Inland Revenue underlines LAQC concerns

By Andrea Milner

It previously voiced concern in a July 2004 media release that some investment advisors were telling their clients that they can claim a tax deduction by selling their residential property to a LAQC, renting the property back from that company and claiming a tax loss.

The IRD warned in that release that such arrangements would often be considered tax avoidance, meaning the taxpayer would have to pay the tax avoided, a penalty of 100% of the tax avoided and use of money interest.

In some circumstances, shortfall penalties of up to 150% may also apply.

Now in the first in a new series of publications the IRD has launched called ‘Revenue Alerts’, it has reissued its warning against this practice in order to claim tax deductions for what are really private expenses.

Property tax specialist Mark Withers says his firm has been involved on several occasions to “dismantle” these arrangements when they have been present in affairs of new clients joining the firm.

He says this activity should not, however, be confused with a “genuine exercise of transfer of a previous family home to a company at market value when the owners wish to rent it to arms length third parties and secure a new home for themselves”.

To determine whether a particular LAQC has resulted in tax avoidance the IRD reviews the arrangement to establish the purpose or effect of setting it up and whether it is consistent with the relevant tax laws, the alert says.

It will also look at how the LAQC reduces or defers a tax liability, whether it is commercially realistic, and whether it is deducting expenses that would normally be considered private or domestic expenses.

The alerts are intended as an early warning service for tax professionals designed to highlight any significant or emerging areas of concern to the IRD. For any alert it issues, the IRD says it is likely that some investigatory work has already been carried out.

“We have already investigated a number of LAQCs and will continue to do so,” says assurance group general manager Martin Scott.

Property accountant Kenina Court says this issue really came to the fore last year when a firm of accountants in the South Island was advising clients to transfer their home into an LAQC and rent it back in order to get a tax deduction on mortgage interest and other expenses, then write it off against their personal income and get a tax refund. 

“The IRD came down on the taxpayers as they could not provide a commercial reason as to why they would transfer their home into an LAQC and make it into a business asset instead of a private asset.”