Chapter 6 - Entities subject to the suggested new rules

6.1 For simplicity, previous sections of this paper have described assets in individual ownership. However, if the new rules were to apply to one kind of entity and not another, some asset owners might be incentivised to move their assets into entities where the new rules do not apply.

6.2 Assets held in entities purely for tax reasons rather than commercial reasons create additional costs in setting up and running those entities, reduce the revenue collected, and create unfair differences between those who use tax-advantaged entities and those who do not.

6.3 Entities used to hold mixed-use assets are likely to be those which are simple and straightforward to set up and operate, and are able to be easily controlled by one individual, or a small group of connected individuals – typically members of the same family.

6.4 The following entities and structures are considered in this chapter:

  • partnerships
  • trusts
  • companies.

6.5 The proposals set out in this chapter rely heavily on the “associated persons” rules to define when an asset is being used for private purposes (as does the core rule when the asset is owned by an individual).

6.6 The associated persons rules provide an efficient and ready-made tool to identify relationships, typically between the owner of an asset and the person who uses the asset, which are very likely to mean that the use of the asset is for private, rather than income-earning reasons. Further information and examples of the associated persons test can be found in Inland Revenue’s Tax Information Bulletin at

Partnerships (including limited partnerships)

6.7 A partnership is simply more than one individual or other entity carrying on a business together with a view to a profit (with different roles allocated to some of the partners in a limited partnership). Partnerships are easy to set up and are controlled by the general partners, so are the kind of structure which might be used to hold a mixed-use asset.

Current tax law

6.8 A partnership is not a taxable entity. As a general rule, partners record their share of the partnership’s income and expenditure in their own tax returns. The requirement for the expenditure to relate to income earning or a business (nexus test) and the private limitation will apply to each partner separately.

6.9 When an asset is used by Partner A, the private use limitation is not considered to apply to deny a deduction for Partner B, but the nexus test will not be satisfied so Partner B will not be entitled to a deduction for expenditure relating to that private use anyway. Overall, however, the same fundamental issue arises here as it does for individuals – uncertainty over the ability to claim deductions for assets which remain unused for some portion of the year.

Suggested approach

6.10 It is suggested that the new rules apply to assets owned by partnerships. Private use will exist when the asset is used by any partner. Consistent with the treatment of property owned by individuals, the associated persons test in section YB 4 of the Income Tax Act 2007 should apply to extend the concept of private use where the asset is used by someone associated with a partner.

6.11 If a threshold test is to be used to determine which assets are subject to the proposals, the threshold should be applied to the aggregate of all partners’ interests, to avoid creating a situation where the rules can be avoided by holding an asset in a partnership of family members.


6.12 A trust is a legal relationship where a trustee has ownership of assets, but is subject to legal obligations in favour of others. In a formally constituted trust, these obligations are set out in a trust deed, which typically either names individual beneficiaries (for example, John and Jane Jones) or describes them by class (for example, the children and grandchildren of Arthur Jones).

Current tax law

6.13 Under the current rules, the trustee can claim a deduction for amounts incurred in deriving taxable income.

6.14 In the context of a holiday home, deductions are available for expenditure incurred in renting the holiday home to third parties. If the holiday home is made available to beneficiaries, the nexus test applies to deny any deductions unless those beneficiaries were to pay for the use of the holiday home (and the trustee treated those amounts as income of the trust).

Suggested approach

6.15 One approach would be to apply the rules to all kinds of trusts. Whether the rules would in fact impact on a trust would then depend on whether the trust had assets which satisfied the asset test (described in Chapter 5).

6.16 Alternatively, the scope of the rules could be limited to entities which are the usual type of “family trusts”, as this is a common ownership structure for holiday homes in particular, and the kind of structure which existing holiday homes can readily be moved into.

6.17 Where the trustees of a trust are a “tax charity” as defined in the Income Tax Act 2007, they will generally not be entitled to claim deductions under the existing law, so the proposals in this paper will not affect them. However, to avoid any confusion it may be worthwhile to expressly state that any new rules do not apply to this kind of trust.

6.18 Other trusts could also be excluded, such as:

  • trusts for the benefit of a local authority;
  • funeral trusts;
  • trust that are widely held, such as some registered superannuation funds; and
  • trusts where the settlor and the members of the settlor’s family are not entitled to benefit.

6.19 For the remaining trusts, private use should exist if the asset is used by any beneficiary, or settlor (defined in section HC 27), or any person associated with a beneficiary or settlor under section YB 4 of the Income Tax Act 2007.


