Unformatted text preview: ACIS 254: ACIS Introduction to Taxation Introduction
Lectures 25 and 26: Qualifying Companies, Loss Lectures Attributing Qualifying Companies and Limited Partnerships Partnerships
Department of Accounting & Department Information Systems, University of Canterbury, Christchurch Christchurch
1 Outline of Lecture
1. Qualifying Companies QCET Calculation Entry Criteria Tax implications 2. Loss Attributing Qualifying Companies Qualifying Companies: An Evaluation Qualifying Advantages and Disadvantages 3. Limited Partnerships 3. Special Partnerships Special New Zealand Limited Partnerships Regime New Tax Treatment of a Limited Partnership Limited Partnerships – An Evaluation 2 Limited Topic 1:Qualifying Companies – Topic Introduction & Overview Introduction
• To effectively tax certain companies as if they were To • • • • •
partnerships. partnerships. Shareholders and directors elect that the company Shareholders becomes a qualifying company under section HA ITA 2007. 2007. Dividends either fully imputed or exempt. Allows a company to distribute capital gains tax free. An election tax (QCET) must be paid on entry to the An regime. regime. Maintain a company structure (limited liability, Maintain ability to transfer ownership) with the tax benefits of a partnership.
3 Qualifying Companies – QCET
• (a + c -b -c/d ) x d
a: amount taxable as a dividend on winding up if amount company disposed of its assets and liabilities at market value. Excess of market value of assets over liabilities on that day, reduced by any amounts not taxable to shareholders if distributed: e.g. return of share capital & distribution of capital gains. b: assessable income derived by the company in taking b: assessable the course of action in a. the c: balance of ICA & any tax owing (refundable) when balance entering regime. entering d: rate of company tax expressed as a decimal. rate
4 Qualifying Companies – Entry Criteria
• Directors & shareholders must unanimously agree that Directors must •
company become a QC. Shareholders must elect to be personally liable for their share of tax. personally Trust shareholder: all the trustees & at least one of the Trust beneficiaries of full legal age and capacity must make elections. Company shareholder: it must elect to must become a QC. become Company must not during the income year lose Loss Company Attributing Qualifying Company (LAQC) status. Attributing Company must not have more than five shareholders. Company Company must be NZ resident & may not have > Company must $10,000 in foreign non-dividend income for year and company may not be a unit trust. be
5 • • • Qualifying Companies – Tax Implications
For Qualifying Company: • Liable for tax in same way as ordinary companies. • Dividend exemptions in ss CW 9 –CW 11 do not Dividend apply to dividends received, unless subject to FDP regime. regime. • Generally taxed on dividends received from other Generally companies including within a wholly owned group. companies • Losses are restricted for grouping purposes, in that a Losses QC in profit can only offset against another QC, in the same group, in loss. same • A QC in loss cannot offset against a non-qualifying QC company in profit. company
6 Qualifying Companies –Tax Implications Qualifying
For Qualifying Companies (continued) For • Imputation credits attached to dividends Imputation received credited to ICA & are available to offset tax liabilities. to • For LAQCs, losses passed on to For
shareholders if criteria met. shareholders • Shareholders can offset these losses Shareholders
against other personal income. against
7 Qualifying Companies –Tax Implications Qualifying for Shareholders for
For Shareholders: • QC can distribute two types of dividends: - taxable & fully imputed; or taxable - exempt & unimputed (all other dividends). exempt • ICs & FDPs are grossed up to determine ICs amount of dividends that may be imputed and paid out. • Taxable to shareholders, but fully imputed, so Taxable no tax liability (except for taxpayers on 33% or higher marginal tax rates). higher • Other distributions are exempt from income Other tax. tax. • Therefore, dividends are effectively received Therefore, tax free by the shareholder. tax 8 Calculation of Shareholder Numbers
• A Qualifying Company must have five or fewer shareholders. • Subject to special rules contained in section HA 7 ITA 2007. • Corporate shareholders are ‘looked through’ to the ultimate Corporate
individual shareholders for calculation purposes. individual • Nominees are ignored. • Shareholders related by blood or marriage to within one Shareholders • Where a trustee is a shareholder – greater of number of Where
degree of relationship are deemed to be one shareholder. degree beneficiaries that have received dividends or who elected the company become a QC on behalf of the trust.
