Look-through companies and property investments – What you should know
In New Zealand, commonly used legal structures for holding investment properties include personal name, trusts, and look-through companies. Each have their own benefits and drawbacks, and their usage will vary depending on the user’s circumstances. This article provides background information on the Look-through Company, and the benefits and drawbacks associated with using this legal structure for property investment in New Zealand.
Look-through Company (LTC)
The LTC is a tax entity that came into effect in 2011, replacing the previously popular Loss-attributing Qualifying Company. A company can become a LTC if it has met all of the requirements outlined here, and files an election with the Inland Revenue Department. The timing of due dates for the elections will vary depending on the status of your company, but typically, a new company can become a LTC from its incorporation date if it has elected to do so by the due date for its first tax return. A company will continue to be a LTC until it no longer meets the eligibility criteria, or until the shareholders revoke the election.
Like any company, a LTC benefits from limited liability, but there are additional costs associated with compliance and corporate obligations, i.e. keeping company records, holding annual meetings etc. Where the LTC differs from an ordinary company is in the tax treatment for its shareholders. For income tax purposes, the company’s assets are considered to be held directly by its shareholders, thus any profits or losses made by the company will ‘flow’ through to the shareholders. The distributions are made in accordance to each shareholders’ ownership stake. Once the shareholders receive their share of the profits and losses, they are then taxed at their personal income tax rates.
A comprehensive fact sheet on LTCs can be found here.
- Loss utilisation – A LTC allows all profits and losses generated by investment properties to flow through to the shareholders. From an investment point of view, this is a major advantage as it allows losses from negatively-geared properties to be used to offset against your taxable income.
- Distributions are pro-rated – This can be beneficial for partners who have different tax rates by allowing more losses to flow through to the person in the higher tax bracket. Alternatively, if you and your partner own positively-geared properties, a LTC can be formed in which the person in a lower tax bracket is the majority shareholder. This would allow the bulk of distributed profits to be taxed at a lower tax rate.
- Ease of transaction – It is potentially more economical to transfer properties held in a LTC to a related party compared to a direct ownership scenario. With LTCs, if you want to sell off your portfolio to a related party, all you need to do is transfer your shares, which can be done at minimal cost. In comparison, it is more expensive and time consuming to transfer titles if the properties are held privately or in a trust, as legal fees for conveyancing are usually more expensive than share transfers for privately held shares in a LTC. However, the lower costs only apply to transferring titles to a related party, as sales to third-party buyers will still go through the same settlement process
- Compliance costs – There may be additional costs associated with maintaining company records in order to meet compliance requirements. Accounting costs are also likely to be higher compared to private ownership.
- Number of shareholders – A LTC is limited to no more than five owners. This is a potential drawback for investors who are thinking about forming a consortium with multiple equity partners.
- Foreign tax treatment – There are countries around the world, e.g. Australia and the UK, which do not allow companies to distribute losses to shareholders. Tax residents of these countries will be unable to utilise losses from New Zealand properties if the properties are held in a LTC.
The information provided in this article is not intended to provide a comprehensive statement of relevant laws and should not be used as a substitute for legal advice. Please consult an expert for advice tailored specifically to your own circumstances.