6.20 A number of issues need to be considered in the context of companies.

6.21 Unlike the other entities, existing rules already apply to companies to deal with the issue of company assets used by shareholders or shareholder employees. This kind of use is the equivalent of the “private use” concept discussed elsewhere in this paper. Detailed rules govern whether this use by shareholders and others should be treated as an in-kind dividend, a fringe benefit or as income of the recipient of the benefit.

Which kinds of companies should the mixed-use asset proposals apply to?

6.22 Not all companies meet the characteristic of a suitable entity to hold a mixed-use asset namely, being easy to set up and control by a single individual or a small group of connected individuals. This criterion will only be satisfied by smaller companies with a small number of shareholders, most of whom are connected. There are three existing types of companies in the Income Tax Act 2007 that are likely to have the characteristics described above. These are:

  • look-through companies;
  • close companies; and
  • qualifying companies.

6.23 Detailed tests define each of these types of companies, but each can be very broadly summarised as requiring ownership or control by no more than five individuals. The detailed tests typically treat people with close family relationships as a single shareholder, so the number of nominal owners may exceed five.

6.24 Officials consider that, to the extent the new proposals are to apply to companies, they should only apply to companies which fall within one of the three definitions outlined above. These are existing, robustly designed and well-understood concepts which are designed to identify companies which, broadly, are controlled by a small number of individuals. Officials consider that using these existing concepts is preferable to creating a new definition of a company that should be subject to the proposed mixed-use asset rules.

6.25 This means that, for companies which fall outside these definitions, the suggested mixed-use asset rules will not apply and existing rules for deductions will continue to apply when assets belonging to the company are used by shareholders or their associates.

Look-through companies

6.26 Because look-through companies have entirely different tax characteristics from other companies, the analysis can be simplified by dealing with them separately.

6.27 The look-through company (LTC) rules started applying from 1 April 2011. Broadly, an LTC is a company with five or fewer ultimate natural-person owners who all elect that the company should be subject to the LTC rules. A company which has LTC status is tax-transparent from the point of view of the company’s and the shareholders’ income tax position, so the company’s income, expenses, gains and losses are passed on to its shareholders and the company itself is not a taxable entity.

6.28 This means that the tax consequences of transactions involving an LTC are significantly different from that of other companies. For example:

  • The company does not pay tax itself, but each shareholder pays a share of the tax which arises on the profits.
  • The dividend rules do not apply.
  • Section DA 1 of the Income Tax Act 2007, which allows a deduction only when expenditure is incurred in earning income or in carrying on a business will not allow a deduction for expenditure incurred in providing a benefit to shareholders – such as the use of a mixed-use asset. This is the same approach which is taken to partnerships, and is not reliant on the private limitation.

Suggested approach

6.29 Shareholders of an LTC face the same question as partners in a partnership face in relation to mixed-use assets, which is the extent to which expenditure relating to non-use periods is deductible.

6.30 The approach suggested for partnerships earlier is to treat private use as any use of the asset by a partner or an associated person of a partner. In the context of an LTC, the equivalent is to treat private use as use by a shareholder or any person associated with a shareholder. Officials recommend that this approach be taken to LTCs, and note that because of the completely different tax rules that apply to LTCs compared with other companies, this suggestion is independent from the approach to companies discussed below.

Exclusion for motor vehicles held by companies from the mixed-use asset rules

6.31 The main type of asset owned by companies which is used for both income-earning and private purposes is motor vehicles. In the company context, the use by a shareholder of a motor vehicle will be subject to either the FBT or the dividend rules. Officials consider this outcome appropriate and do not propose to apply the new rules to motor vehicles owned by companies.

6.32 Exclusion of motor vehicles from the mixed-use asset rules for companies is consistent from an outcome perspective to their exclusion for other entities (where the motor vehicle logbook rules are suggested to remain in place).

Reconciliation of mixed-use asset rules with existing rules for taxing shareholder use of company assets

6.33 In the sections above, it has been suggested that if the proposed mixed-use asset rules are to apply to companies, they only apply to the defined smaller companies, not larger companies, and that they not apply to motor vehicles. Specific suggested rules will apply for LTCs.

6.34 The remaining complexity is how the proposed mixed-use asset rules should be reconciled with the existing rules which tax the use of company assets by shareholders and their associates.

Dividend rules

6.35 If a company asset is used by a shareholder, the market value of that use is treated as a dividend. The amount of the dividend is reduced by any amount paid by the person receiving it. The purpose of these rules is to ensure that shareholders of companies cannot step around the rules which apply to cash dividends by taking value out of the company in a non-cash form. They recognise that any transfer of value from the company to its shareholders should attract the same tax consequences, regardless of the form that transfer of value takes.

