IR 435 April 2005 Qualifying companies A guide to qualifying company tax law Legislation changes April 2008 The company tax rate (CTR) has been reduced from 33% to 30%. For qualifying companies, this means: a reduction in the rate of QCET for elections paid for the 2009 income year onward recording QCET payments from 17 May 2007 as a credit in the ICA (imputation credit account) a change to the way you determine the tax-exempt portion of any imputed dividends you distribute. This guide has not yet been updated with the changes. For details, see our Tax Information Bulletin No 3, Vol 20 at www.ird.govt.nz
QUALIFYING COMPANIES 1 Introduction The tax provisions governing qualifying companies aim to treat a company and its shareholders as one entity as much as possible for income tax purposes. This is similar to the way in which partnerships are treated. Throughout this booklet you may come across terms you are not familiar with, or that are used differently from their everyday meanings. The glossary on page 5 explains these terms. The Income Tax Act 1994 applies to income derived in the 2004 05 and prior tax years. The Income Tax Act 2004 applies to income derived in the 2005 06 and subsequent tax years. The information in this booklet is based on current tax laws at the time of printing.
2 QUALIFYING COMPANIES Contents Introduction 1 Glossary 5 Part 1 General 9 Main points 9 Advantages 10 Disadvantages 10 Part 2 Who can become a qualifying company? 11 Eligibility criteria 11 Shareholder count test 12 Part 3 Qualifying companies 17 Directors elections 17 Shareholders elections 17 Trustee shareholder rules 18 Majority and minority shareholders 18 Shareholder liability 19 Shareholder s effective interest 20 Market value interest 20 Rules to determine effective interest 21 When qualifying company status commences 21 New company elections 22 Non-standard balance dates 22 Confirmation of status 22
QUALIFYING COMPANIES 3 Part 4 Loss attributing qualifying companies (LAQC) 23 Criteria 23 Elections 24 Non-resident shareholders 24 Ceasing to be an LAQC 24 Retaining LAQC status 25 When a company loses its LAQC status 25 Attributing losses 25 Subvention payments and loss offsets 26 Treatment of foreign losses 26 Revoking foreign loss elections 26 Part 5 Revocations 27 Ceasing to be a qualifying company or LAQC 27 Maintaining qualifying company or LAQC status 28 Change of shareholding 29 Liquidating or winding up a qualifying company 30 Part 6 Qualifying company election tax (QCET) 31 Calculating QCET 31 Assessment and payment 32 Penalties 32 Prior year losses 32 Effect of revoking the qualifying company election 33 Part 7 Dividends 35 Types of dividends 35 Imputation credits to be attached to dividends 36 Amount of dividend that will be taxable 37 Dividend withholding payment credits 37
4 QUALIFYING COMPANIES Part 8 Imputation credit account (ICA) 39 ICA rules that apply to qualifying companies 39 Debit balances 40 Part 9 Taxing qualifying companies 41 Intercompany dividend exemption 41 Subvention payments and loss offsets 41 Fringe benefit tax (FBT) 41 Part 10 Taxing shareholders 43 Dividends received from a qualifying company 43 Exempt dividends distributed to beneficiaries 43 Deductible interest on money borrowed to purchase shares 43 Deduction for attributed loss 44 Part 11 How to keep your qualifying company status 45 Part 12 Differences between qualifying companies and non-qualifying companies, for tax purposes 48 Services you may need 50 Inland Revenue s website 50 INFOexpress 50 For more help 50 Call recording 51 Privacy Act 1993 51 If you have a complaint about our service 52
QUALIFYING COMPANIES 5 Glossary Controlled foreign company (CFC) A foreign company controlled by five or fewer New Zealand resident shareholders. Dividend withholding payments (DWP) When a company receives dividends from a non-resident company, it must make dividend withholding payments (DWP) on behalf of its shareholders. The DWP will be credited to either the company s imputation credit account (ICA) or, if it has elected to maintain one, its dividend withholding payments account (DWPA). Effective interest A shareholder s effective interest generally means their voting interest in the company. However, where a market value circumstance exists, the average of market value and voting interest must be taken. E-File A computer system that allows the user to file tax returns directly from their PC to Inland Revenue s mainframe computer. Excluded option Any option to acquire or dispose of a share in a company when any of the following points are possible. The directors did not know, and could not reasonably be expected to have known, that the option had been granted. Neither the grantor nor their associate holds shares at the time the option is granted, unless the grantor is the company. The option is granted at arm s length. The option s exercise price equates to the market value of the share. The option relates to an excluded security. The option relates to a pre-budget security and the option was granted before 30 July 1991.
