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Inland Revenue

Tax Policy

Chapter 1 - Introduction

1.1 Closely held companies are companies with few shareholders. Such companies comprise a significant proportion of the approximately 400,000 companies[1] in New Zealand. Many of these companies use the general company tax rules to govern their interface with their shareholders. However, there are specific tax rules available for certain types of closely held companies.

1.2 Since the early 1990s very closely held companies had been able to pass capital gains and company losses through to shareholders by electing to become a qualifying company (QC) or a loss-attributing qualifying company (LAQC). In 2010 the Government announced major changes to those specific tax rules, essentially removing LAQCs, closing off the QC rules for new entities and providing a replacement option that enabled a closely held company to be treated as if it were a partnership. Under this new approach, a company’s income and expenditure would be directly attributed to its owners in proportion to their interests, via the new look-through company (LTC) rules.

1.3 Transitional arrangements were provided to help QCs become LTCs. The government also undertook to review the dividend rules with a view to simplifying them for closely held companies more generally.

1.4 Since then, a range of concerns have been raised about the workability of the LTC rules, particularly for small businesses. This may be deterring companies from becoming LTCs as well as imposing additional compliance costs on those that become LTCs. At the end of the 2014 income year, although there were around 50,000 LTCs, there were also still nearly 70,000 QCs. While there are a range of reasons for a company continuing to be a QC, it should not be because the LTC rules are hard to comply with.

1.5 Accordingly, this issues paper reviews the LTC rules and suggests a range of changes to make the rules more workable. It also considers changes to the dividend rules applying to closely held companies that are neither LTCs nor QCs. Again this work is consistent with the Government’s objective of simplifying tax requirements and reducing compliance costs for small and medium businesses.

1.6 The focus, however, has not been purely on simplification. Consideration has also been given to the fundamental policy approach to ensure that any changes that are recommended are consistent with wider tax policy frameworks and support the integrity of the tax system. The policy approach is outlined in Chapter 2 and includes consideration of the treatment of capital gains made by closely held companies.

1.7 Outside of liquidation, capital gains and other tax preferences[2] are clawed back when distributed by standard companies. In contrast, the LTC regime provides a vehicle for directly flowing through capital gains tax-free throughout the life of a company as LTCs are intended to be a genuine parallel to direct ownership. Extending this approach outside of LTCs raises complex issues that cannot be considered in isolation. It would therefore be premature to contemplate changes in these areas without significant further work, which could be handled through the standard tax work programme process at a future date. In the meantime, we consider it is important to proceed with the specific simplification initiatives proposed in this paper.

1.8 Some significant changes are being suggested. They include changes to the criteria that a company has to meet in order to qualify as a LTC, most notably in relation to trusts, the use of LTCs as a vehicle for conduit investment by non-residents and the requirement that the LTC have only one class of share. The changes would also narrow who would be covered by the restriction that limits an owner’s LTC losses to the amount they have at risk (the deduction limitation rule). The changes are intended to better reflect the intended closely held nature of a LTC. A summary of the suggested changes is provided below. They are discussed in detail in the following chapters.

1.9 Some key statistics are provided in Appendix 1.

Summary of suggested changes


Entry criteria
  • Changes should be made in relation to trusts:
    • A beneficiary that has received any distribution in the last six years should be a “counted owner”.[3]
    • A company should not be eligible for LTC status if a trust that is a shareholder makes a distribution to a corporate (non-LTC) beneficiary.
    • The trustee should continue to be a single counted owner in the event that no distributions are made in the relevant period (last six years).
  • Charities and Māori authorities would be precluded from being shareholders in LTCs or beneficiaries of trusts that own shares in LTCs. This would not impact on standard charitable donations.
  • More than one class of share should be allowed so as to provide for different voting rights, provided all shares still have uniform entitlements to income and deductions.
  • As a LTC is not intended as a conduit vehicle, its foreign income would be restricted to the greater of $10,000 or 20 percent of its gross income when more than 50 percent of the LTC’s shares are held by non-residents, if it wishes to retain its LTC status.
Deduction limitation rule
  • The restriction that limits an owner’s LTC deductions to the amount they have at risk should be confined to just situations when there are partnerships of LTCs.
  • Some technical changes should be made to the formula to clarify its application for those still covered by the rule.
  • Deductions that have had to be carried forward can be used as an immediate deduction against the shareholders’ other income in the 2017–18 income year.
  • The anti-avoidance valuation rule (in section GB 50) designed to ensure that partners’ transactions are at market value should be extended to include LTC shareholders.
Existing QCs
  • Existing QCs should be allowed to continue but, to address concerns that they could be sold for a windfall gain, they would lose their QC status upon change of control of the company.
Remission income
  • There should not be remission income for a shareholder when an amount owed to them by the LTC is subsequently remitted because the LTC cannot repay the loan.
  • There should be a legislative technical fix to ensure that the remission income rules apply as intended when a debt is remitted by a third party, to clarify the value of a loan that is impaired.
Entry matters
  • The income adjustment done at the time of entering into the LTC regime (the untaxed reserves formula), should be changed to ensure that the income adjustment reflects shareholders’ marginal tax rates rather than the company rate of 28%.
  • A technical change should be made to clarify the values at which a LTC’s assets and liabilities are deemed to be held by LTC owners on the company entering the regime.

Initiatives to simplify and reduce the compliance and administration costs associated with closely held companies that are neither LTCs nor QCs

  • Liberalisation of the restrictions around tainted[4] capital gains to ensure that genuine capital gains made by small businesses do not become taxable on liquidation merely because there is a transaction involving an associated party. Tainting would not apply when the associated person is a non-corporate and we are considering whether there are other cases when it should not apply.
  • The deduction of RWT from fully imputed dividends between companies would be optional rather than obligatory. This would be of benefit to a wide range of companies.
  • Optional removal of resident withholding tax (RWT) obligations from small companies in respect of the dividends and interest they pay to their shareholders would be considered as part of the wider work on streamlining business tax processes.
  • Streamlining RWT obligations when cash and non-cash dividends are paid concurrently so that they can be treated as a single dividend.
  • Shareholder salaries could be subject to a combination of PAYE and provisional tax provided the company maintains the approach consistently from year to year.

Next steps

1.10 Once the consultation period has closed, officials will report to the Government on the feedback and the Government will consider what legislative changes are appropriate. Such changes are intended to be included in the next omnibus taxation bill, with most of the changes applying from the beginning of the 2017–18 income year.

How to make a submission

1.11 You are invited to make a submission on the proposed reforms and points raised in this issues paper. Submissions should be addressed to:

Closely held company taxation issues
C/- Deputy Commissioner, Policy and Strategy
Policy and Strategy Division
Inland Revenue
PO Box 2198
Wellington 6140

Or email [email protected] with “Closely held company taxation issues” in the subject line. Electronic submissions are encouraged.

1.12 The closing date for submissions is 16 October 2015.

1.13 Submissions should include a brief summary of major points and recommendations. They should also indicate whether the authors would be happy to be contacted by officials to discuss the points raised, if required.

1.14 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their release. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.


[1] Based on companies filing tax returns.

[2] Tax preferred income is income received by a company where New Zealand company tax is either lightly imposed, or not imposed at all.

[3] Counted owners are the owners of the LTC. A LTC can have no more than five counted owners.

[4] Capital gains become “tainted” gains when a company sells a capital asset to a person or entity which is a related person. Tainted gains are taxable in the hands of shareholders.