7 Dec, 2021 | The Week in Tax
- Latest Covid-19 developments
- How Christopher Luxon’s property portfolio is representative of the taxation of property debate
- Inland Revenue releases draft statement on charities and donee organisation
Transcript
Last week, New Zealand entered the new COVID-19 protection framework, or the traffic light system. Currently here in Auckland, we are on red and most of the rest of the country is on orange, with a few other exceptions. As part of this, the Government has made a new transition payment available, which is aimed particularly at businesses in the Auckland, Waikato and Northland regions, because these are the ones who have had the longest period under the old alert level system.
This transition period payment will be paid through the Resurgence Support Payment system starting in a week’s time from 10th December. It’s set at a higher base level than the current Resurgence Support Payments, applications for which closed last night, by the way. The payment is $4,000 per business, plus $400 per full time equivalent employee, up to a cap of 50 full time equivalent employees. The maximum that any business can receive is $24,000. Treasury estimates the likely total cost of the payment is going to be somewhere between $350-490 million.
This is a new support being made available. The Leave Support Scheme and Short-Term Absence Payment are also available. The Government will be considering further targeted support once the new Covid-19 protection framework beds in.
One other thing to note is that the rules have been changed so that recently acquired businesses can access the Resurgence Support Payment. This is because under the previous rules, the applicant had to have been operating as a business for at least one month before August 17th. So, businesses acquired after July 17th were not eligible for any payment. Although few businesses were affected by the previous criteria, it made a difficult time even worse.
The test will be that the business that was sold must have been in operation for at least a month prior to August 17th and the new business is carrying on the same or similar activity as before the change in ownership. This is a welcome little break. However, there will still be pressure on businesses. As is well known, hospitality and tourism have had a very, very hard time of it over the last 16 weeks of lockdown
Mega landlords
Moving on, there’s been quite the debate this week over the taxation of property as a number of factors came together. Stuff has been running stories on what it calls mega landlords. One story noted that the proposed changes to the interest limitation rules have led investors to start reconsidering their investment portfolio. And also there’s been changes in the Bright-line test, which is now runs for 10 years.
A survey from the Chartered Accountants Australia and New Zealand (CAANZ) and in conjunction with Tax Management New Zealand, found that the proposed tax policies had already affected many property investors’ behaviour. 70% of the 360 odd respondents reported that their clients had changed or were planning to change their investment behaviour. What exactly that might be obviously depends on individual circumstances. According to CAANZ’s New Zealand tax leader John Cuthbertson, it’s likely to be not purchasing additional properties. However, as he also pointed out there’s still some confusion and uncertainty around the complexity of the rules.
Multi property owners
And then Christopher Luxon, the new leader of the National Party, came under some fire when it was revealed that he had seven properties as part of his investment portfolio. However, as business journalist Bernard Hickey pointed out this is actually an entirely rational investment approach under current rules.
This is the crux of the matter. Property has been very tax-preferred, particularly in relation to the non-taxation of gains, and the deductibility of interest even though there are two parts to the economic return, i.e. the taxed rental income and the (usually untaxed) capital growth. Apparently, the value of Luxon’s properties increased by approximately $4 million over the last 12 months. He can reasonably expect that none of this gain will be taxed.
These themes form the background behind the new legislation to limit interest deductions. It so happened that last Monday Parliament’s Finance and Expenditure Select Committee heard oral submissions on the new tax bill, the Taxation (Annual Rates for 2021-2022, GST and Remedial Matters) Bill to give it its full title.
The FEC received 83 written submissions, which are available on its website, including a monster 216 page submission from CAANZ. The size of that submission, which was one of the largest I’ve ever seen, gives you some idea of the complexity involved in this whole matter.
Listening to the oral submissions, the constant refrain was that the proposed rules are far more complicated than people realise, and we don’t know what the unintended consequences might be. The Corporate Taxpayers Group (their submission was a more manageable 21 pages) suggested that really the introduction of the interest limitation rules should be deferred until 1st April so that people can get their head around what’s going on. I think this is a fair point and one other submitters made.
CAANZ and the Corporate Taxpayers Group were concerned about how rushed this whole process has been and how that fits in with the Generic Tax Policy Process (GTTP). I and one or two other submitters suggested that there really needs to be a thorough review of the bright-line test and this legislation in line with the GTPP, because that’s what’s supposed to happen and hasn’t been happening recently. The bright-line test, for example, was introduced six years ago so it’s time for a review as to how it’s working. Since its introduction the bright-line period has gone from two years to ten years period. How is that working? is a fair question to ask.
