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Personal Tax Change Impact

You need to consider now how you will structure for the 39% personal tax rate change, writes Mark Withers.

By: Mark Withers

31 January 2021

For many investors, the dramatic drop in interest rates has meant that their portfolios have made the transition from loss-making to profit-making. Coupled with the fact that from April 1 individuals who earn over $180,000 will be paying 39% income tax on personal incomes, it’s time for many to revisit the way their portfolios are structured.

Adding to the complexity is the new Trustees Act which is causing trustees to consider if a trust is the way to go forward. The Government has not signalled any change to the trust tax rate of 33%, so those with trusts the lower tax rate, rather than the high marginal rate for individuals, must be examined in light of rental income that might be taxed personally.

Many investors will have look-through companies (LTC) and some will have qualifying companies (QC) holding their property assets. These structures are both likely to have shareholdings held personally as they hark back to a time when much property structuring was focused on taking advantage of tax losses. Some investors will have standard companies for their business activities that may also be owned personally.

In a situation where a company’s shares are held personally, dividends from them will attract tax at the personal tax rate, either immediately, as they are with LTCs or at the point where retained profits are distributed as dividends in the case of QCs and standard companies.

In this article we take a look at some of the issues that have to be navigated when shareholdings in companies are moved from individuals to trusts.

LTCs and QCs

The start point for any transfer is to actually determine the value of the shares in the company. For property companies this will mean determining the value of individual properties and contemplating liabilities a company has to its lenders and also to its shareholders with regards to shareholder loan accounts. Having placed a fair value on the company, shares decisions will need to be made about whether the shares will be gifted to the trust outright or whether the trust will be indebted to the individuals for the shares sold.

These decisions can impact entitlements to the likes of rest home subsidies and will determine in whose hands the wealth actually lies. There are also numerous tax issues to navigate when contemplating the sale of shares in a company to a trust.

Standard Companies

For standard companies, retained profits may have accumulated and the company may have generated imputation credits associated with the tax that has already been paid at the company tax rate of 28% on these historic profits. There are shareholder continuity rules that must be observed that require a 66% continuity of shareholding if these imputation credits are to be carried forward. A loss of credits will mean tax has to be paid again on the ultimate distribution of retained earnings so they will generally need to be attached to dividends before the shares are transferred to a trust.

Because the company tax rate is 28% a further withholding tax payment of 5% will be required to top the tax up to the 33% shareholder rate.

For standard companies with losses, there is also a 49% shareholder continuity rule to observe if losses are to be carried forward past the shareholding change. For LTCs, where tax on profits will have already been paid at the personal level the issues are different. Changes in shareholding of LTCs can restart and trigger bright-line subject to whether changes are made pursuant to relationship property agreements, so this is a huge issue to consider.

A change of shareholding with LTCs is considered deemed disposal of underlying properties so depreciation recovery will also have to be weighed up. QCs also have their challenges.

Changes in shareholding require QC status to be re-elected for and there is a 50% continuity of shareholding rule if QC status is to be retained. Dividends from QCs must also be flowed through trusts to individual beneficiaries if QC status is to be retained.

This means the trust structure may be ineffective at protecting the income being derived. For property companies, QC status is what allows dividends from capital gains to be distributed tax free.

So, while many investors have seen their portfolios change from loss to profit, prompting a desire to alter structuring arrangements, it has never been more fraught with danger. It’s critical to fully examine the issues associated with a change of shareholding before actually doing so. It’s important to get advice from legal and tax experts before you proceed.

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