6 QUALIFYING COMPANIES Excluded security Any fixed-rate share or section FC 2 debenture that does not carry any decision-making rights, except to protect the holder. Fixed-rate share A share issued where the dividend is payable at a fixed rate and is not issued with the purpose of avoiding income tax. Flat-owning company Flat-owning companies are not business companies they are set up to own residential property. Shareholders in a flat-owning company are entitled to use or occupy the property. Foreign company Any company that: is not resident in New Zealand, or is resident in New Zealand but, under a double tax agreement, is treated as not being a resident for tax purposes. Foreign investment fund (FIF) A foreign entity in which a New Zealand resident has an interest that entitles them to derive income from the fund (for example, offshore unit trust or superannuation fund). Jointly and severally liable This means each shareholder, beneficiary or trustee separately, and all the shareholders, beneficiaries or trustees jointly, can be held liable for any debt. Loss attributing qualifying company (LAQC) A qualifying company that meets the criteria set down in section HG 14, and that has been elected by its shareholders and directors to be treated as an LAQC. An LAQC attributes the losses it incurs to its shareholders, to offset against their assessable income. Look through A test to determine the number of natural person shareholders in a company. If a company has another company as a shareholder, it is necessary in some instances to look through the second company to see who really owns the shares.
QUALIFYING COMPANIES 7 Market value circumstance A market value circumstance exists in relation to qualifying companies in any of the following situations. The company has debentures on issue to which section FC 1 or FC 2 apply (and that are not excluded securities or pre-budget securities). The company has any shares on issue where a third party guarantees dividend payment. There is an option, other than an excluded option, to acquire a share in the company. An arrangement exists with the purpose of defeating a provision that depends on measuring voting and market value interests. Market value interest A person s market value interest in a company is measured where a market value circumstance exists. At any time, a person s market value interest equals their share of the total market value of shares and options held in the company. Minor For the purposes of this legislation we regard a minor to be any person under the age of 20 years. Nominee Any person who is nominated by another person to hold anything on behalf of, or to the order of, that other person. They must be a natural person, a qualifying company or a trustee of a trust. Period of grace Where the elections to have a company treated as a qualifying company or an LAQC have been revoked, the company has a period of grace in which to make new elections without losing its qualifying company or LAQC status. Pre-budget security A fixed-rate share or a section FC 1 or FC 2 debenture issued before 8 pm on 30 July 1991, or issued pursuant to a binding contract entered into before that date, where the terms of the contract or security are not subsequently altered.
8 QUALIFYING COMPANIES Qualifying company A company that meets the criteria, and whose shareholders and directors have elected to treat it as a qualifying company. Qualifying company election tax (QCET) The tax payable by a company, in accordance with section HG 11, when it becomes a qualifying company. This tax is payable on any untaxed retained earnings made before the company becomes a qualifying company. This is because after it becomes a qualifying company, these retained earnings can be paid as tax-free dividends to the shareholders or have maximum imputation credits attached to them. Sui juris A legal phrase used to describe people who have the legal capacity to deal with their property, make binding contracts, and to sue or be sued. People who do not have full legal capacity (that is, non sui juris) include minors and people who have an intellectual disability. Unit trust Any scheme in which subscribers or contributors to the trust share in the income and gains from the trust s investments. For taxation purposes a unit trust is treated as a company. Voting interest This is intended to reflect a person s economic interest in a company. A person s voting interest at any time equals their percentage share of total shareholder decision-making rights carried by shares or options in that company.
QUALIFYING COMPANIES 9 Part 1 General Main points The following is a brief outline of how the qualifying company system works. Subject to certain conditions, the directors and shareholders can elect that their company become a qualifying company. A qualifying company pays income tax on its profits in the same way as other companies, subject to certain rules that are discussed in Part 9 of this booklet. Generally, shareholders must elect to become personally liable to pay any income tax not met by the company. The company may be liable to pay qualifying company election tax (QCET) upon electing to join the system, because some untaxed reserves can then be distributed tax-free by the qualifying company. Capital gains can be distributed tax-free without winding up the company. Only dividends with imputation credits attached are taxable to the shareholders. Any losses incurred and/or carried forward before becoming a qualifying company are forfeited. A qualifying company can elect to become a loss attributing qualifying company (LAQC), provided certain conditions are met. While a company is an LAQC it must attribute its tax losses to the shareholders, who then claim a deduction for the losses. Once the company attributes the losses it is not able to carry them forward, or use those losses itself.
10 QUALIFYING COMPANIES Advantages There are some obvious advantages to becoming a qualifying company. There are commercial benefits in maintaining a company structure with the taxation benefits of a partnership (for example, limited liability, the ability to transfer ownership). Dividends will be tax-free, except to the extent that imputation credits can be fully attached. Capital gains (realised and unrealised) can be distributed tax-free without winding up the company. Shareholders of an LAQC can offset the company tax losses against their own income. Disadvantages The most obvious disadvantages of becoming a qualifying company include the following points. Shareholders will be personally liable for any income tax not paid by the company. QCET may be payable when a company elects to become a qualifying company. Company losses incurred before becoming a qualifying company are forfeited. If a qualifying company is in a profit situation it cannot group with non-qualifying companies for loss offset or subvention purposes. A limited amount of interest can be deducted for shareholders. Once the losses have been attributed to the shareholders of an LAQC, the LAQC forfeits the attributed loss amounts.