6.36 The dividend rules require the shareholder to treat the value received as income, and the gross value of the use of the asset will be taxed at the shareholder’s marginal tax rate. The company is obliged to pay withholding tax. The company is denied a deduction for the expenditure incurred in providing the dividend.

FBT rules

6.37 If the asset is used by a person who is a shareholder/employee, the company can elect to treat the use of the asset as a fringe benefit. Rather than treating the fringe benefit received by the employee as income, a fringe benefit tax (FBT) liability is imposed on the company. The rate of FBT payable by the company is designed to result in the similar amount of tax being paid as if the company had paid the employee a cash amount of an equivalent value.

Income rules

6.38 Under current law, accommodation provided in relation to employment or an “office” such as a directorship is treated as income to the recipient, and is not a fringe benefit.

Analysis of existing rules

6.39 While each of these sets of rules acts to create a tax charge for the use of assets by a shareholder or associate, they will give rise to a different tax consequence from the suggested mixed-use asset rules. This is for two reasons:

  • Expenditure incurred in providing a benefit which is subject to income tax or FBT is generally considered to be deductible. If expenditure is incurred in providing a dividend, a deduction will not ordinarily be available for that expenditure (although it may be available if an amount is paid for use of the asset). Provided the asset is used in the business or to produce income, as well as being used by shareholders, a company is likely to treat expenditure relating to the period the asset is not used as deductible. This contrasts with the suggested mixed-use asset rules where the income-focused or genuine mixed-use outcome will limit deductions for periods of non-use.
  • Each of the three rules levies a tax liability on the recipient of the benefit, or in the case of FBT, levies a tax liability on the company which is equivalent to the amount of income tax the shareholder would pay on an equivalent amount of cash. This contrasts with the approach under the suggested mixed-use asset rules, as the person who uses the asset is not taxed on the value of the benefit received but is denied a deduction for expenditure relating to the private use.
Options for dealing with mixed-use assets in companies

6.40 There are potentially three ways to fit the suggested mixed-use asset rules in with the existing rules which apply to companies.

Not applying the suggested mixed-use asset rules to assets held by companies at all

6.41 The rationale for adopting this approach would be that the existing mechanisms already deal with the use of company assets by shareholders and associates, so there is no problem here which needs to be addressed. This approach is the simplest, and the most conservative from the point of view of leaving existing legislative mechanisms as they stand.

6.42 However, the tax consequences under the existing rules will be different from the tax consequences under the mixed-use asset suggestions. This might encourage some asset owners to move their assets into different entities, defeating the fairness objectives of the reforms proposed in this issues paper.

Require companies to calculate deductions in accordance with the mixed-use asset rules, but leave the existing dividend, FBT and income rules in place

6.43 Adopting this approach would require companies to apply the proposed new deduction rules to mixed-use assets. These will be situations when the dividend, FBT and income tax rules apply.

6.44 This approach applies the same limitation of deduction rules to companies as those which apply to other entities. Consequently, there is no incentive, from the point of view of maximising deductions, to shift assets from other ownership structures into companies, and at this level the outcome is “fair”.

6.45 However, the key difference is that the standard company rules (dividend, FBT and income tax rules) create a tax liability for the shareholder who receives the benefit of the use of the asset. (In the context of FBT, the liability arises in the company but is a proxy for the income tax liability the recipient of the benefit would otherwise bear.) This seems like a less attractive outcome to asset owners than that available under one of the other entities, where the deduction rules are the same but the benefit of the use of the asset is not taxed.

6.46 However, limiting the deduction and taxing the benefit is consistent with the scheme of shareholder and company taxation generally. If a company pays a cash dividend to a shareholder, it cannot claim a deduction for the cash paid, and the shareholder is liable for tax on the dividend received, although this conceptual double taxation may be relieved by imputation. Applying the mixed-use asset rules to determine deductibility where the benefit is treated as a dividend is entirely consistent with the treatment of other dividends.

6.47 Where the company has imputation credits which it can allocate to the shareholder, the additional tax charge borne by the shareholder will be limited to the difference between the company rate of 28% and (typically) the top individual rate of 33%. However, if the company does not have sufficient imputation credits, or the 5 percent difference is considered material, this approach gives rise to a greater overall tax liability than other types of entities, where the same deduction limitations will apply but no tax liability will arise for the person using the asset. In these instances this difference will encourage people who control companies which hold mixed-use assets in companies to move those assets out of companies and into other forms of ownership.

