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Accounting for look-through company income/deductions

Income, expenses, tax credits, gains and losses from the look-through company's (LTC) activities are passed through to the owner of an LTC, in proportion to the owner's effective look-through interest. Each owner is responsible for declaring the income and deductions on their own income tax return.

The owner will be liable for any tax payable on their net LTC income which is included in their taxable income. They'll also be allowed a deduction for any loss incurred by the LTC against any other income sources they may have, subject to the loss limitation rule if applicable.

Loss limitation rule

The loss limitation rule ensures that the losses an owner can claim reflect their economic loss in the LTC.

The LTC's deductions are allocated to its owners in the same way as income is allocated. The amount of deductions an owner can use is limited to the contribution the owner has made to the company, or is liable for. This is known as the owner's basis. You can find more information on owner's basis calculations in the Partnership and look-through company (LTC) return (IR7G) guide and the Look-through companies (IR879) guide.

For the 2017-18 and later income years, the loss limitation rule applies only to LTCs in joint venture or partnership. Losses previously restricted under this rule are available for use against income in the 2017-18 and later income years.

Filing returns

LTCs file a Partnerships and look-through companies (LTCs) income tax return (IR7) each year which shows the total income and deductions for the company for that year. A Look-through company (LTC) income/loss distribution (IR7L) is attached to the IR7. It is a summary of the income and deductions for each owner.

Find out more about filing an LTC tax return

Changes in shareholding

A change of shareholding does not automatically mean a company ceases being an LTC.

The only time a change in shareholding will make a company cease to be a LTC is if the change means that the company is no longer eligible to be an LTC.

If ownership changes during an income tax year owners can determine their effective look-through interest using either the weighted average basis method or the accounts method.

Weighted average basis

This method works out an average of an owner's look-through interest based on the number of days in the income year that they owned shares in the LTC or their market value interest in those shares.

Example

Max had 100% shareholding in an LTC with a March balance date. On 30 June he sold 30% of his shares to Wilma, leaving him with 70% shareholding in the company.

The company had $50,000 income and $70,000 allowable expenses.

Max had 100% shares for 91 days (1 April to 30 June, not a leap-year) and 70% shares for 274 days (1 July to 31 March). Assuming that his owner's basis calculation allows the full expenses, he would work out his share of the LTC income/expenses as follows:

Income 91/365 days x 1 x $50,000
$12,466
  274/365 days x 0.7 x $50,000
$26,274
Total      
$38,740
Expenses 91/365 days x 1 x $70,000
$17,452
  274/365 days x 0.7 x $70,000
$36,784
Total      
$54,236
Total income/(loss)      
($15,496)

Wilma had 30% shares for 274 days. Her calculation would be as follows:

Income 274/365 days x 0.3 x $50,000 $11,260
Expenses 274/365 days x 0.3 x $70,000 $15,764
Total income/(loss)       ($4,504)

The total income for all shareholders adds up to $50,000 and the total expenses add up to $70,000. This is a good way to make sure that each calculation is correct.

Accounts method

This method calculates owner's interest based on actual income received and expenses incurred at the time the owner had shares in the company. This requires accurate accrual accounts to be prepared for each period of ownership in the year.

We may require the LTC to use the accounts method if its taxable income in a 12-month period is $3 million or more, and if we consider that the accounts method would result in a more equitable and reasonable measure of effective look-through interest.

Example

Using the example of Max and Wilma above, the company had drawn up a set of accounts for the period before and after Wilma acquired shares in the company.

  1 April to 30 June 1 July to 31 March Annual
Income
$30,000
$20,000
$50,000
Expenses
$20,000
$50,000
$70,000

Max would work out his share of the income and expenses as follows:

  1 April to 30 June 1 July to 31 March Total
Income
$30,000 (100%)
$14,000 (70% of $20,000)
$44,000
Expenses
$20,000 (100%)
$35,000 (70% of $50,000)
$55,000
Total income/(loss)     ($11,000)

Wilma would work out her share of income and expenses as follows:

  1 July to 31 March Total
Income $6,000 (30% of $20,000)
$6,000
Expenses $15,000 (30% of $50,000)
$15,000
Total income/(loss)  
($9,000)
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