QUALIFYING COMPANIES 11 Part 2 Who can become a qualifying company? Eligibility criteria To become a qualifying company, all the following criteria must be met. The company must not be a foreign company at any time during the year. However, a company that has non-resident shareholders will not necessarily be excluded from becoming a qualifying company. The company must not be a unit trust. The company must not receive more than NZ$10,000 in foreign-sourced non-dividend income per year. To determine the $10,000 limit, a deduction is made for the lesser of: gross foreign non-dividend income (accrual income) 10% of the company s annual gross income before any deductions. Each shareholder must be either a natural person, another qualifying company, or a trustee of a trust of a specified kind (see Trustee shareholder rules on page 18 for more details). The company must have no more than five shareholders at all times, unless it is purely a flat-owning company. Shareholders related within one degree will count as one shareholder (see Shareholder count test on page 12 for further details). Valid shareholder and director elections must have been made, and not revoked, during the year. In addition, the company should not have lost its qualifying company status as a result of losing its LAQC status. The shareholders must have elected to be personally liable for any income tax not paid by the company. A shareholder is liable for a share of the company s tax, equivalent to their effective interest.
12 QUALIFYING COMPANIES Shareholder count test There are special rules for determining the number of shareholders for qualifying company purposes. Shareholders related by blood or marriage to within one degree of relationship are deemed to be one shareholder (for example, parent and child, husband and wife). To determine the number of degrees of separation in a relationship, visualise a family tree and count the steps back to a common ancestor and then forward to the other person. Each link between names is one degree of relationship. For example, a brother and sister are related to within two degrees, as follows. Parent Son Daughter If all three are shareholders, they will count as a single shareholder. However, if only the siblings are the shareholders, they will count as two shareholders. Please note that a relationship between a step-parent and step-child is a second degree of relationship. Corporate shareholders Only companies that are also qualifying companies may hold shares in a qualifying company (except when they are acting as a nominee). In determining whether there are five or fewer shareholders, the company is not counted as a single shareholder. Rather, you must look through the company to count each of its individual shareholders. Trustee shareholders If a trustee is a shareholder it is necessary to look through the trust to the beneficiaries of the trust. The number of beneficiaries (shareholders) for the purpose of this count test will be the greater of: the number of beneficiaries who have received dividends from the trust in that income year where all the dividends were derived from a qualifying company, or the number of beneficiaries who elected that the company become a qualifying company. Note In most circumstances, trustees, as shareholders of qualifying companies, are required to pass out dividends to beneficiaries.
QUALIFYING COMPANIES 13 Nominee shareholders Shares held on behalf of a person are deemed to be held by that person. If a nominee shareholder is a trust or another company rather than a natural person, this alone will not prevent a company from becoming a qualifying company. The following special rules also apply. Death or dissolution of marriage of the shareholders does not break the one-degree test, provided the company was a qualifying company and the shareholders were deemed to be one before the event. Holders of debentures to which sections FC 1 or FC 2 apply are treated as shareholders. Shareholder count test examples Company shareholders Company C Ltd has the following shareholding: } 50% Company D Ltd 34% Luke 33% Harry brothers 33% Ben 50% Company E Ltd 25% Peter 25% Mary 25% Sam 25% Susan } } husband and wife husband and wife In this example, Company C Ltd has five shareholders for the purpose of deciding whether it is eligible to become a qualifying company. The three brothers are related by two degrees and are therefore counted individually. Since husband and wife are related within one degree, Company E Ltd has two shareholders for the qualifying company shareholder count.
14 QUALIFYING COMPANIES Trustee shareholders Company B Ltd was incorporated on 1 April 2004 with the following shareholding: 10% Jack 90% family trust trustee Jack beneficiaries Sandra (Jack s wife) Matt Neve Oliver Piers }Jack and Sandra s infant children Jack makes shareholder elections as shareholder and as trustee. Sandra elects as the sui juris beneficiary. Assuming five beneficiaries have received qualifying company dividends through the trust, the company s shareholding, including Jack, totals six. However, since these shareholders are all related to within one degree, the company has only one shareholder for the shareholder count test.
QUALIFYING COMPANIES 15 Mixed shareholding Company A Ltd was incorporated on 1 April 2004 with the following shareholding: 40 % Bob 10 % Sue (Bob s wife) 13 % Phil (Bob s son, aged 21) 13 % Stephen (Sue s brother) 13 % Jamie (Stephen s son) 6 % family trust trustee Bob beneficiaries Sue Phil Jamie 5 % Company F Ltd 99% Bob 1% Denise (nominee for Bob) In this example, Company A Ltd has two shareholders for the purpose of deciding whether it is eligible to become a qualifying company: 1) Bob, plus Sue, Phil (one degree from Bob) and Denise (nominee) 2) Stephen, plus Jamie (one degree from each other). You may need to apply the test more than once, starting with different shareholders, to arrive at the least number of shareholders.
