Chapter 4 - Disposal events

4.1 With flow-through tax treatment, a shareholder of a qualifying company would be treated as carrying on the activities of the company, and having the status, intention and purpose of the company. A shareholder would also be treated as holding the property that a qualifying company holds. This is the same approach as under the existing partnership rules.

4.2 The following events would result in qualifying company shareholders being treated as disposing of their interest in the qualifying company, with resultant tax consequences:

• a shareholder disposes of their shares in a qualifying company;
• a qualifying company ceasing to meet or electing out of the qualifying company rules; and
• the liquidation of a qualifying company.

Disposal of shareholder interest in a qualifying company

4.3 If a shareholder disposes of their interest in a qualifying company, they would, under the new rules, be treated as disposing of their share of the underlying company property, including any revenue account property, and would bear any tax consequences associated with the disposal. This is a natural consequence of flow-through treatment applying. However, it could result in significant compliance costs for qualifying companies and their shareholders.

4.4 Sections HG 5 to HG 10 of the Income Tax Act are special disposal provisions designed to reduce compliance costs for partners and partnerships. It is proposed to apply the same rules for qualifying companies to reduce the tax consequences of a deemed disposal of shareholder interests.

4.5 The application of these rules to qualifying companies would remove the requirement for an exiting shareholder to account for tax when the tax adjustment that would otherwise be required is below certain thresholds. A shareholder will be required to account for tax on disposing of their interest in a qualifying company only if the value of the proceeds from the disposal exceeds the total net tax book value of their share of company property by more than $50,000. However, if the $50,000 threshold in section HG 5 is exceeded, an exiting shareholder would not need to account for tax in certain circumstances. These exclusions would be the same as for partnerships and are contained in sections HG 5 to HG 10 of the Income Tax Act.

Qualifying company status ending

4.6 If a company revokes its election into the qualifying company regime or fails to meet the eligibility requirements, flow-through treatment would cease to apply and the company would be subject to normal company taxation rules generally from the start of that income year. Companies who elect out of the qualifying company regime could choose for this to apply from the start of a subsequent income year.

4.7 When a company ceases to be a qualifying company, there would be a deemed disposition and reacquisition of the company’s assets at their market value on that date. This would give rise to tax consequences for the shareholders, who would be treated as disposing of their share of the qualifying company’s property. For example, shareholders would be liable to tax on any gain from revenue account property. The company (which has lost its qualifying company status) would be treated as having acquired the property at its market value. The company’s available subscribed capital would be based on any capital contributed by the shareholders under the Companies Act 1993. To ensure that double taxation does not arise on eventual distribution, the portion of shareholder funds that represents undistributed reserves of a revenue nature will be treated as a capital gain amount.

Disposal on liquidation

4.8 On liquidation of a qualifying company, the disposal provisions in section HG 4 would apply. A shareholder of a qualifying company would be treated as disposing of and reacquiring all their interests in the company at market value. This would give rise to tax consequences – for example, for property held on revenue account. Thus, the tax treatment of a qualifying company on liquidation and a partnership on final dissolution will be aligned.