There’s more to overseas rental properties than meets the eye
Tax Alert - May 2020
By Stephen Walker & Nick Cooke
On 13 March 2020, Inland Revenue released two draft Interpretation Statements and a Currency Conversion Approval for public consultation, which have been drafted to address a range of tax issues that tax resident individuals may face if they own overseas rental properties. You’re probably wondering why Inland Revenue have drafted guidance on the taxation of overseas rental properties as they’re no different to New Zealand rental properties, right? Well, not quite. Read on to find out more.
Back to basics
Before we explore the tax issues that arise on owning overseas rental properties, it’s worth recapping when overseas rental properties and any associated income will fall into the New Zealand tax net. New Zealand imposes tax on the basis of the tax residence of a person and the source of the income that they earn. Tax residents are, in the first instance, subject to tax on their worldwide income.
For a New Zealand tax resident, this means any income earned or deemed to accrue in relation to an overseas rental property will be taxable in New Zealand. This is irrespective of whether the country in which the property is physically located will tax the same income.
Overseas rental income
Overseas rental income must be calculated according to New Zealand tax laws. This means a person cannot simply take the overseas net income/loss and report this amount in their New Zealand tax return. Instead, New Zealand’s tax rules regarding calculation of gross income, depreciation and allowable expenditure must be applied. As New Zealand’s tax rules will differ to the laws of the overseas country, the taxable income in New Zealand and the overseas country are unlikely to be the same.
Furthermore, New Zealand’s standard balance date is 31 March which differs to the balance date of other countries. For example, Australia’s balance date is 30 June, while in the US it is 31 December and in the UK it is 5 April. This means that in performing the calculation of taxable income, you may not be considering income and expenditure derived or incurred over the same period. To make things easier, an individual can elect to return overseas rental income in the New Zealand tax year in which the overseas balance date falls. Note however that this election is not available to individuals who have net overseas income of more than NZD 100,000.
Even where such an election is made, individuals must still ensure that income and expenditure is calculated according to New Zealand tax laws.
Conversion of foreign currency into New Zealand dollars
Income earned and expenses incurred in a foreign currency must be converted to New Zealand dollars for the purposes of calculating your New Zealand tax liability. This conversion must be completed using the close-of-trading spot rate on the date the amount is required to be measured or calculated. However, Inland Revenue will allow alternate currency conversation methods such as the 'annual' or 'monthly' method. Under each of these methods, instead of converting foreign currency amounts on a daily basis, amounts are aggregated and converted either at the end of the income year or month using an annual or monthly foreign exchange rate respectively.
Annual and monthly exchange rates are published by Inland Revenue on their website and these must be used wherever possible. However if you need to convert foreign currency for which rates are not published by Inland Revenue, you can use exchange rates from other reputable sources such as the Reserve Bank of New Zealand.
Whichever conversion method or exchange rate source you decide to use, you must ensure that the same rate sources are used for all properties and all future conversions.
Many people will have borrowed money from an overseas bank to fund the purchase of the overseas rental property. But these individuals may be unexpectedly caught out by the Non-Resident Withholding Tax (NRWT) and Financial Arrangement (FA) regimes. Both regimes add further complexity, time and cost to owning an overseas rental property, making ownership of an overseas rental property less attractive than you may think.
Obligation to withhold Non-Resident Withholding Tax (NRWT)
Where a New Zealand tax resident individual pays interest to a non-resident, the individual may be required to withhold NRWT and pay this to Inland Revenue which applies irrespective of whether the individual uses overseas funds to make the payment or not. This requirement doesn’t exist if the overseas bank has a branch in New Zealand, which applies to most, but not all, Australian banks.
The standard rate of withholding is 15% although this may be reduced by a double tax agreement with the overseas country. In light of such obligations, it may be beneficial for the individual to register under the Approved Issuer Levy (AIL) regime, which effectively reduces the rate of withholding to 2% of the amount of interest paid.
Financial Arrangement regime
If a person has borrowed money in a foreign currency from an overseas bank to fund the purchase of the overseas rental property, the Financial Arrangement rules have to be considered.
Under the Financial Arrangement (FA) regime, prescribed spreading methods are used to calculate the accrued interest and unrealised foreign exchange gains or losses arising on the foreign currency loan, which must be returned each year. Any accrual income will be assessable income, while accrual expenditure will be deductible. A Base Price Adjustment (BPA) must then be completed upon disposal of the loan. This is essentially a wash-up calculation bringing into account any further income or expenditure.
Certain individuals will qualify as 'cash basis persons', in which case, they can instead return income and expenditure on a realised only basis. Although, a person must ensure that they satisfy the cash basis criteria every year which can be a complicated and time-consuming exercise.
Sale of the property
The sale of an overseas rental property may be caught by New Zealand’s 'bright line-test' which effectively taxes gains on the sale of residential investment properties which are bought and sold within five years. This rule can apply irrespective of whether tax is payable in the overseas country.
Where any gain is also taxed in the overseas country, a foreign tax credit may be available to reduce double tax. However, obtaining a foreign tax credit to reduce or eliminate double tax can be troublesome. For example, to get a foreign tax credit the foreign tax paid must be substantially the same nature as New Zealand income tax. This may be challenging if the overseas country operates a capital gains tax system.
We’re not able to go into all of the tax issues arising from overseas rental properties, there’s just too many! However, the above illustrates some of the issues and tax regimes that need to be considered. If you have an overseas rental property, we recommend you contact your regular Deloitte advisor for further information or assistance.
May 2020 Tax Alert contents
- COVID-19: Loss carry-back rules – fine in theory, but watch for fishhooks
- COVID-19: Employment tax updates for a remote workforce
- COVID-19: What impact will COVID-19 travel restrictions have on your company’s tax residence?
- COVID-19: Practical relief from consequences of COVID-19 travel restrictions for individuals
- COVID-19: Customs Considerations for Exports and Imports
- Information is Key: The proposed tax-related amendments to the Overseas Investment Act 2005
- There’s more to overseas rental properties than meets the eye
- Employee or independent contractor?
- COVID-19: Common questions in relation to the Wage Subsidy Scheme, the Extended Wage Subsidy Scheme and the Small Business Cashflow Loan Scheme
- Snapshot of recent developments