Talking about the distortions
In the course of the hearing Green MP Chloe Swarbrick rather mischievously raised the issue of an inheritance tax with one submitter. That promptly earned her a bit of a telling off from the chair of the FEC. In my oral submission, I took the opportunity to put forward the Fair Economic Return proposal Susan St John and myself have developed. Whether that gets any traction remains to be seen.
To perhaps unfairly reference Christopher Luxon again, the concern we have is that his $4 million of capital appreciation in the past 12 months is most likely not to be taxed. And whether that’s actually an appropriate tax setting is something we don’t believe is correct. And I think the evidence is growing about how distortionary it is and that something needs to change.
This whole debate, which went on this week and will continue, reinforces the point that Craig Elliffe made in last week’s podcast that the debate over the taxing of property or capital isn’t going away because the current position is unsustainable. A point that rarely gets made is that Aotearoa-New Zealand is really unique in not either having a capital gains tax, or a wealth tax or estate and gift duties or taxing imputed rental. All of those exist in one form in most of the major jurisdictions of the OECD and G20, but there is none of them that don’t have any of those except for ourselves. So that’s why I think this debate will continue.
Doing charity, or accumulating wealth?
Moving on, I remember listening to the late Sir Michael Cullen talking about his experience on the Tax Working Group. I asked him about whether anything had been a surprise to him, and he replied he had been surprised by the extent of what was happening in the charitable sector,
This is something that pops up from time to time with criticism and accusations of charities abusing their charitable status to get an unfair advantage over other businesses. Sanitarium is the one charity (of the Seventh-day Adventist Church) that often pops up when this happens. The Tax Working Group’s view on charitable donations was that it is a long-standing relief. In its view the issue will be around whether, in fact, those charitable organisations are making charitable donations. The concern that arises is when they’re not and they are accumulating wealth without distributing it.
Now it so happens that this week Inland Revenue released a draft operational statement on charities and donee organisations. Now this is a bit of a monster statement, it runs to 105 pages. It outlines the tax treatment and obligations that apply to charities and donee organisations and how the Commissioner of Inland Revenue will apply the relevant legislation.
As I said, the statement is so big it’s been split into two parts, one for charities and one for donee organisations. I’m not proposing to run through this in detail right now, but the statement sets out briefly what exemptions are available and how Inland Revenue is expecting that process to be managed. Inland Revenue is taking submissions until the end of next February. And I would expect that this would generate quite a bit of feedback.
It’s good Inland Revenue has set out formal rules for charities and donee organisations. It is also, in my mind, an indicator that Inland Revenue has some concerns about what’s been happening in this sector, and it is now making very clear what are the rules, what it expects to see, and there will be consequences if the rules aren’t followed.
Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening (and reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
4 Oct, 2021 | The Week in Tax
- Draft interest limitation legislation including 20 year new build exemption
- Interest deductions on taxable disposals
- The view of the Ministry of Housing and Urban Development
Transcript
The draft legislation for the interest limitation rules was finally released on Tuesday through a Supplementary Order Paper to the Taxation (Annual Rates for 2021-22, GST and Remedial Matters) Bill. This Supplementary Order Paper (SOP) introduces amended sections CB 6A and CB 16A, which cover the changes to the bright-line test rules, and also to cover the interest limitation rules is a new subpart DH with sections DH 1 to DH 12. There are also new sections FC 9B to FC 9E which relate to the ability to roll over for the bright-line test purposes. In addition, there was a release of the regulatory impact statement and some very useful information sheets, six in all covering the basics of the changes.
There has been no change to the basic position, which was outlined in March, that interest limit deductibility would be limited for residential investment properties. As of today, between now and 31st March 2023, 25% of interest relating to residential property investment is non-deductible. And then that proportion of non-deductible interest will rise steadily over the next following years until it’s fully non-deductible with effect from 1 April 2025.
To quickly recap, the main home is not affected by these proposals. It’s been confirmed that the limitation would not apply to interest related to any income earning use of the owner occupier’s main home, such as flatting. Commercial property which is not related to the provision of accommodation isn’t affected either. Farmland, certain Māori land, emergency, transitional, social and council housing are all exempt. So too is commercial accommodation but not short-stay accommodation which could provide a residential dwelling (Airbnb would be the target here). Care facilities, retirement villages and rest homes are exempt, as are employee accommodation, student accommodation and land outside New Zealand.
