareholder.”
It means that losses attributed from LAQC that a shareholder will be able to set off against his/her personal income will be restricted to his /her investment in the company. So if a shareholder has $20000 investment in a company and the tax loss attributable to him is $25000, he/she will be able to set off only $20000 against personal income.
This may seem worrying on the face of it as many investors buy investment properties which are up to100% financed (though secured against other properties). The issues paper states that Investment will include the share of any debt guaranteed by the shareholder.” Practically in all cases the loans from financial institutions are guaranteed by the shareholders. Whatever is personally guaranteed by shareholders will form part of their investment. So the majority of property investors may not be affected by this proposal.
If we go by speech of Hon Bill English, Minister of Finance, and the words are-
“Many investors hold property through Loss Attributing Qualifying Companies or LAQCs. After a short period of consultation, legislation will be proposed so that from 1 April 2011 all LAQCs will be taxed as limited partnerships.
The main impact of this change will be to ensure both profits and losses are assessed at the marginal tax rate of the investor”
So, the only purpose, the proposed tax changes to LAQCs will serve is that all profits and losses will be taxed in the hands of shareholders, which should effect a small section of residential property investors. But definitely, the change will make the tax system fairer.
Ravi Mehta is an Auckland based Financial Advisor and can be contacted on ravi.mehta@pfsl.co.nz. A disclosure statement as required under Securities Act 1988 is freely available on request.