The reality of LACQs

A friend recently asked me what all the fuss was about LAQCs, and what they were anyway. He had read about them having something to do with the property market and that the Government was looking at cracking down on them.

Tax people seem to like acronyms. In this case, LAQC stands for loss attributing qualifying company. They are a subset of qualifying companies (QCs).

The QC regime was introduced in the early 1990s. They were designed to provide a way for small sole trader or partnership businesses to incorporate and gain the advantages of being a limited liability company, but without getting caught up in a lot of the tax hassles that come with companies.

For example, a company can generally only distribute capital gains tax free by winding up, whereas sole traders can just take the money. Companies generally have to carry forward tax losses, whereas sole traders can offset business losses against any other personal income.

QCs are normal companies that have been registered with the Inland Revenue Department (IRD) as having elected to be a QC. There are a lot of requirements to be met. For example, you can only have five or fewer shareholders and they have to elect to be personally liable for any unpaid income tax of the company. QCs suit small, owner-operated companies.

Once the election is effective, an LAQC is taxed a lot more like a sole trader. Capital gains can be paid out tax effectively, and losses flow through to the shareholders rather than being carried forward.

However, the benefits of being an LAQC have been seized upon by the property investment sector. They are now a common structure for owning a rental property. This has been to the point that there are a lot of misconceptions about them.

For example, some people think that you need an LAQC to get the tax benefit of losses from a rental property. That is untrue. If you own a rental property in your own name, you can offset any loss against your other income. You don't need an LAQC to do that. In fact, having the property in your own name is probably cheaper from a compliance point of view because you won't have to do a set of company accounts, which can be expensive because of all the financial reporting rules for companies.

There are only a couple of specific situations where you might want to use an LAQC. These relate to making effective use of any losses and using the company structure to maximise deducting interest costs in certain situations.

The Government now thinks that the use of LAQCs has gone too far. The IRD has released an issues paper proposing big changes for LAQCs.

They suggest profits being dealt with on a "flow- through" basis, just like losses. That is, shareholders will pay tax on the company profits at their personal tax rates rather than enabling the profits to be "parked" in the company at the company rate (currently 30 per cent, and soon to be 28 per cent).

Further, the ability to use company losses will be restricted to the amount of the shareholder's investment in the company, similar in application to the rules applying to limited partnerships.

A practical example of what the changes mean is the proposal that LAQCs would no longer file a company tax return. They would file a partnership tax return.

People who already have LAQCs or are thinking about getting into one should review their position in light of the proposals. The new rules are expected to come into effect for the 2011-12 tax year.

* Geordie Hooft is a Christchurch-based partner of Grant Thornton New Zealand.

Opinions expressed in this column are general in nature and are not intended as a recommendation or guidance to any individuals in relation to structuring their tax or finances. Readers should not rely on these opinions and should always seek independent professional advice specific to individual circumstances.

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