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Inland Revenue

Tax Policy

Chapter 6 - Qualifying companies

What should be done about those companies that remain as QCs?

6.1 An aim of the review is to make the LTC rules more workable so that more small businesses can use them. If this objective is achieved, will the LTC rules be sufficient to cover all targeted small companies, including QCs? As discussed earlier, it is not desirable to have multiple regimes covering essentially similar types of businesses but with slightly different boundaries. This is particularly the case when those regimes are optional and it is relatively easy to switch from one to the other to minimise tax liabilities.

6.2 Furthermore, allowing existing QCs to continue will provide them with a permanent advantage,[31] leading to their being traded for tax purposes and potential involvement in undesirable tax behaviour.

6.3 While we might anticipate that the numbers of QCs will decline over time, the feedback from some stakeholders has been that the LTC regime is too limited to cover all closely held companies. For example, the requirement that there must be only one class of shares would preclude some QCs from becoming a LTC. As noted earlier, we intend to recommend allowing more than one class of shares, provided the only variation relates to voting rights.

6.4 Another concern is that some QCs may be deterred from transitioning into the LTC regime because under the LTC rules existing shareholders face tax consequences, such as depreciation claw-back and the taxation of any gains made on revenue account property upon exit from the LTC regime. To reduce compliance costs, the tax on the disposal of the underlying property is ignored when the tax adjustment is below certain thresholds. In contrast, under the QC rules the exiting shareholder is treated as selling their shareholding which in most cases would not have a tax consequence. Our conclusion is that although the tax consequence on disposal does create compliance costs, even with (or in some cases because of) the thresholds, it is difficult to find a robust alternative. Hence, recognising disposals seems to be a necessary feature of the LTC rules, as it is for ordinary partnerships.

Proposed approach

6.5 On balance, our conclusion is that the existing QCs should be retained, but a QC should lose its QC status upon the sale of the company. The loss of QC status upon sale would discourage trading in QCs where that trading is driven by their tax advantage.

6.6 The sale of the company would be measured by a change in control (that is, a change in shareholding of over 50 percent in aggregate). We envisage that this would involve applying a shareholder continuity type test to measure if control had been retained by the same group of owners, using as the continuity period the period commencing from the date of enactment of the legislation up to the date of sale of an interest in the LTC.


[31] A QC can provide a better outcome from the perspective of a shareholder on a 33% personal tax rate as it allows capital gains to flow though to that shareholder while taxable income is taxed at the lower company tax rate until it is distributed.