Related Party Capital Gains - Can they be tax free? #CGT

The Inland Revenue department has brought in new legislation related to capital gains and their taxation in New Zealand. The new rules became effective from 30 march 2017, they significantly reduce the reach of related party capital gains and now the legislation provides several workarounds In terms of getting these gains out to the shareholder tax free.

The concept of a capital gain is incredibly important, it is defined for tax purposes as

·        a gain relating to the disposal of property

·        Capital gain where no part of gain is assessable income of the company

·        Capital gain distributed from another company on liquidation

·        Revaluations under herd scheme under EC16

Prior to the legislation changes in March 2017, related party gains were previously excluded from the definition of capital gains, and therefore were taxable when distributed to shareholders upon the company wind up. Furthermore, the related party definition was very large, and could capture capital gains arising from the sale to associated persons/parties.

Post March 2017, the capital gain/loss now only applies if:

·        The disposal is between two companies that have 85% common voting interests or market value circumstances at the TIME OF DISPOSAL, AND

·        On liquidation of the company with the capital gain, the owner of the property that gain arose from has common voting interests or market value circumstance of 85% or more.

What does this mean? The new rule significantly reduces the reach of related party capital gains, resulting in the ability to work around this rule with potential restructures. There are essentially two outs, one when the asset is sold and the other at the time of the wind up of the company.

 The new rule can cover gains prior to the legislation start date, meaning that if a company has existing gains (prior to March 2017) then these can be distributed tax free, provided that the amount being distributed is after 30 March 2017. This can resolve previous issues if we have a situation where a company has not wound up its operations, even if there is a tainted capital gain sitting in that company, there is the opportunity to re-structure before liquidation and distribution.

In practice, this means that there are several situations where capital gains are tax free on liquidation & distribution.

1)     A capital gain arising from the sale of the business to an entity other than a company (i.e. a trust), there is no related party capital gain and therefore gain may be distributed tax free on wind up.

2)     Company sells its business to another company (while the companies are associated, they do not have common voting interests of greater than 85%), gain can be distributed tax free on wind up.

In summary, related party capital gains will apply if the transaction is company to company (if the sale of the business is to a non-company, then it doesn’t apply) and those companies have a 85% common voting interest at the time of sale, AND they have 85% common voting interests with the owner of the property at time of wind up.

The new rules are much more reasonable and easy to apply, and provides opportunity for tax payers to manage their tax liabilities resulting from the sale of assets or a business, provided they have planned accordingly.