At the end of last year, the Government released the new legislation in relation to the tax treatment of Qualifying Companies (QCs) and Loss Attributing Qualifying Companies (LAQCs). Many ‘mum and dad' investors have shareholdings in QCs/LAQCs: they have been popular ways of holding interests particularly in residential and commercial rental property but also in numerous other types of investment or activity. The tax law changes proposed by the Government are about to change all that.

The major changes signalled earlier this year were firstly that QC/LAQC profits (not just losses) would be allocated to shareholders, and secondly the ability of shareholders to offset QC/LAQC losses against their taxable income would be limited to the shareholder's investment at risk. The major points that came out of the draft legislation release were:

• LAQCs will not be able to attribute losses to shareholders for income years starting on or after 1 April 2011.
• Rather than QCs/LAQCs being outlawed completely or the tax rules for them simply being modified, they will continue to exist for the time being. However there will now be a further entity type created for tax purposes - a Look Through Company or "LTC".
• LTCs will be a sort of cross between a company (they will be a ‘normal' company for commercial purposes), and a partnership (which allocates its income, expenses etc to its partners for tax purposes).
• As a general rule if shareholders of existing QCs/LAQCs act within certain timeframes, generally by half way through their 2011-12 tax year (next tax year) they will be able to restructure from their existing QC/LAQC to a LTC, partnership/limited partnership, or sole trader structure without immediate tax consequences.
• LTCs will, as signalled earlier this year, allocate both profits and losses to shareholders. Also as signalled, shareholders will be limited (significantly in some cases) in their ability to utilise losses.
• It remains to be seen whether QCs/LAQCs are outlawed altogether - the Government is doing more work on this at present.

The new LTC regime will take effect from the first income year beginning on or after 1 April 2011. For those taxpayers with early balance dates (October 2010 to February 2011), any transition will not occur until the 2012 income year.

The proposals do have some positive aspects. For example tax laws around QCs/LAQCs have tripped taxpayers up many times: shareholding changes that have inadvertently resulted in QC/LAQC status being lost, trust shareholders not distributing dividend income as required, errors in the treatment of distributions to shareholders etc. The ability to ‘transition' away from a QC/LAQC may enable some to put these issues behind them to some extent, subject to IRD's standard four year window to issue reassessments.

Under the proposals there is also the attractive ability for a taxpayer to reconsider their choice of entities or structure, and potentially move to a more advantageous or flexible structure without the usual tax costs of making that change.

For existing QCs/LAQCs, the temptation may be so convert to LTCs without giving the matter much thought. However, given the restrictions in the new legislation, we would anticipate that a large number of existing QCs/LAQCs will not gain anything from transitioning to a LTC, especially given the removal of deductions for depreciation on buildings from 1 April 2011. For example many LAQCs which own property may cease to be loss making going forward.

The ability to transition to a new structure is an important aspect of the new rules and it is not something that taxpayers should waste by rushing in without considering the various options available to them.

While the LTCs look and feel much like LAQC's, it is important to note that there are some fundamental differences which taxpayers will need to understand prior to entering into the regime.

You would have given some thought to your future investment and tax profiles by now, and with the new legislation now in place it is the perfect time to have a fruitful discussion with your adviser about the best options for you, and getting the best outcomes going forward.

For more information contact your Client Adviser or click here.