Now, the big exception to this is an exemption for a “new build.” This is going to last for 20 years from the date on which a Code of Compliance Certificate is issued. These provisions are in the proposed section DH 4. An interesting thing about this new build exemption is that it applies for the 20-year period, regardless of the number of owners. So, it’s not just the first owner, the builder perhaps, who has the exemption, but all subsequent owners up to a 20-year period. So that’s probably as simple as they could make it which is generous.
It’s interesting when you look at the accompanying regulatory impact statement to see that the Ministry of Housing and Urban Development was opposed to limiting interest deductions for residential property because it thought it was concerned about the negative impact this could have on new housing supply. The Ministry of Housing and Urban Development said it preferred a long new build exemption, at least 20 years, which it saw as crucial to ensure that the new supply of houses was not reduced.
I would actually recommend a good read of the regulatory impact statement, it’s got a lot of fascinating insights. So, the Ministry of Housing and Urban Development got its wishes, but I do know from consultation that there was a general hope that there will be a longer period granted for this new build exemption.
A new build doesn’t actually have to be a completely new material. It can include modular or relocated homes, which is excellent. And it also covers converting an existing dwelling into multiple new dwellings. And critically, because this was a sticking point when the announcements were first made, it also covers converting commercial building into residential dwellings.
When does the new build exemption apply? Well, it applies either from when you acquire your new build, if it already has a Code of Compliance Certificate or you acquired off the plans or when your new build receives a Code of Compliance Certificate. I imagine there will be submissions wanting to extend that period on that, but at least it’s a line in the sand. I do think it’s probably on balance, allowing it to cover run for 20 years, regardless of the number of owners it might run through is also sensible.
The rules clarify that there’s a land business exemption if you hold the land as part of a developing, subdividing or land dealing business or if you’re in the business of erecting buildings. Also, interest relating to remediation work and other expenses relating to the ownership and development of land also qualifies for the land business exemption.
There’s a development exemption which will apply for interest on land you develop, sub-divide or build on to create a new build. And again, that exemption will apply from when you start developing the land and it ends when you sell the land or receive a Code of Compliance Certificate for your new build, at which point it flips over to the new build exemption.
Now, what happens if you sell the property and you’ve had interest deductions denied, but the gain is taxable for whatever reason, either under the bight-line test or another reason? In most cases, you’ll be allowed to treat the non-deductible interest as a cost for the purposes of calculating the gain. However, the deduction will be limited to the gain on sale. In other words, if the total interest costs not previously deducted, exceed a taxable gain that may that arises on the sale, only the interest to the point of the total amount of the gain will be allowed.
The new subpart DH deals with the issue of existing loans and rules around borrowing. If you borrowed funds on or after 27th March 2021, the interest is no longer allowed from 1st October 2021. Except if you used the funds to purchase a property acquired before 27 March or for a new build. In relation to refinancing, amounts up to the level of the original loan will not affect the deductibility of interest. And if that original loan was subject to being phased out over time, then the same treatment applies.
There are also provisions covering the question of deductions for interest on variable loans, such as a revolving credit or overdraft facility. If the amount outstanding is higher than the amount outstanding on 27 March, only the interest on the amount outstanding at 27th March will be deductible under the phased approach. The interest on the rest will be deemed to be non-deductible. There’s going to be a special transition rule to help work out what happens if you took out a loan prior to 27, the March 2021.
What if you can’t work out exactly how much the loan was used for residential property and how much was used for other business purposes? The example they give here is buying a truck for a transport business. What will happen is that loan will be treated as being used to acquire other business property first, based on the market value of that business property, and then the balance will be applied to residential property. That’s actually quite a generous treatment.
So, as I said, the regulatory impact statement makes for some interesting reading, you can see the arguments between Treasury, which supported this initiative, don’t allow deductions and don’t think there should be a newbuild exemption. On the other hand the Ministry of Housing and Urban Development and Inland Revenue took the completely opposite approach to Treasury arguing we really we don’t think these rules should be adopted.
According to Inland Revenue, the option which has been adopted, Option Three, is expected to raise $1.12 billion over the forecast period from 1st October 2021 through to 31 March 2025. It will be interesting to see how those extra funds are deployed. You’d hope that they would be used to build more social housing and help ease the crisis, but we shall see.
As you can imagine, it wasn’t just the Ministry of Housing and Urban Development and Inland Revenue who were a bit sceptical of the proposals. A total of 484 submissions were received from various bodies. The majority came from private landlords, but also included tax advisors, property investors, representative groups, real estate agents, iwi groups, property developers and engineers. This has stirred up quite a significant amount of debate and will continue to do so. We’ve got a long way ahead of us as we work through all these provisions. And no doubt, as we drill down into the detail, more points of contention will emerge.
