ARE TAX BENEFITS A GOOD REASON TO CHANGE COMPANY SHAREHOLDINGS?

Are tax benefits a good reason to change company shareholdings? Should you change the shareholding in a company to get better tax results?

Changing a company shareholding purely to reduce tax — even with a sympathetic backstory — risks being challenged as tax avoidance under IRD’s general anti-avoidance rule. The test isn’t whether the change is legal on paper; it’s whether you’d have made this exact change if there were no tax benefit at all. A shift driven by real changes in who’s doing the work, contributing capital, or carrying risk holds up, because it would have happened regardless of tax. A shift where nothing has really changed except the tax result does not. Bottom line: get the economic reasons straight (and documented) before changing shareholdings — and even then, watch for tax traps in the mechanics of the change itself (see the companion article on considerations).

SCENARIO

You and your significant other each own 50% of the shares in an LTC. It owns negatively-geared rental property. At tax time, you get your 50% share of the loss, which (back in the day) gave you a nice tax refund. Previously you both earned about the same, but now there is a child in the mix, and one of you is working less as a result, and earning less as a result.  Suddenly that 50/50 company shareholding doesn’t look so good. Should you change it to 99/1 to get better tax refunds?

CONSIDERATIONS

The short answer is no. If you do anything with the motive to purely pay less tax, then you leave yourself open to being accused of tax avoidance.

Inland Revenue looks at the dominant purpose behind a change like this. If reducing tax is the main driver, the change can be challenged — even if there’s a plausible-sounding story attached to it. What to do then? Well, there may well be economic reasons for the change, which had not previously been considered. When you take these into account, any so-called tax benefits could well become purely incidental.

WHY TAX AVOIDANCE RULES BITE HERE

New Zealand’s general anti-avoidance rule (section BG 1 of the Income Tax Act) lets Inland Revenue void the tax effect of an arrangement if its purpose or effect is tax avoidance — even if every individual step is technically legal. The key test is whether the arrangement uses the tax rules in a way Parliament didn’t intend, judged against what a reasonable, sensible business or family arrangement would look like without the tax result attached.

For a shareholding change, this means asking: would you have made this exact change, at this exact time, in this exact proportion, if there were no tax benefit at all? If the honest answer is no — if the 50/50 to 99/1 split only makes sense once you factor in the bigger refund — then the tax benefit isn’t incidental, it’s the point, and that’s precisely what IRD is looking for. A change driven by a real shift in who’s doing the work, who’s carrying the risk, or who’s contributing the capital survives this test because it would have happened anyway, tax or no tax.

WHAT COUNTS AS A GENUINE ECONOMIC REASON?

Every situation is different, but here are examples of the kind of non-tax factors that can genuinely justify a shareholding change:

• Change in involvement — one partner is now doing significantly more (or less) of the day-to-day work of managing the rental property.
• Change in financial contribution — one partner is putting in more capital, or taking on more of the debt or risk associated with the LTC.
• Succession or estate planning — restructuring shareholdings as part of a broader plan to pass on assets to the next generation.
• Risk protection — separating ownership interests for asset protection reasons, independent of any tax outcome.

Going back to the scenario above: if the partner earning less has also stepped back from managing the rental property, and the other partner has taken on more of the financial risk and day-to-day responsibility, that’s a genuine economic story. The resulting tax refund is a side effect, not the reason for the change. If, on the other hand, nothing about each partner’s involvement or contribution has actually changed, and the only thing that’s different is the tax result, that’s a much harder position to defend.

KEY TAKEAWAYS

• Changing shareholdings purely to reduce tax risks an IRD tax avoidance challenge.
• Genuine economic or personal circumstances — not tax — should drive the decision. Any tax benefit should be a side effect, not the goal.
• Document your reasons for the change at the time. This matters if IRD ever asks.
• Even with good reasons, the mechanics of the change (Brightline, shareholder current accounts, depreciation) can still create tax bills — see Changing Shares in LTCs: Considerations for details.

As each situation is different, it’s not practical to cover every scenario here, so please feel free to contact us to discuss your circumstances.

From 1 April 2019, tax losses will no longer flow through from LTCs that are residential land rich. Please contact us for advice on how to get the best results from your portfolio, build wealth and minimise tax.