The Inland Revenue Department (IRD) is continuing their investigation into the sale of private homes to Loss Attributing Qualifying Companies (LAQC) involving a mail out of over 45,000 letters to LAQC directors.
The issue at hand was first brought up by the IRD in a media release in the July of 2004, when the IRD voiced the concerns and objections to the possible practice of the selling of private residential property to a LAQC and renting it back, in order to claim a tax loss. While the IRD acknowledged that the mere selling and renting of a house from an LAQC does not constitute tax avoidance, and also that every suspected case of tax avoidance needs to be treated individually, they did release a general guideline of markers that they use to determine suspicion.
An individual who owns a home would set up a LAQC, with them as either the sole shareholder or the controlling shareholder. The property would then be sold to the LAQC and subsequently rented back to the individual at a fair market rate. The LAQC would claim expenses such as interest on mortgage, maintenance of the property and any other house associated costs. The expenses would exceed the rent income and the subsequent losses would be attributed to the shareholders, who offset the loss against other incomes that they might have.
The IRD re-iterated their stance on the matter of selling property to an LAQC in this arrangement, in a “Revenue Alert” released in October 2007. The release highlighted that the above arrangement can be construed as tax avoidance under section BG1 of the Income Tax Act 2004, primarily as many of the expenses one would deduct under an LAQC would be un-deductable in the case of a private owner. Further, they highlighted the fact that the expenses that are deducted would need to be commercially realistic, otherwise they act as a further marker of suspicion.
Following an initial letter trial that proposed a voluntary disclosure, the IRD tested the letter sending effectiveness and response rate of over 2000 LAQC directors, a further 45,000 letter campaign is began at the start of October 2008.
Due to the results of the initial trial, a number of clarifications and refinements have been made by the IRD in their approach to shortfall penalties. Currently, a shortfall penalty can reach a maximum of 150%, in the most serious of cases. Although, according to the IRD, it is expected that most cases will likely be charged with either UTP (Unacceptable Tax Position) or a NTRC (Not Taking Reasonable Care) penalty, both of which are charged at 20%. As every cases will be looked at and judged individually it is impossible to give a strict criteria upon which the shortfall penalties will be laid.
All disclosures made by an individual in regards to an LAQC will be treated as having been made pre-audit, as such they will qualify for a 100% reduction in shortfall penalties. While this does not mean that no shortfall penalties will be charged, it just means that in the case that they are raised, they will automatically be reversed by the IRD.