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QUALIFYING COMPANIES 17 Part 3 Qualifying companies The Qualifying company or loss attributing qualifying company elections (IR 436) form incorporates both director and shareholder elections. You can get this from our website or order a copy through INFOexpress see page 50. Directors elections All the directors of the company must elect in writing that the company shall become a qualifying company. A director is any person: on whose instructions the normal directors of the company are accustomed to act, or who occupies the position of director regardless of any title they have been given. Note An agent employed to advise or prepare tax returns cannot sign the election on behalf of any shareholder or director. Shareholders elections As well as the directors elections, all sui juris shareholders must elect in writing that the company become a qualifying company. The shareholders must also elect to be personally liable for their share of any income tax not paid by the company for each year the election is in force. If a shareholder is a trust, all the trustees and at least one of the sui juris beneficiaries (or a sui juris volunteer) must make elections see page 18. If a company is a shareholder, the shareholding company itself is required to elect. The look through test applies only in determining the number of shareholders. In the example of the company shareholder count test given on page 13, only the two company shareholders would be required to elect, even though (for shareholder count purposes) there are five shareholders. Majority shareholders (those having effective interests of 50% or more) may elect on behalf of any minority shareholder (those with effective interests less than 50%). See page 18 for further information. Any nominee shareholder must also make an election for the company to be a qualifying company and will be liable for any unpaid income tax, as is any shareholder, unless a majority election is made on their behalf.
18 QUALIFYING COMPANIES Trustee shareholder rules If any shareholder is a trustee, the following rules will apply to meet the qualifying company criteria. Every beneficiary of that trust, which received dividends from a qualifying company, must be a natural person or a qualifying company. The trustees must distribute dividend income (including cash and taxable bonus issues), derived from a qualifying company during the income year, to beneficiaries as beneficiary income. Normal trust rules prevail in that the income must be paid or applied within six months of balance date. These rules are relaxed when the trust pays or vests as much of the dividend income as is allowed under general trust law. Any trustees of a trust who are shareholders and one or more sui juris beneficiaries must make a shareholder qualifying company election. Where there are no sui juris beneficiaries, a sui juris natural person must make a volunteer election on behalf of the beneficiaries and will assume their liability. The liability of the trustees and the elector beneficiaries for the trust s proportional share of the qualifying company s tax is joint and several. This means either or both can be held liable. The trustees liability will be limited to the value of the net assets of the trust. If a volunteer election has been made, it will be revoked when a beneficiary becomes sui juris, and that beneficiary must then make an election for the qualifying company status to continue. Majority and minority shareholders A minority shareholder is a shareholder who has an effective interest of less than 50%. A majority shareholder is a shareholder or group of shareholders who have an effective interest (either individually or combined) of 50% or more. Majority shareholders can make a qualifying company election on behalf of any minority shareholder(s), and become liable for the minority shareholders share of the company s income tax as well as their own proportional liability. Where more than one shareholder has made a majority election on behalf of a minority shareholder, the liability is joint and several. A majority election will be revoked where a majority shareholder becomes a minority or a minority shareholder becomes a majority.
QUALIFYING COMPANIES 19 Shareholder liability The shareholders liability for the qualifying company s income tax is based on the shareholders effective interest in the company. Sui juris shareholders are liable for any income tax the company has incurred but failed to pay during the time it is a qualifying company. Shareholders who hold shares jointly (including trustees, and volunteer and sui juris beneficiary electors) will have joint and several liability to the extent of their joint effective interest. Summary of shareholders liability Minority Majority Election made, liability based on effective interest Majority election on minority s behalf, no liability Liability based on effective interest Shareholders who make majority elections on behalf of minority shareholders are also liable for those shareholders effective interest Joint majority elections made with other shareholders, joint and several liability for minority s effective interest Nominee Trustee Same as for minority Jointly and severally liable with the elector beneficiaries and/or volunteer, based on the trust s effective interest Liability limited to value of trust s net assets Beneficiaries or volunteers Same as for trustee
20 QUALIFYING COMPANIES Shareholder s effective interest A shareholder s effective or voting interest in a company is measured by the percentage of decision-making rights carried by the shares (and options) in a company, in relation to: dividends or other company distributions company constitution variation of the company s capital director appointments or elections. Example A voting interest calculation A shareholder owns 40% of the shares in a limited company. The shares carry voting rights over distributions made by the company and variation of the capital only. The voting interest is calculated as: Distributions + constitution + variation + directors in capital 40 + 0 + 40 + 0 = 80 100 100 100 100 400 = 20% Where a shareholder s economic interest in a company is not accurately reflected by their voting interest because of other specific factors, the shareholder s effective interest is calculated as the average of the shareholder s voting interest and market value interest in the company. Market value interest A shareholder s market value interest in a company at any time equals their share of the total market value of shares (and options) held in the company. There are specific factors that require a market value interest to be calculated these are called market value circumstances. The following list defines the situations where a market value circumstance exists. The company has debentures on issue to which section FC 1 or FC 2 applies (but not excluded securities or pre-budget securities).