9 Ceasing to be a Qualifying Company
1. Director’s Election is revoked by the board - not by Director’s retirement or dismissal retirement 2. Shareholders Elections revoked either: 2. • Voluntary - in writing by the shareholder, or • Automatic/deemed, e.g. by: - Death of a shareholder; - Sale of person’s entire shareholding to an entirely new shareholder; - Joint election has been made and revocation by one of the joint electors; the - Company ceases to be a LAQC. Company 10 10 Ceasing to be a Qualifying Company
If a new shareholder election is made If within the period of grace, the company will not lose its QC status. will Period is: Period • - 12 months for death of a shareholder • - 63 days in all other cases • IRD, upon application of the company, IRD, may extend these periods.
11 11 Qualifying Companies –Elections
• QC elections generally take effect QC •
on the first day of income year following the year of election. following Newly formed companies may Newly become QC’s from beginning of first income year, if an election notice is filed within time of filing company’s first tax return. company’s Elections are made by directors Elections and shareholders on behalf of the company. company.
12 12 • Topic Two: Loss Attributing Qualifying Companies - Losses are passed on to shareholders if criteria are met. Losses - Shareholders can offset these losses against their other Shareholders • • • • •
personal income, or carry loss forward. Criteria to be a LAQC (include): - election by directors and shareholders. - one class of share – shares must carry the same rights to one vote and distributions. vote All directors and shareholders of legal capacity must All elect that the company become a LAQC. elect When a company loses its LAQC status it also ceases to When be a QC from the beginning of the income year in which 13 13 LAQC status is lost. Qualifying Companies: An Evaluation
• Advantages of the Regime: • Dividends paid by a QC will either be Dividends • • •
received tax free to recipient, or have maximum ICs attached. Both realised & unrealised capital gains can Both be distributed tax free without winding up company. company. Eliminate the problems with an overdrawn Eliminate shareholder current account. There is no requirement to maintain 66% There shareholder continuity in order to carry forward ICs (unlike ‘normal’ companies). forward
14 14 Qualifying Companies: An Evaluation
• Disadvantages: • Shareholders partially lose limited liability status, & Shareholders • • • • • •
become personally liable for company's unpaid tax. become Election tax may be payable on entry - effect is to Election bring forward tax payment on these earnings. bring Previous years losses are forfeited. Shareholder liability of unpaid company income tax. QC primary liability for tax but shareholders liable for any amount of income tax that company fails to pay. for Extent of individual's liability is calculated on their Extent effective interest in company which generally depends on shareholder’s voting interest. on Cash flow implications of QCET entry tax. Cash 15 15 Comment on the Regime’s Success • 31 March 1993 - 1700 qualifying companies existed 31
in Christchurch region. in • Total percentage of registered companies that entered Total
Qualifying Company Regime was approximately 8.95%. 8.95%. • More recent data obtained with respect to Loss More Attributing Qualifying Companies as at 8 January 2007 – Inland Revenue confirming 90,380 LAQC’s nationwide. nationwide. sized businesses over the last few years. • This would support the growth in small to medium This
16 16 Practical Implications
• The regime allows Qualifying Companies to The
distribute capital gains tax free. distribute • Offers an opportunity to cure overdrawn Offers shareholder current accounts. shareholder – Two methods: • Assets can be re-valued – dividend declared from the Assets • revaluation reserve and credited to the shareholder’s current account current In the case of an LAQC a large salary could be declared In which when credited to the current account will remove the debit balance. the
17 17 Qualifying Company vs. Partnership • Intention of QC regime to more closely align the Intention • •
concept of a QC with a partnership for tax purposes. concept Difference - Partnership does not pay tax at all on its Difference income. income. A QC will always pay tax on its income and then QC distribute effectively tax-free income to its shareholders in the form of taxable, but fully imputed, or exempt dividends. or
Note: – Note: A shareholder on a 33 % or higher marginal tax rate may have to pay the additional tax amount in their personal tax return. tax
18 18 Qualifying Partnership vs. Partnership Qualifying (continued) (continued)
• In a partnership the income of the partnership for the In • • •
whole year is allocated to partners regardless of any other circumstances. other In the case of a QC the income does not have to be In distributed to shareholders. distributed The QC may decide to retain some of the income at The the company level. Like a partnership the QC will be able to pass both Like realised and unrealised capital gains tax-free to its shareholders without having to wind up the company. shareholders
19 19 Qualifying Partnership vs. Partnership Qualifying (continued) (continued)
• The QC regime also allows the payment of a The • • •
deductible salary to shareholder-employees, unlike the general position in relation to partnerships. the The option to extract profits from a QC as The remuneration rather than dividends is retained. remuneration An LAQC is able to distribute losses to its An shareholders in a similar manner to a partnership. shareholders Trade-off is that shareholders are forced to accept Trade-off liability for the company’s income tax if it fails to pay. pay.
