Look Through Companies – Attractive for Investment Property Ownership?
It is common for clients to come to us and say that their lawyer or mortgage broker has advised them to set up a look through company (LTC) to acquire their investment property. My first question back to the client is usually, “whether they were told why they should use an LTC?”, often followed closely by “do you actually understand what an LTC is and how it works?”
As a result of the responses received, I thought it would be useful to prepare an article on LTC’s to assist in a greater level of understanding for those considering the use of an LTC for acquiring their investment property.
In the first instance it must be said that the following narrative is purely for general information purposes only and therefore the content should not be relied upon for any other purpose. Those contemplating use of an LTC should always seek direct, specific advice from their advisor to ensure that their individual circumstances warrant the use of this type of investment vehicle.
Many of you in the property investment market may already have a working knowledge of the loss attributing qualifying company (“LAQC”) regime. The LTC regime replaced the LAQC regime effective 1st April 2011.
So some key points to understand about an LTC:
Point 1 – an LTC is simply a taxation status assigned to those companies that qualify
At common law, an LTC is an ordinary limited liability company. It is recognized as being a separate legal entity at law and in principle is governed by the Companies Act 1993.
From a taxation perspective however, an LTC is transparent – in other words it is looked through for income tax purposes. Each income year, the income or loss of the LTC is attributed to the shareholders of the company in proportion to their respective ownership interest in the company.
So where shareholder A has a 70% ownership interest in the LTC, shareholder A will be attributed 70% of the profit or loss for the year and shareholder A will be directly assessed for any income tax payable on that profit allocation.
Point 2 – an LTC will not grant additional tax deductions
A common misunderstanding is that “if I use a company to own my investment property, it will provide me with a greater level of deductions than I would achieve with non-company ownership”.
This is not true. The deductibility of any expense in the majority of cases will not be determined by the type of taxpayer who incurred the expense but instead by the expenditure item itself satisfying certain tests set out in the income tax legislation. Consequently you will often get the same deduction whether you owned the investment property yourself or whether it was owned by an LTC.
An LTC may however provide a mechanism to make presently non-deductible expenses, deductible but this is a separate issue.
Point 3 – distributions by an LTC are not subject to further tax
Often there will be timing differences between when the income is considered derived by the LTC for taxation purposes and when any cash is actually paid out to the shareholder in respect of that income.
When a non- LTC company pays out income to its shareholders, it will usually be known as a dividend payment, and the dividend will be assessable income to the shareholder in the income year received.
However under an LTC scenario, because the shareholder is directly taxed on their share of the income each year, any subsequent payment of the cash to the shareholder is not subject to further taxation.
Point 4 – an LTC has no imputation credit account
A company which owns a number of investment properties which is not an LTC, has a potential tax issue whenever a single property is sold.
Often the property is being sold to realize a capital gain. However any attempt to pay that capital gain out to the shareholders of the company pre the liquidation of the company, can expose the otherwise tax free amount to a tax impost upon distribution.
This is because most distributions during the life of a company are deemed to be dividends and most dividends require a dividend withholding tax of up to 33% to be withheld from the dividend at the time of payment. The level of dividend withholding tax can be reduced to the extent that the company has imputation credits to attach to the dividend payment (presently to a maximum of 28%).
However since the capital gain will not have been taxed when derived by the company, the usual scenario will be that the company has little or no imputation credits to attach to the subsequent dividend and consequently the rate of dividend withholding tax is higher.
The look through nature of an LTC overcomes this issue because the capital gain is directly attributed to the shareholders in the income year it is derived (retaining its tax free nature in the shareholders tax return) and as already outlined in point 3, any subsequent cash payment to the shareholder of the capital gain is not subject to any further taxation.
So when is an LTC recommended?
Scenarios under which an LTC would be recommended include, but are not limited to:
- Buying a new home for yourself while looking to retain the existing home as a rental property, as a way to obtain deductibility on mortgage interest that would otherwise be linked to the purchase of the new family home and therefore non-deductible
- Looking to buy a property offshore as a way to maximize the use of any foreign tax credits, due to the shareholder getting direct use of the tax credits
- Buying a property with others who are unrelated to ensure access to losses while limiting joint and several liability issues that may arise under a partnership structure
- Streaming of income/losses to shareholders as appropriate to maximize tax positions (any anti-avoidance issues taken into consideration naturally)
- Ease of access to capital gains if expected to arise during the life of the company (trader issues having been taken into account)
Disadvantages of the LTC
While an LTC can provide many benefits as a potential investment vehicle, there are unfortunately also a number of disadvantages:
- The number of shareholders can be no more than 5 and shareholders must be either individuals, trusts or other LTC’s
- There is a loss limitation rule which restricts the use of any loss attributed, to the shareholders true economic exposure with respect to their investment in the company
- Income is subject to tax at the shareholders marginal tax rate so the ability to use the 28% corporate rate is lost
- Tax payable on any company profit becomes a personal tax debt for the shareholder under an LTC structure as opposed to a non-LTC company where the shareholder would usually be sheltered from the company’s income tax debts
This article has hopefully provided greater insight for you with respect to the use of LTC’s. The information however is very general and should you like any aspect explained in more depth, or should you wish to seek advice as to whether you should be considering the use of an LTC for your next acquisition, please feel free to contact the writer.