Require companies to calculate deductions in accordance with the mixed-use asset rules, and exempt the receipt of any such benefit by a shareholder or associate from the dividend, FBT and income rules

6.48 If this approach were to be adopted, a modified version of the mixed use asset rules would apply to companies, potentially limiting the deductions available. However, the use of the asset would no longer be income, a dividend, or a fringe benefit to the shareholder or associate – those rules would be “turned off” in instances where the mixed-use asset rules apply.

6.49 No additional tax liability would arise to the shareholder for receipt of the benefit, just as no tax liability arises (now, or under the proposals in this paper) where a person who owns a mixed-use asset directly uses it for their own benefit. The only tax impact would be the potential limitation of deductions.

6.50 However, “switching off” the key elements in the rules which deal with the distribution of value from companies delivers an outcome which is inconsistent with the taxation of companies generally. While concerns are unlikely to arise with the main category of mixed-use assets of holiday homes, clear boundary rules would be needed to ensure that companies could not use these rules to, for example, avoid paying FBT on assets such as yacht.

Analysis and suggested approach

6.51 The first approach, of leaving companies out of the rules altogether, would mean that companies will generally be entitled to greater levels of deduction than other entities. This means the fairness objectives of these rules are not achieved.

6.52 The third approach, of applying the new deduction rules to companies and “switching off” the dividend, FBT and income rules appears to align with other entities under the mixed-use asset rules, but creates an outcome which is at odds with the general treatment of distributions or other transfers of value out of companies. It is an attempt to provide non-company treatment to a company structure. A better approach for those who wish to hold assets in a company, but to be taxed as if they held them personally, is to use the look-through company structure. The look-through company rules are an existing policy framework designed to deliver exactly that hybrid between the corporate rules of a company and the tax treatment of individual (or partnership) ownership.

6.53 Officials prefer the second approach, of leaving the dividend, FBT and income rules in place but applying the new suggested mixed use asset rules to calculate deductions While this would initially appear to give rise to “double taxation” of the benefit on the use of the fixed asset, it is akin to when a cash dividend is paid. As noted above, if the company has imputation credits available, it can distribute those to the shareholder, and if distributed at the 28% tax rate, will mean that the additional tax liability borne by the shareholder is small and the incentive to move assets out of a company structure and into another entity is also small.

6.54 Earlier in this chapter it is noted that the dividend, fringe benefit and income rules can apply to different benefits. Different tax treatments may be preferred by different companies and shareholders, depending on matters like the availability of imputation credits in the company and the value to the company of the increased deductions which are available if an FBT or income tax treatment is applied.

6.55 Officials at this stage do not suggest any change to the rules which currently apply to determine which of these tax treatments is required to be used. Submissions are invited on this issue.

Companies – other matters

6.56 Current tax laws allow companies to deduct interest which they incur essentially regardless of the purpose of the borrowing. This provision may need to be overridden by mixed-use asset rules which act to limit deductions.

6.57 A deduction is allowed for the interest cost incurred by those who borrow to purchase shares in a company. If the mixed-use asset rules were to apply to limit deductions within a company for the interest incurred in borrowing to purchase a mixed-use asset, an alternative structure might be for the shareholder to borrow the required funds, and use those funds to purchase the shares in the company. The company would have enough money to purchase the asset without any interest deduction. The shareholder would be entitled to a deduction for the interest incurred in borrowing money to purchase the shares in the company.

6.58 To ensure the mixed-use asset rules were not avoided in this way, a look-through rule would need to be implemented to limit an interest deduction claimed by someone who purchases equity or debt in a company which held a mixed-use asset, or when any company in a group of companies owned a mixed-use asset. This could be in a similar form to the existing rule which limits interest deductions for shareholders of qualifying companies who receive non-cash dividends.

Submission points

  • Do you agree that, in order to ensure equitable outcomes, the proposed mixed-use asset rules need to apply to entities other than individuals?
  • Are there any issues with the general use of the associated person’s rules to determine when private use occurs? Are there any instances where this might be too wide a net?
  • Do you agree with the recommended approach to mixed-use assets held by companies, which is to apply the rules which limit deductions but leave the dividend, FBT and income rules in place?
  • Are there any circumstances when one of the dividend, FBT or income rules are not available for a benefit from use of a mixed-use asset, but should be?
  • Do you think that there will be some movement of mixed-use assets out of companies and into other entities if these proposals are implemented?