Property problems: Property investment tax changes still some way off

Q: My family is considering investing in rental property using an "LAQC", which we understand will be tax effective. However, we have heard the Government may be looking at scrapping LAQCs. Does this mean that using an LAQC is no longer an option? If so, are any other tax effective options available?

A: So far the Government has not put forward any firm proposals to reform (or repeal) the qualifying company (QC) and loss attributing qualifying company (LAQC) tax regimes. Instead, in the context of reform proposals relating to partnerships, officials have indicated the QC/LAQC regimes will be reviewed, querying what, if any, place those regimes will have once the proposed reforms are introduced.

LAQCs in particular have received attention because of their use in investment structures found to be, or perceived as constituting, tax avoidance arrangements.

However, a review of the QC and LAQC regimes should not significantly shape your decision regarding an appropriate investment structure because any reform would not come into effect for some time.

The result of consultations could be the retention of the QC/LAQC regimes especially for closely held family or similar ventures or, at worst, transitional provisions mitigating adverse reform impacts.

Therefore, choosing an investment structure that meets your commercial objectives and is tax effective will depend on the particular circumstances of your family and planned investment(s). However, generally, these options (and combinations) are available:

1. Individual investment - investors are taxed on income from the investment plus other income (less deductions) at their personal tax rate. Losses in excess of income in relation to the investment (eg interest, depreciation and other expenses for rental property) can be used to shelter other income.

2. Investment as a joint venture or partnership - under these arrangements, income and deductions "flow through" to investors, so taxation is essentially the same as in option 1.

3. Investment through a "qualifying trust" (not a unit trust) - income distributed to beneficiaries (during, or within a certain time after, an income year) is taxed at each beneficiary's tax rate, while other trust income is taxed at 33 per cent at trustee level. But losses can be used only at trustee level.

4. Investment through a company (including a unit trust) - the company is taxed at 33 per cent on its income, while dividends received by shareholders are taxed at each shareholder's tax rate, subject to a credit for company tax paid to the extent that "imputation credits" are attached to dividends. Taxable dividends generally include distributions of both company revenue and capital gains but a QC or LAQC can distribute capital gains tax free to shareholders.

Company losses can only be used at company level but an LAQC's losses flow through to shareholders.

The partnership reform proposals include codification of tax rules for partnerships (option 2 above) plus new rules for proposed "limited partnerships" (LPs), which primarily have provoked attention on LAQCs.

An LP will consist of at least one general partner in a management role and with unlimited liability, and any number of limited partners, being investors with no management role and liability limited to their investment. For tax purposes, "flow through" treatment will apply.

So far, this is similar to an LAQC (although the general partner/limited partners structure may not readily apply to closely held ventures undertaken using LAQCs).

However, unlike the LAQC regime, the proposed LP rules restrict the extent to which LP losses can be claimed by a limited partner, with the intent of reflecting the partner's loss with reference to their partnership "basis".

The fact that an LAQC (or structures such as partnerships of LAQCs) allows unlimited flow- through of losses, and might undermine the proposed reforms if used instead of an LP, will probably be a focus of any LAQC review.

Although LAQCs are often used for rental property investments, you should not assume this is the only option. It may be simpler and still tax effective to invest individually or as a joint venture/partnership, or a qualifying trust may be appropriate.