QUALIFYING COMPANIES 21 The company has shares on issue where a third party guarantees dividend payment. There is an option, other than an excluded option, to acquire shares in the company. An arrangement exists with the purpose of defeating a provision that depends on measuring voting and market value interests. Rules to determine effective interest There are some special rules for calculating the effective interest in a company. Where the shareholder is another company, there is no look through to the ultimate shareholders. If the voting interest or market value interest varies during the year, the effective interest for the period is determined on a weighted average basis. When a shareholder s election is revoked, the voting and market value interests are nil from the date the revocation takes effect. If the shareholder is a trustee, and a sui juris beneficiary or natural person volunteer revokes their election, the trustee s voting and market value interests are nil from the date the revocation takes effect. When qualifying company status commences All elections apply from the first day of the income year following the year in which the election has been made and received by Inland Revenue, unless a later date has been specified on the election notice. You must check that the correct year has been specified. If the election states a particular date and is received late, it will be deemed to apply from the following year.
22 QUALIFYING COMPANIES New company elections For new companies, elections may apply from the beginning of the company s first income year, provided they are received within the time required to file the first return of income. An extension of time may be granted to file returns to the following 31 March at the latest. Therefore, if it is likely the return will not be filed before the approved extension of time date, the elections should be filed separately. Returns can be sent through E-File, but it is not possible to send the elections this way they must be posted to Inland Revenue. As the elections are likely to arrive later than the E-Filed return, we will accept elections received within a reasonable period, generally six working days from the date the return is filed. Shelf companies that are purchased in the current year, but were incorporated in a previous year and have never traded, may be treated as a new company for the purpose of electing to become a qualifying company. Note We will accept elections to become a qualifying company up to six days from the date the return is filed. Non-standard balance dates Elections relate to income years, and therefore should be received before the company s income year begins. For example, if a company has a 30 June balance date and wishes to become a qualifying company with effect for the 2005 income year, it must have elected on or before 30 June 2004. Confirmation of status Once we have processed the elections, we will send the company a letter to acknowledge that it is registered as a qualifying company or LAQC. The letter will also show the date from which the status will apply. It is important the elections are checked thoroughly before being lodged, so the confirmation reflects what was requested. In the case of foreign loss elections, we will send the LAQC a letter to confirm that it may retain its attributed CFC or FIF losses.
QUALIFYING COMPANIES 23 Part 4 Loss attributing qualifying companies (LAQC) A qualifying company can become a loss attributing qualifying company (LAQC), allowing it to pass through or attribute its losses to its shareholders in proportion to their effective interest in the company. A loss incurred by an LAQC must be attributed to its shareholders. The shareholders then treat such losses as expenditure incurred in deriving gross income. This means they can either be claimed as a deduction or carried forward. Once they are attributed, the company cannot also carry the losses forward. Criteria To become an LAQC the following criteria must be met. A company must be a qualifying company at all times during the year, and all the shares must carry the same rights to vote and receive distributions from the company. All the shares in the company must carry the same rights to exercise voting power concerning company distributions, company constitution, capital variation and director appointments, and to receive distributions of profits and net assets. Section FC 1 and FC 2 debentures are deemed to be shares and must also satisfy these requirements. Therefore, a qualifying company with such debentures on issue is unlikely to meet the LAQC criteria. All sui juris directors and shareholders in a company must have elected in writing that the company become an LAQC, and these elections must not have been revoked. Majority elections may be made for minority shareholders who choose not to elect. We must receive the elections before the beginning of the income year in which they will apply. No share in the company has been the subject of an arrangement to defeat the intent and application of the LAQC rules.
24 QUALIFYING COMPANIES Elections All sui juris directors and shareholders or elector shareholders must elect in writing that the company shall become an LAQC. We must receive the elections before the beginning of the income year to which they will apply. A majority shareholder can elect for a company to become an LAQC where a minority shareholder does not elect to join the system. As with qualifying companies, new companies may file the elections within the time limit for filing the first return of income. The Qualifying company or loss attributing qualifying company elections (IR 436) form incorporates both director and shareholder LAQC elections. Where the shareholder is another qualifying company or a trustee, elections should be made by the company and the trustee respectively. You can get this from our website or order one by phoning INFOexpress see page 50. Where possible, if the company is electing to become a qualifying company and LAQC from the same date, these elections should be sent to Inland Revenue together. Non-resident shareholders There are no restrictions on non-residents being attributed losses. However, the ability to claim those losses in their own country will be determined in that jurisdiction. Ceasing to be an LAQC A company will cease to be an LAQC if any of the following events occur. Voluntary revocation made in writing by any sui juris director or shareholder. The revocation applies from the beginning of the income year in which it is made, unless a later year is specified. Automatic revocation will occur if a shareholder dies, or if shares are sold or issued to a new shareholder without appropriate re-elections. The revocation applies from the beginning of the income year in which the death or sale occurs. As with a qualifying company revocation, we may defer the cessation date see page 27 for further details.