The process going forward is that the Finance and Expenditure Committee should call for submissions very shortly and it’s expected there will be about six weeks to respond. Now, according to the Parliamentary timetable, the actual report on the tax bill of which this legislation is now part is due to be released next March. So, as I said, there’s some way to go before we might see the final form of the legislation. But at the moment it’s applicable and these rules are in force. We’ll obviously keep you updated on developments along the way.
Well, in the meantime, that’s it for today. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
6 Jul, 2021 | The Week in Tax
- How the interest limitation rules will apply to taxable sales of property
- Interpretation statement on income tax and GST treatment of businesses disrupted by the COVID-19 pandemic
- Global minimum tax rate proposals
Transcript
Chapter 5 of the discussion document on the proposed interest limitation rules deals with the matter of great interest to a lot of people, and that is what happens with interest deductions which have been disallowed for a residential investment property which is subsequently sold, and the sale is taxable. Now, just to recap, the interest deductions for residential investment properties are to be restricted and eventually disallowed in full starting from 1st October this year. There is an exemption to this if the property qualifies for the development or new build exemption, which we discussed last week.
Now, amidst all the noise, it’s worth pointing out, the reason for this proposed treatment is to reduce the tax advantage for property investment and not full deductions for interest have been allowed. But the income from a capital gain has often not been taxed.
So the question that then arises is, should a deduction for interest be allowed for at the time of sale if the sale is taxable – or what we call on revenue account. As in that case, all the income from investing in the property is taxed.
Now, just as an aside on this, the terminology of revenue and capital account causes some confusion. It was interesting last week when I was presenting to the Employers Manufacturers Association and the New Zealand Chinese Building Industry Association that there was obvious confusion in the audience around the terminology of revenue and capital account.
The short answer is that land held on revenue account will be taxed on sale. So, for example, that would be properties purchased with the intention of disposal or acquired for the purposes of business relating to land such as development. It gets a little bit more confusing with the bright-line test because property is taxed under the bright-line test, become held on revenue account only once it is known that they will be sold within the bright-line period. Prior to that point they’re not held on revenue account.
Otherwise, the discussion document in Chapter 5 at paragraph 5.8 goes into some detail about what the types of properties which will be deemed to be held on revenue account and therefore taxable, but for the purpose of the interest limitation rules that the question the discussion document wants to address given that we are denying deductions from 1 October, what do we do when a property is sold, which is taxable, i.e. was held on revenue account?
Four Options are proposed. Option A deductions are denied in full. Option B interest deductions are allowed at the point of sale and under that option it would be possible for excess deductions to be offset against other income.
For example, Annette buys a house for $1 million, three years later, she sells it for $1.2 million. The house was used as a residential rental property for the whole period. Over the three years, she incurred $300,000 of accumulated interest deductions.
Under Option B she would be able to deduct $200,000 dollars against the taxable liability arising from the sale of property in the year of sale. The remaining $100,000 could be offset against other income for the year, resulting in net taxable reduction of $100,000 available to her.
Now, what the discussion document points out, and this is a problem Inland Revenue is going to have to think carefully about, is if Annette sold that property on capital account, say it wasn’t subject to bright-line test, she wouldn’t get a deduction for the interest. And that means that she has an incentive to say that she’s selling on revenue account. So, this deferred interest deduction Option sets up a tension within the new rules, which is inevitably going to lead to quite a lot of discussions between Inland Revenue and taxpayers about transactions. Anyway, that’s Option B; interest is deductible at the point of sale, and any excess can be offset against other income.
Option C allows a deduction for the accumulated interest at the point of sale, but only enough that it does not give rise to a gain or loss. So, in Annette’s case of $300,000 of accumulated interest and a taxable gain of $200,000, only $200,000 of the accumulated interest is allowed as a deduction in the year of sale. The excess $100,000 would be forfeited.
Option D is a variation on this. It says the $200,000 is allowed at the point of sale and the excess $100,000 would be ring fenced and carried forward under the ring-fencing rules for offset against property income.
Now, as mentioned above, there is this ongoing tension that this whole provision will create between sales on revenue account where interest becomes deductible and selling on capital account where interest is non-deductible. The discussion document then does consider whether some interest should be allowed for sales made on capital account.
