About Qualifying Companies

One Entity for Tax Purposes
The tax provisions governing qualifying companies aim to treat a company and its shareholders as one entity as much as possible for income tax purposes.
This is similar to the way in which partnerships are treated.

The Income Tax Act 1994 applies to income derived in the 2004–05 and prior tax years. The Income Tax Act 2004 applies to income derived in the 2005–06 and subsequent tax years.

What Are Qualifying Companies?
The qualifying company regime is contained in the Act, part HG. The purpose of the rules was to treat small closely held companies in a similar way as that afforded partnerships. This is done by deeming the shareholders and the qualifying company to be one entity for tax purposes.

However, it does not do away with the benefits of corporate ownership, such as limited liability.

There are 2 classes of qualifying companies:

  1. One is composed of a loss attributing qualifying company (LAQC) in which company net losses are attributed to the shareholders on the basis of their interest in the LAQC. An LAQC must meet the requirements of an ordinary qualifying company, in addition to other requirements.

  2. The second class consists of the other qualifying companies which must carry their net losses forward.

A qualifying company pays two types of dividends - fully imputed dividends which are taxable and exempt dividends.

A qualifying company will pay taxable dividends to the extent of the amount of imputation credit available that it can attach. After that, the dividends that the company pays will be exempt from income tax.

This gives shareholders tax-free access to capital gains which are derived by closely held companies without the need of having the company liquidated. This is regarded as a great advantage for having a qualifying company status.

Main Rules of the Qualifying Company Regime
The main rules are:

  • Directors and shareholders can elect that the company become a qualifying company

  • A qualifying company pays income tax on its profits in the same way as other companies, subject to certain rules.

  • A qualifying company is required to satisfy its tax liabilities in the same way as other companies

  • The company may be liable to pay qualifying company election tax (QCET) upon electing to join the system, because some untaxed reserves can then be distributed tax-free by the qualifying company.

  • A company may be liable to pay qualifying company election tax once it becomes a qualifying company.

  • Shareholders must elect to become personally liable for his/her share of any income tax not met by the company

  • A qualifying company can distribute capital gains tax free without the need to liquidate the company

  • Capital gains can be distributed tax-free without winding up the company.

  • Only those dividends with imputation credits are taxable to the shareholders

  • Any losses arising before the company became a qualified company are forfeited once it enters into the regime

  • Qualifying company election tax is payable because some dividends previously taxable can now be paid tax-free

  • A qualifying company can elect to become a loss attributing qualifying company (LAQC), provided certain conditions are met.

  • An LAQC must pass to its shareholders any tax losses it incurs while it is an LAQC

  • While a company is an LAQC it must attribute its tax losses to the shareholders, who then claim a deduction for the losses. Once the company attributes the losses it is not able to carry them forward, or use those losses itself.