A look-through company is similar to a limited liability/standard company set up under the Companies Act 1993. However, the laws differ regarding the taxation of the company’s income. An LTC is a separate legal entity, but, for income tax purposes, it’s treated like a partnership. It has flow through treatment for tax purposes. The income and expenses are returned as income in the shareholder’s tax return. The shareholder is also treated as owning a proportionate share in the LTC’s underlying assets.
This flow through tax treatment has been one of the primary advantages of using an LTC. It allows the company to transfer its income and expenditure to its shareholders directly. This enables shareholders to either offset their personal income, or to be taxed at their personal tax rate. By off-setting any losses in the company, against the shareholder’s income from other sources, you can reduce the rate of tax payable, and save money. Unfortunately, this generally no longer works for rental investments.
According to Inland Revenue, to become, and remain, an LTC, a company must meet the following criteria for the whole of each income year:
If an LTC does not meet these criteria it automatically stops being an LTC. There is a deemed disposal of all assets – with the corresponding tax implications!
The shareholders are deemed to have ownership of the underlying assets of the LTC for taxation purposes. Any sale of these shares is deemed to be a sale of those underlying assets (potentially triggering any tax consequences). From a purchaser’s perspective, this can be positive or negative. It may result in an increased or decreased tax base (as opposed to taking on unrealised tax liabilities). From a vendor’s perspective, this can be an issue as this may result in tax being realised on the disposal of the shares where this would not have occurred in a standard company.
In summary, the LTC rules are relatively complex and require ongoing management to ensure the criteria are continually met. However, a LTC offers a useful tax structure for a wide range of potential uses. This includes:
Aside from tax, an LTC is just an ordinary company. This means that from all other legal perspectives you have a company with limited liability and subject to the ordinary company legal framework.
*This publication contains generic information only. NZ Tax Desk Ltd is not responsible for any loss sustained by anyone relying on the contents of this publication. We recommend you obtain specific taxation advice for your circumstances.
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