Tax shortfalls - loss attributing qualifying companies

Section 141 FD of the Tax Administration Act 1994

Introduction

To the extent an adjustment reduces a net loss of a loss attributing qualifying company (LAQC), shortfall penalties will be charged to the shareholder, not the company. If the shareholder does not claim a deduction for the attributed loss, no penalty is charged. The change provides a better mechanism for reducing the double incidence of penalties if an LAQC and shareholder are both penalised for the same shortfall.

Background

Net losses of an LAQC are attributed to shareholders. Before the enactment of the Taxation (GST, Trans-Tasman Imputation and Miscellaneous Provisions) Act 2003, the law allowed shortfall penalties to be charged to both the LAQC and the shareholders if a loss claimed by an LAQC was adjusted and caused a shortfall for the shareholder as well.

The Act was retrospectively amended in 2003 to add section 141FC, allowing a shareholder in an LAQC to receive an offset to his or her penalty if the LAQC paid its penalty in full. This approach was adopted because it did not cut across Chapman v Commissioner of Inland Revenue (HC M402-SD02). At the time the Amendment Act was passed, the case was under appeal.

The section 141FC offset mechanism was clumsy from both a taxpayer's and Inland Revenue's perspective. Once the Chapman case was resolved (the appeal was withdrawn) a more conceptual approach to this issue became possible.

Key features

New section 141FD applies automatically when an LAQC has a net loss and that loss is subsequently reduced or reversed. The LAQC will not be charged a shortfall penalty in these circumstances. The shareholder will be charged a shortfall penalty if he or she has claimed a deduction for the attributed loss.

If an adjustment results in net income to the LAQC, however, the company will be charged the shortfall penalty.

Section 141FC, which allows a shareholder in an LAQC to apply for an offset of a shortfall penalty if a penalty is charged to both the shareholder and the company, has been repealed.

Application date

The new rules apply to shortfall penalties imposed for return periods beginning on or after 1 April2005.