20 20 Topic 3: Limited Partnerships • In June 2006 – New Zealand Government released In
discussion document which contained a proposal to introduce a limited partnership regime into New Zealand. Zealand. Limited Partnerships used extensively overseas. A number of advantages – limited liability and flow number through of tax losses. through A number of hybrid structures – LP, LLP, and number Qualifying Companies. Qualifying Prior to introduction of the limited partnership, New Prior Zealand had the special partnership.
21 21 • • • • Special Partnerships
• Special partnership – two types of partners – general Special • • • •
and special. and General partners are responsible for the management General of the business and are jointly and severally liable for partnership debts. partnership Special partners – limited liability, no management Special responsibilities. responsibilities. Could be formed for any business except insurance Could and banking. and Could not be set up for longer than 7 years (although Could could be renewed at expiration of this time). could
22 22 Special Partnerships (continued)
• For income tax purposes – a special partnership was For •
essentially treated as a general partnership. essentially Loss carry forward restriction – special partners could Loss only carry forward their share of any net loss from a SP if they earn New Zealand assessable income during the year the SP loss was incurred, otherwise loss is forfeited. loss Not the most appropriate vehicle for certain types of Not investment in New Zealand. investment Special partnership does not have a separate legal Special not personality. personality.
23 23 • • Special Partnerships (continued)
• Although special partners in a special partnership Although • • • •
have limited liability, don’t have separate legal personality. personality. Separate legal entity status greatest protection - if a Separate ‘conflict of laws’. ‘conflict Special partners can lose their limited liability status Special if involved in management of the special partnerhsip. if Foreign investors – could forfeit losses (over taxed). Label of ‘special partnership’ led to confusion. Label
24 24 The New Zealand Limited Partnerships Regime • New business vehicle – the limited partnership. • Separate legal entity formed by statute. • Limited partner’s liability for partnership limited to Limited • • •
amount of their contribution. amount Limited partner prohibited from participating in Limited management. management. Limited partnerships are used widely internationally as a Limited vehicle for investing in another country. vehicle The Limited Partnerships Act 2008 came into force 2 The May 2008. May
25 25 The New Zealand Limited Partnerships Regime The (continued) (continued) • The Taxation (Limited Partnerships) Act 2008 came The • • • • •
into force 1 April 2008 – deals with taxation of general and limited partnerships. general A limited partnership must have at least one general limited and one limited partner. and Cannot be both a limited and general partner at the Cannot same time for the same limited partnership. same No maximum number of partners. Any person could be a partner – including a Any company, general partnership, overseas limited partnership. Must have a written partnership agreement. 26 26 The New Zealand Limited Partnerships Regime The (continued) (continued) • Minimum content required in Limited Minimum
Partnerships Agreement. Partnerships
– Entitlements of partners to distributions – Whether financial statements must be audited • Register at Companies Office. • Unlimited duration (subject to LP agreement Unlimited
and a number of terminating events). and • Will exist until it is deregistered. 27 27 The General Partners of the Limited The Partnership Partnership
• Similar legal position as partners of a general Similar •
partnership. partnership. General partners are jointly and severally liable with General other general partners for the limited partnership debts and liabilities the LP has incurred while that person is a general partner. person However, unlike a general partnership, unless However, stipulated, the general partner is only liable to the extent that the LP is unable to pay its debts and liabilities.
28 28 • The General Partners of the Limited Partnership The (continued) (continued) • The Limited Partnerships Act 2008 permits The general partners to invest in the LP. general • By making a capital contribution, a general By partner will have a partnership interest – entitled to receive distributions from the LP. entitled • The liability of general partner is residual – The assets of limited partnership applied first to any debt or liability before general partner becomes liable.
29 29 The Limited Partners of the Limited Partnership • Limited partners essentially treated like shareholders. • Liability limited to amount of capital contribution to Liability • • •
the partnership. the Limited liability status contingent on limited partners Limited not taking part in the management or day to day running of the firm. running Limited partner essentially analogous to a non-active Limited partner. partner. If limited partner takes part in management - may be If liable as a general partner to a third person who deals with LP and suffers loss. 30 30 The Limited Partners of the Limited Partnership The (continued) (continued) • Limited partner liable to same extent as Limited
general partner, however the limited partner will not have the benefit of residual liability – could be substantially exposed. could • Safe harbours – necessary for investors
Prescriptive – Prescriptive list approach adopted for New Zealand – the LPA 2008 contains a schedule listing wide range of activities with breaching this rule. rule.