Under Option E, no deductions would be allowed. And the paper describes this as not allowing any interest deductions as a rough offset for the benefit of the capital gains not being taxed. And it goes on to note “this would have the strongest impact on reducing investor demand for residential property”. So that’s bound to be attractive to the Government given its intentions behind the policy.
Alternatively, Option F is that no deductions are allowed up to the amount of the untaxed gain, but any excess becomes deductible. This is an economic return argument. For example, Ray sells a residential rental property for untaxed gain of $200,000, but had incurred $150,000 dollars of interest, which had been disallowed for the period the property was rented. In that case, no interest deduction would be allowed, and they’ve completely forfeited.
If, on the other hand, the untaxed gain was still $200,000, but $250,000 of interest had been disallowed, Option F would allow a deduction of $50,000 for the excess interest over the gain.
So there’s a bit of detail here. I’m pretty certain people will want to see an interest deduction at the time of sale come in. And obviously the most generous option would be Option B.
The discussion document is asking for feedback on which of these proposals should apply and they’re all set out in Chapter 5. It’s reasonably readable, there’s just a lot of it. But I’d still urge everyone to have a read and make submissions as appropriate. And remember, the deadline for submissions is 12th July.
Pandemic support
Now, moving on, we’re still dealing with a pandemic, and on that point, as of Thursday, 1st July, a Resurgence Support Payment became available for those in the Wellington and greater Wellington area affected by the move to level two. Inland Revenue has opened applications for this Resurgence Support Payment and applications are open for the rest of July.
Now, at the same time, Inland Revenue has released an Interpretation Statement IS 21/4 on the income tax and GST deductions for businesses disrupted by the Covid-19 pandemic.
What this interpretation statement does is consider whether a business can claim an income tax deduction for expenditure or loss incurred when the businesses downscaled or stopped operating because of the pandemic. It also looks at GST implications of those events.
Generally, an income tax deduction will usually be allowed where a business has downscaled or ceased operating temporarily, provided no capital expenditure restriction under the Income Tax Act would apply.
However, a deduction will usually be disallowed where the business has completely ceased, even if it is possible that the business may restart later. And it gives an example of an English language school where they terminate the lease. The view taken by the Interpretation Statement is in those circumstances the business had ceased and from that point onwards, deductions are going to be restricted.
Now in determining whether a business has ceased operating temporarily or permanently it’s a question of fact, and the Interpretation Statement looks to the nature of those activities carried on and the business’s intention in engaging in those activities.
Coming back to this English language school example when it’s operating all its enrolled students are from overseas. Then it must close because the country went to Alert Level 4 and it remained closed until Alert Level 2. What the example provides is that for the period during Level 4 lockdown, because there was an intention to operate once the lockdown was over, all deductions for expenditure incurred during this period would be allowed, such as rent rates, power, water, insurance, etc.
Likewise, GST input tax deductions would be allowable. Now, on GST, what the Interpretation Statement points out is if a GST registered person ceases to carry on a taxable activity they may be required to deregister for GST and then they’d be liable to pay output tax on the value of goods and services used in the business at the time of de-registration.
But generally speaking, if businesses have been affected by the pandemic, but had the intention to try and carry on trading, they should be okay on income tax deductions and GST input claims. But if they reached a point where they basically have stopped, issues around deductibility and availability of input, tax claims and GST registration will need to be addressed.
International tax reform – 15% or 21%?
And finally this week, 130 countries and jurisdictions have signed up for a new Two Pillar plan to reform international tax rules and ensure that multinational enterprises pay a fair share of tax wherever they operate. There’s been a statement signed establishing a new framework for international tax reform. There’s a small group of nine of nine jurisdictions that have not yet signed the statement.
And the remaining elements of this framework and how it’ll be implemented will be finalised in October. One of the key things that they’ve signed up to is Pillar Two, which seeks to put a floor on competition over corporate income tax through an introduction of a global minimum corporate tax rate.
And the proposal is that the minimum tax rate will be at least 15%. The estimate is that that’s going to generate about USD150 billion in additional global tax revenues annually.
And Pillar One, which deals with taxing rights, will mean about another USD100 billion of profit to be reallocated to market jurisdictions.
Now, our government will be watching this with interest, but in the past, we’ve discussed whether in fact this may have a significant impact for the Government’s finances, but still it’s progress. We’re still waiting to see whether this global minimum tax rate will settle at 15%. The US, as I’ve described previously, wants 21%. But it’s a question of wait and see. And as always, we’ll bring you developments as they happen.
Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week ka kite āno!