QUALIFYING COMPANIES 25 Retaining LAQC status When an automatic revocation has occurred, LAQC status will not be lost if the company makes a new election within the period of grace. This period is: 12 months in the case of death of a shareholder 63 days in all other cases. These periods may be extended on application to Inland Revenue see pages 28 to 30. When a company loses its LAQC status When a company loses its LAQC status, it also ceases to be a qualifying company from the beginning of the income year in which LAQC status was lost. The company may reapply for qualifying company status, but it may have to pay more qualifying company election tax (QCET). The difficulty with this is that the revocation will be retrospective to the beginning of the income year, while an election cannot apply before the next income year. Therefore, in most cases, a revocation will result in the company ceasing to be a qualifying company for at least one year. Attributing losses Any losses incurred while a company is an LAQC must be attributed to the shareholders in accordance with their effective interest within the company. Once attributed, that loss is no longer available to the company. When completing the company s IR 4 return the amount attributed to individual shareholders should be shown on the Company shareholders details (IR 4S) form and should total that year s loss incurred. You can get an IR 4S from our website or order a copy by phoning INFOexpress see page 50. When a company converts excess imputation credit to a loss, that loss forms part of the current year losses and should be attributed to shareholders. Previous year losses being carried forward may not be attributed at any time. In practice, this will only relate to companies who incur losses while they are a qualifying company and several years later elect to become an LAQC. When the shareholder is a trustee, the attributed losses may only be offset against the trust s income prior to distribution. Any excess is carried forward to the next year. There are no provisions for the losses to be allocated to beneficiaries.
26 QUALIFYING COMPANIES Subvention payments and loss offsets Special rules apply for group companies. A qualifying company profit can only be offset by a loss offset or subvention payment if the other company is also a qualifying company. A qualifying company loss can be offset against any group company profit (whether it is a qualifying company or not). If a company elects to be a loss attributing qualifying company (LAQC), any loss incurred after becoming an LAQC must be passed on or attributed to the shareholders in full. The LAQC can not offset losses to other group companies prior to attributing to shareholders. Treatment of foreign losses Losses from CFCs or FIFs are included in losses attributed to the shareholders by an LAQC. However, these losses retain their identity and are ringfenced. This means that they can only be offset against other CFC or FIF income received by the shareholders (in accordance with the international tax system). If none of the shareholders personally receive CFC or FIF income, they may be unable to benefit from these losses. It may be preferable for the LAQC to retain the losses and carry them forward to be offset against its future CFC or FIF profits. To do this, a written election must be made by all sui juris shareholders on the Foreign loss election or revocation (IR 444) form. You can get this from our website or order a copy by phoning INFOexpress see page 50. We must receive this election before the beginning of the income year to which it will apply. For a new company, we must receive the election within the time in which the first return of income must be filed. Revoking foreign loss elections A foreign loss election must be revoked in writing by all sui juris shareholders on a Foreign loss election or revocation (IR 444) form, which you can get from our website or order through INFOexpress see page 50. The revocation will apply from the beginning of the income year in which we receive it, unless a later year is specified. CFC or FIF losses incurred before becoming an LAQC are retained by the company and carried forward regardless of any election revocation.
QUALIFYING COMPANIES 27 Part 5 Revocations Ceasing to be a qualifying company or LAQC A company will cease to be a qualifying company or LAQC if either of the following two events occur. Directors elections are revoked A director election is revoked by a resolution of the board of directors, notified in writing to Inland Revenue on the Revocation of qualifying company or loss attributing qualifying company election (IR 437) form. Directors may not individually revoke the election, and there is no need for further elections if directors change. In addition, there are no periods of grace for director revocations qualifying company status is lost immediately and any new election will take effect from the next income year. Shareholders elections are revoked Shareholder elections are revoked in either of the following ways. Voluntary revocation the shareholder must make this in writing to Inland Revenue and to the company on the IR 437. Automatic or deemed revocation this can be caused if: a shareholder dies a previously non sui juris shareholder becomes sui juris an entire shareholding is sold to a new shareholder if the sale is made to an existing elector shareholder, revocation will not be caused a previously non sui juris beneficiary, for whom a volunteer election has been made, becomes sui juris there has been a majority election and a minority shareholder becomes a majority shareholder, or vice versa a joint election has been made that is revoked by one of the joint electors the company ceases to be an LAQC the company no longer meets the qualifying company criteria as set out earlier in Eligibility criteria see page 11. The cessation of qualifying company status may be deferred when this happens. See Maintaining qualifying company or LAQC status on page 28.