31 31 The Limited Partnership • The limited partnership, like a company is a separate The • •
legal entity distinct from its partners. legal Must contain words ‘limited partnership’ or ‘LP’ or Must ‘L.P’ at the end of the name. ‘L.P’ Similar features to companies incorporated under the Similar Companies Act 1993 Companies
– Must have a registered office in New Zealand – File an annual return imited • A llimited partnership will not be able to make a distribution to limited partners unless a general partner is satisfied on reasonable grounds that immediately after payment of the distribution the limited partnership will be solvent.
32 32 Tax Treatment of a Limited Partnership • ‘Partnership’ defined in section YA 1 ITA Partnership’ 2007 – includes a limited partnership. 2007 • As part of introducing Limited Partnership As regime, Government undertook review of provisions in ITA dealing with partnership taxation. taxation. • The Taxation (Limited Partnerships) Act 2008 The – deals with tax treatment of both general and both limited partnerships.
33 33 A flow-through approach
• Aggregate (flow through) approach to partnerships. • The basic rule for partnerships (including LP’s) is The • • • that for income tax purposes, these entities are fiscally transparent. fiscally GST treatment different – General partnerships GST separately taxed under GST Act 1985. separately GST treatment of a limited partnership is as a GST company. company. Section 57 GSTA 1985 that imposes joint and several Section liability on members of a partnership’s GST does not apply to a limited partnership formed under the LPA 2008.
34 34 Income and Expenses
• Under aggregate approach, income and expenses flow Under • • •
to partners. to Main advantage of limited partnership – the tax status Main of each partner will determine how the partner is taxed. taxed. For example: charitable trust as a limited partner – For income allocated is exempt. income This diversity of tax rates is not available if the This business is conducted through another vehicle other than a partnership. than
35 35 The anti-streaming rule
• Income Tax Act 2007 contains anti-streaming Income
rule to ensure income, tax credits, rebates, gains, expenditure or loss from a particular source are allocated to partners in the same proportion as each partner’s partnership share in the income of the partnership. in • Intended to prevent ‘streaming’ of these items Intended to specific partners. to • One exception to flow through approach – One deductibility of losses for limited partners. deductibility
36 36 The loss limitation rule
• Acknowledges the reality that unlike partners in a Acknowledges
general partnership, limited partners are not exposed to any risk of loss greater than the amount of their limited partnership investment. limited Essentially passive nature of their investment – can Essentially be seen as a cost of having the protection of limited liability. liability. Does not apply to general partners. Aimed at preventing erosion of the New Zealand tax Aimed base. base.
37 37 • • • Limited Partnership vs. Company
• Both company and limited partnership are separate legal Both • • • • •
entities. entities. Shareholders and limited partners respectively have limited Shareholders liability. liability. Note: no limitation for shareholder liability with respect to Note: unpaid income tax for Qualifying Companies and Loss Attributing Qualifying Companies. Attributing Losses incurred by a company (including a QC) are Losses quarantined at the company level (unless a group for tax purposes). purposes). Company - to carry forward losses subject to 49% continuity Company rule. rule. LAQC – losses attributed to shareholders in proportion to their LAQC interest in the company during the year.
38 38 Limited Partnerships – An Evaluation
• • • • • • •
Introduction of Limited Partnerships Regime a positive step. Will facilitate foreign investment in New Zealand. Limited liability status will appeal to many investors. Investors need to be aware of loss limitation rule. Consideration of ‘safe harbours’ and the Limited Partnership Consideration agreement essential for limited investors wishing to have some form of input. form Raises questions about the future of the Loss Attributing Raises Qualifying Company. Qualifying More attractive than an unincorporated joint venture as limited More partnership will be established and regulated by statute. 39 39 Key Points: Key
• NZT 2009 Chapter 14 selected readings. • Qualifying companies represent attempt to treat certain Qualifying • • • • • • •
companies like partnerships for tax purposes. companies Note entry criteria – many companies are ineligible. Elections must be made by directors & shareholders. QCET is payable – designed to ensure tax is paid. QCET is Note the various tax implications upon entry. For any particular company, one must weigh up the advantages For and disadvantages of entry. and Limited partnerships – new vehicle for investment and tax Limited purposes. purposes. LAQCs may become less popular.
40 40 © Alistair Hodson 2009 ...
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