LTCs “Beware the fish hooks!!”
The Look Through Company (LTC) is the new kid on the block. The regime effectively replaces the old Loss Attributing Qualifying Company (LAQC). In essence an LTC is a company which behaves more like a partnership than a company for tax purposes.
In LTCs both gains and losses are passed onto shareholders in direct proportion to their individual shareholding. Unlike other company structures, assets and liabilities are also considered to be the personal property of shareholders.
In fact shareholders of LTCs are treated as owners for tax purposes and not shareholders. As we will see this can create some serious tax costs for the uninitiated.
The main drive for people to consider an LTC is usually the need to access company tax losses. However, an LTC is a very different animal than the old LAQC. To those in the tax game the LTC regime is generally considered to be complex and difficult to manage.
There are many potential fish hooks which could be discussed. I have chosen three which I believe to be amongst the most risky. Remembering this is a guide and if you want an assessment for your particular situation please give us a call and arrange a time to meet.
Fish hook #1, Owners Basis
Under the LAQC regime it did not matter how much equity you had in the company, if it made a loss then shareholders could access that loss. This is not necessarily the case with LTCs, which limit losses to the extent of an owners "economic risk".
Every year the extent of this economic risk has to be calculated in the form of an "Owners Basis" (OB) calculation. The calculation and maintenance of OB can be a complex exercise in itself and creates higher compliance costs.
In its most basic form the OB calculation considers contributions made to the company by owners against what they have taken out. If the expenses and drawings from the company exceed the amount invested then expense deductions are disallowed and ring fenced until the owner has sufficient investment to utilise them.
An implication of this is that current account balances must be monitored and kept at reasonably healthy levels. Owners need to consider the impacts on their OB if they take drawings. Excessive drawings can easily create a negative balance.
In an LTC income and expenditure are treated independently. With no OB, deductions against LTC income will be disallowed and therefore owners could be left with a tax bill on the resulting income. This fish hook severely reduces the flexibility of owners to take drawings from the company.
Fish hook #2, Maintaining status
A company must meet certain criteria to be considered an LTC. These criteria must be continually met at all times during the year. It is not difficult to breach these criteria and fall out of the regime. The implications of falling out of the regime include exit tax calculations and two year waits on re-entry. In the meantime any unutilised deductions are likely lost in a black hole.
One cause for breaching the LTC rules is exceeding the owner count test (LTCs are limited to five). This is due to the fact that there are complexities around the calculation of owners for this test. In LTCs owners are not necessarily limited to the number of company shareholders. This is especially the case if one of the shareholders is a Trust. Potentially trust shareholders can lead to many more owners (beneficiaries of trust distributions) being brought into the equation.
If not managed and monitored correctly there is a high risk of breaching the owner count test. Shareholders/owners can also choose to revoke a company's LTC status.
It just takes one disgruntled shareholder to request a revocation for it to happen. Even if the other shareholders do not consent to the revocation they cannot stop it. This creates yet another potential tax bill and one outside of the control of other shareholders.
Fish hook#3, Shareholder changes
Shareholdings in companies often change. In practice this is often just a matter of filing a transfer with the Companies Office. However, in an LTC as well as considering the owner count test issue any transfer of shares is treated as a disposal of the owners underlying property. Therefore, often barring limited exemptions, the exiting owner is responsible for calculating and paying any tax arising from that disposal.
Assets need to be disposed of at market value and any taxable gains realised would be considered taxable. Something as simple as a share transfer is likely to result in a tax bill for LTC owners. Unmanaged share transfers could also breach the owner test and push a company out of the regime. Both of these scenarios involve a tax cost.
LTC's at what cost?
LTCs do offer a limited liability company with the benefits of loss allocation. However, at what cost? These three potential fish hooks demonstrate the costs of successfully navigating the complexity of the current regime and may far outweigh any benefits in practice.
Comment below and tell us your thoughts on the plusses and minuses of LTC's.
Adrian Ferris is a qualified Chartered Accountant, managing TvA's Commercial Team.
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If you have any questions related to Look Through Companies send us an email at firstname.lastname@example.org or contact Adrian on 03 578 3386.