28 QUALIFYING COMPANIES Revocations apply from the beginning of the income year in which we receive the notice, unless a later year is specified. Deemed revocation applies from the beginning of the income year in which the event occurs that causes the revocation. The date Inland Revenue and the company receive the notice or the date on which the event occurs will be used to determine the effective interest in the company of the person making the revocation, unless a later date is specified. Maintaining qualifying company or LAQC status Where a shareholder election has been revoked, either voluntarily or automatically, a company will not lose its qualifying company or LAQC status provided a new election is made within the period of grace, which is 12 months in the case of death of the shareholder 63 days in all other cases. These periods may be extended on application to Inland Revenue. The date of cessation as a qualifying company may also be deferred on application. Replacement elections will be effective from the beginning of the income year in which the revocation occurred. In order to calculate a shareholder s effective interest when a replacement election has been made during an income year, the date on which the person became a shareholder is taken into account, even if this is earlier than the date on which they made the election. Example An elector shareholder, A sells her shares on 30 June 2004. This causes an automatic revocation of the qualifying company status effective from 1 April 2004 (assuming the qualifying company has a 31 March balance date). On 30 July 2004, the new shareholder, B re-elects to continue as a qualifying company (within the 63-day period of grace). The replacement election is effective as at 1 April 2004. B s effective interest is calculated from 30 June 2004, even though this is earlier than the date on which he made his election.
QUALIFYING COMPANIES 29 Change of shareholding Once a company becomes a qualifying company it is important to monitor any changes in shareholding. The following is a summary of the changes that require action if a company wishes to maintain its qualifying company status. Death of a shareholder (deemed revocation). New shareholder elections about qualifying company status are required within 12 months of the date of death of a shareholder. We may extend this period on application. A minority shareholder becomes a majority shareholder. If the shareholder previously elected to become a qualifying company, no further action is required. If a majority election was made on behalf of the shareholder, they must now make a new election within 63 days of becoming a majority shareholder. A majority shareholder becomes a minority shareholder. No action is required for their own election. However, if they made a majority election on behalf of minority shareholder(s), new elections must be made by or for those minority shareholders. Sale of a shareholder s entire shareholding. If an entire shareholding is sold to an existing elector shareholder, no action is required. If the sale is made to a new majority shareholder, a new qualifying company election is required within 63 days of the sale. If the shareholding is sold to a new minority shareholder, they may elect for themselves, or a majority election may be made on their behalf. This election is also required within 63 days of the sale. A majority shareholder sells shares to a new majority shareholder. When a shareholder has 100% effective interest in a qualifying company and disposes of 50% to a new shareholder, both shareholders are majority shareholders. Since there has been a change in shareholding, the new majority shareholder must elect within 63 days to maintain the qualifying company status. A previously non sui juris shareholder becomes sui juris. If a volunteer election regarding qualifying company status was made on the beneficiary s behalf, they must re-elect within 63 days of becoming sui juris.
30 QUALIFYING COMPANIES Liquidating or winding up a qualifying company Once a company is removed from the Companies Register it is technically no longer a qualifying company. However, Inland Revenue has issued a policy that qualifying company status will not be lost by virtue of the company being ceased. Liquidating companies should be aware that: shareholders will still be liable for the effective interest of any income tax liability regardless of the status of the company the company may be liable for any debit imputation credit account (ICA) balance that may have been deferred.
QUALIFYING COMPANIES 31 Part 6 Qualifying company election tax (QCET) Qualifying company election tax (QCET) is an entry tax to the qualifying company system based on the amount that would represent an unimputed dividend to the shareholders if the company was to be liquidated immediately before it became a qualifying company. QCET is taxed at 33%. This is necessary because all distributions from a qualifying company are exempt, to the extent that imputation credits cannot be attached, and this treatment is not intended to apply to previously accumulated reserves. Calculating QCET The standard QCET formula is: ( ) a + c - b - c x d d Where: a is the amount that would be taxable on distribution under a deemed winding up, excluding 10-year bonus issues b is the gross income, less allowable deductions derived by the company on a notional winding up. This includes such items as depreciation recovered, bad debts and losses on sale of assets c is balances in the company s imputation credit account (ICA) and dividend withholding payment account (DWPA) immediately prior to becoming a qualifying company, plus any unpaid income tax and dividend withholding payment (DWP), less any refunds due from the 1989 income year to the year prior to becoming a qualifying company d is the company tax rate expressed as a decimal (0.33). The Supplement to qualifying company election tax (QCET) return (IR 438) is available to simplify calculating QCET. You can get it from our website or order a copy by phoning INFOexpress see page 50.
