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Tax in the first year for look-through company owners

Under the LTC rules a company's reserves may be distributed or drawn down on without the owners being liable for tax on distribution. This treatment isn't intended to apply to previously accumulated company reserves.

Each owner's income for the first year a company is an LTC is equal to their proportion (based on their effective look-through interest) of the company's reserves that would be taxable if the company was liquidated and all assets were distributed to the company's shareholders.

When a calculation is needed

A calculation is done for each owner when:

  • an existing company becomes a look-through company (LTC). This includes companies that re-enter the LTC rules.
  • a non-LTC company amalgamates with an LTC.

There's a different calculation depending on which year is the LTC's first income year.

Each owner is considered to have received income based on the result of this calculation. The owner will need to declare the amount of the income (and imputation credits where available)  in their own income tax return.

When a calculation isn't needed

This does not apply to new companies who become an LTC from their date of trading. This is usually the company's incorporation date but could be later if the company was previously non-active and had never traded.

This also did not apply to a company that was a qualifying company/loss attributing qualifying company (QC/LAQC) and transitioned into an LTC in one of the first two transitional years beginning on or after 1 April 2011.

Find out more about transitions from a QC/LAQC to an LTC

Calculating each owner's share of the companies reserves

If the LTC’s first income year is the 2016-17 and earlier income years

Each owner must account for their share of the companies' untaxed reserves by using the following formula:

dividends + balances - assessable income - balances
tax rate
- exit exemption

Where the items in this formula have the following definitions:

dividends are the total amounts that would be dividends if, immediately before it became or amalgamated with an LTC, the company:

  • disposed of all of its property (other than cash) to an unrelated person at market value for cash, and
  • met all of its liabilities at market value, excluding income tax payable through disposing of the property or meeting the liabilities, and
  • was liquidated, with the amount of remaining cash distributed to shareholders without imputation credits attached.

balances is the sum of:

  • the balance in the company's imputation credit account, and
  • an amount of income tax payable for an earlier income year but not paid before the company became a LTC less refunds due for the earlier income year but paid after the company became a LTC.

assessable income is the total income that would be derived if the company:

  • disposed of all its property other than cash to an unrelated person at market value, and
  • met all of its liabilities at market value, excluding income tax payable through disposing of the property or meeting liabilities.

less the amount of deduction the company would have for taking these actions.

Tax rate is the company tax rate in the income year immediately before the company became a LTC. This will be shown as a decimal (eg 0.28).

Exit exemption only applies to companies that were once LTCs and have become LTCs again. The exit exemption would apply to any retained reserves from the previous LTC period that had not since been distributed. See "Exit exemption calculation" below.

The amount calculated under this formula is recorded as "Other income" in the owner's income tax return.

Example

X Co is an ordinary company with two individual shareholders. Steve has a 40% shareholding and Cheryl has a 60% shareholding.

X Co converts to an LTC. As a result it must perform a calculation to determine the amount of income for its owners upon becoming an LTC.

X Co calculates its dividends to be $300,000. The balance in X Co’s imputation credit account is $75,000. X Co has never been an LTC before.

(300,000+75,000) - 0 - 75,000
0.28
- 0 = $107,142.86

The amount of income Steve would declare in his income tax return is $42,857.14 ($107,142.86 x 40%).

The amount of income Cheryl would declare in her income tax return is $64,285.71 (107,142.86 x 60%).

Each owner would declare their proportion of the company’s untaxed reserves in their own income tax return in the year the company becomes an LTC.

If the LTC’s first income year is the 2017-18 or a later income year

The amount calculated is treated as a dividend with imputation credits attached where available and is calculated using the following formula:

untaxed reserves + reserves imputation credit

Where the items in the formula have the following definitions:

reserves imputation credit is the total amount of credits in the company's imputation credit account, up to the maximum permitted ratio for the untaxed reserves. This amount includes income tax payable for earlier income years which has not yet been paid, and should be reduced by the amount of any income tax refundable from an earlier income year which has not yet been refunded. The amount is treated as an attached imputation credit included in the dividend calculated.

untaxed reserves is calculated using the following formula:

dividends - assessable income - exit exemption

Where the items in the formula have the following definitions:

dividends are the total amounts that would be dividends if, immediately before it became or amalgamated with an LTC, the company:

  • disposed of all of its property (other than cash) to an unrelated person at market value for cash
  • met all of its liabilities at market value, including income tax liabilities for the disposal year but excluding income tax liabilities that would arise solely from meeting all of its liabilities at market value or from disposing of all of its property, and
  • was liquidated, with the amount of remaining cash distributed to shareholders without imputation credits attached.

assessable income is the total income that would be derived if the company:

  • disposed of all its property other than cash to an unrelated person at market value, and
  • met all of its liabilities at market value, excluding income tax payable through disposing of the property or meeting the liabilities

less the amount of deduction the company would have for taking these actions.

Exit exemption only applies to companies that were once LTCs and have become LTCs again. The exit exemption would apply to any retained reserves from the previous LTC period that had not since been distributed. See "Exit exemption calculation" below.

The amount calculated under this formula is then multiplied by the owner's effective look-through interest in the LTC. This is the amount of the dividend to be recorded in the owner's income tax return.

Example

Y Co is an ordinary company with three individual shareholders. Steve and Cheryl each have a 40% shareholding and Thomas has a 20% shareholding.

Y Co converts to an LTC and must perform a calculation to determine the dividend income for its owners. It calculates its untaxed reserves as $300,000 using the formula above. The balance in Y Co’s imputation credit account is $90,000 and the company has an amount of income tax payable for the previous year of $10,000 which has not yet been paid.

300,000 + 100,000 (90,000 +10,000) = $400,000

Both Cheryl and Steve would declare an amount of $160,000 ($400,000 x 40%) as a dividend with $40,000 ($100,000 x 40%) of imputation credits attached in their own income tax returns in the year Y Co became an LTC.

Thomas would declare an amount of $80,000 ($400,000 x 20%) as a dividend with $20,000 ($100,000 x 20%) of imputation credits attached in his income tax return in the year Y Co became an LTC.

Note

A separate formula exists for a QC becoming an LTC that would have insufficient imputation credits to fully impute the dividend. See “Separate formula for some transitioning QCs” below.

Separate formula for some transitioning QCs

If a QC has insufficient imputation credits to fully impute the dividend calculated using the above formula, then they use this formula:

(balances
tax rate
- balances) + balances imputation credit

where the items in the formula have the following definitions:

balances is the sum of the company's imputation credit account and amount of income tax payable for an earlier income year but not paid before the relevant date, less refunds due for the earlier income year but paid after the relevant date.

tax rate is the company tax rate in the income year immediately before the company became a LTC. This will be shown as a decimal (eg 0.28).

balances imputation credit is the same as the amount of the item balances, and is treated as an attached imputation credit included in the dividend calculated. The resulting amount is multiplied by the owner's effective look-through interest and is included in the owner's own income tax return.

Exit exemption calculation

Use the following formula to calculate the exit exemption:

exit dividends
- dividends after look-through

Exit dividends are the amount that would be taxable dividends of the company on distribution following a winding up immediately after the company ceased to be an LTC.

Dividends after look-through are the total dividends paid by the company after it ceased to be a look-through company.

Read more about dividends paid from LTC-retained profits after it becomes an ordinary company

See also