32 QUALIFYING COMPANIES Assessment and payment QCET is self-assessed and is subject to review by Inland Revenue at any time. The Qualifying company election tax (IR 4P) return must be sent to Inland Revenue, even if no QCET is payable. The IR 4P and any QCET payable is due by the end-of-year tax due date for the income year prior to that in which the election took effect. Example A limited company elects to become a qualifying company with effect from 1 April 2004. QCET is due 7 February 2005, which is the date the company s end-of-year tax is due for the 2004 tax year, unless they have a tax agent, in which case QCET is payable by 7 April 2005. Penalties Unpaid QCET is treated as unpaid end-of-year tax for the purpose of calculating penalties. An initial 1% late payment penalty will be charged on the day after the due date. A further 4% penalty will be charged if there is still an amount of unpaid tax (including penalties) at the end of the 7th day from the due date. Monthly incremental penalties of 1% are charged on the amount of tax outstanding (including unpaid tax, initial late payment penalties and any other penalties). Interest is calculated on a daily basis on the amount of unpaid tax including penalties. The rate is set by Government and varies from time to time. Prior year losses A company cannot carry forward losses incurred prior to becoming a qualifying company they must be forfeited. Losses incurred after a company becomes a qualifying company (but not an LAQC) may be carried forward.
QUALIFYING COMPANIES 33 Effect of revoking the qualifying company election When a revocation is made, it takes effect from the first day of the income year in which it occurs, unless a later date is specified. A revocation at any time before the end of the first income year for which an election was made removes a company s QCET liability. If the revocation occurs after the QCET has been paid, the QCET will be refunded. When you advise us that a revocation has occurred, you should also specify what QCET has been paid and needs to be refunded. Example A limited company elects to become a qualifying company on 28 March 2004, and this is effective for the 2005 income year. QCET is payable by 7 February 2005, unless they have a tax agent, then QCET is payable by 7 April 2005. If they revoke the election before 7 February 2005, no QCET payment is required. If they pay the QCET on time and revoke the election after 7 February 2005 but before 31 March 2005 (that is, within the first income year after the election was made) the QCET will be refunded.
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QUALIFYING COMPANIES 35 Part 7 Dividends Types of dividends A qualifying company will generally only distribute two types of dividends to resident shareholders: taxable (fully imputed) exempt (other dividends not able to be imputed). A cash dividend or taxable bonus issue is deemed to have an imputation credit attached, provided the qualifying company has a credit balance in its imputation credit account (ICA). The amount of the imputation credit will depend on the balance in the ICA. Dividends paid to New Zealand resident shareholders that do not have imputation credits attached (including non-cash dividends and capital gains distributed), will be exempt from income tax. Dividends paid to New Zealand resident shareholders will not have resident withholding tax (RWT) deducted. Non-resident shareholders are taxed on the dividends in the same way they would be taxed for dividends received from a non-qualifying company. Therefore, dividends (both cash and non-cash) paid to non-resident shareholders will still be subject to non-resident withholding tax (NRWT). The following is a summary of the treatment of various distributions. Capital distributions (realised or unrealised) will be tax-free to shareholders. Imputation credits may only be attached to cash dividends, and are deemed to be attached to the taxable part of the dividend. Exempt dividends received by a trustee shareholder retain their exempt status when passed through to beneficiaries as beneficiary income. Dividends paid to residents are not subject to RWT. Dividends paid to non-residents shall be subject to NRWT.
36 QUALIFYING COMPANIES If a shareholder has a later balance date than the qualifying company, the dividend is deemed to be derived by the shareholder in the next income year. Non-cash dividends are not assessable to the shareholders and the expenditure incurred in providing them is non-deductible to the company. Imputation credits to be attached to dividends Imputation credits can only be attached to cash dividends and taxable bonus issues. The dividend will either be fully or partially imputed, to the extent that imputation credits can be attached. The amount of the imputation credit is determined according to the following formula. The lesser of: maximum imputation credits available under the imputation system, that is, 33 / 67 or 49.25% an amount calculated as: a x b c Where: a is the ICA closing balance of the imputation year in which the dividend was paid b is the amount of the dividend, excluding imputation credits c is total dividends (excluding imputation credits) paid by the company during the imputation year. Example Closing ICA balance $ 3,000 Cash dividend paid to a shareholder $10,000 Total dividends paid by the qualifying company $20,000 $3,000 x $10,000 $20,000 = $1,500 maximum imputation credit to be attached to $10,000 dividend
QUALIFYING COMPANIES 37 Amount of dividend that will be taxable The amount of a dividend taxable to a shareholder is calculated using the following formula: a + b c Where: a is the imputation credits attached to the dividends b is the DWP credits attached to the dividends c is the resident company tax rate expressed as a decimal. The balance over this amount will be exempt. In the example on page 36, the shareholder received a $10,000 dividend with an imputation credit of $1,500 (gross dividend of $11,500). Using the formula given above, $6,955 is exempt and $4,545 is taxable with an imputation credit of $1,500, that is: $1,500 0.33 = $4,545 Dividend withholding payment credits An equivalent formula can be used to attach dividend withholding payment (DWP) credits to any dividends paid. Note A company that keeps a withholding payment account (WPA) may attach a combination of imputation and dividend withholding payment (DWP) credits to a dividend. In this case the company must ensure that the combined imputation and DWP ratio of the dividend does not exceed the maximum ratio of 33:67. In this example no DWP credits have been attached.