Property tax consultation launched

By Robyn Walker, Annalie Hampton, Susan Wynne, Hiran Patel & Jess Wheeler
 

Following on from the surprise announcements on 23 March 2021 that there would be a material change to the taxation of residential properties, in June the Government has released further detail about those proposals. This came in the form of a 143 page Government Discussion Document; which was supplemented by a range of fact sheets, which break down the proposals into more digestible chunks:

• Changes to interest deductibility
• Who is affected by the interest deductibility changes?
• What type of properties are affected by changes to interest deductibility?
• The treatment of new builds under the bright-line test and changes to interest deductibility
• The development exemption
• Should interest deductions be allowed when property is sold?
• Changes to the bright-line test
  

The overarching purpose of the changes are to help achieve the Government’s goals around housing affordability:

“The Government’s goal is to encourage more sustainable house prices, by dampening investor demand for existing housing stock to improve affordability for first-home buyers. … The proposal to exempt property development and new builds should help boost supply by channelling investment towards increasing housing stock and away from direct competition with first home buyers and owner-occupiers for existing housing stock.”

What the documents released highlight is that there can be a high level of complexity when it comes to implementing something which may sound conceptually simple. In some cases the outcomes for taxpayers will be clear, but in others it’s not so clear cut. The Discussion Document seeks to identify some of the tricker scenarios and explain how the proposals could apply.

Some key parts of the document include:

• What property should be subject to the rules? Exclusions are provided for a range of scenarios where property is not negatively impacting on the ability of an owner-occupier to acquire a house, for example, land outside New Zealand, employee accommodation, farmland, care facilities, rest homes and retirement villages.
• Who should be subject to the rules? It’s proposed that all taxpayer types (e.g. individuals, companies, trusts, partnerships) will be in the rules, but when it comes to companies only “close companies” and “residential investment property rich” companies will be subject to the rules. The exclusion for non-close companies means that many listed companies which might own a few properties as an incidental part of their business don’t need to trace and allocate interest to a (comparatively) small asset. Ensuring “residential investment property rich” companies are still subject to the rules is to prevent an incentive for landlords to pool their properties in a single widely held vehicle in order to get deductions. A company will be residential investment property rich if 50% of assets (by value) are residential property.
• If a taxpayer has a mixture of property types, how do they figure out what debt funding relates to residential property versus non-residential property?
  It will be necessary for taxpayers to trace their funding arrangements to each purpose and allocate interest appropriately.
• What happens if a property owner refinances debt, is this considered new borrowing? It should be possible to refinance borrowings for pre-27 March 2021 property, however this should be done with a degree of caution to avoid inadvertently resulting in debt becoming non-deductible. In principle, provided the refinanced debt is equal to or less than the previous debt level it should remain deductible (subject to the phase out rule); to the extent debt exceeds the debt level at 26 March 2021 interest will be non-deductible from 1 October 2021.
• If property developers can continue to claim interest deductions, who is a property developer? The Discussion Document works through this, however in many instances, the output for a property developer will be a “new build”, which interest is deductible against.
• So what is a new build? The Discussion Document is fairly generous in allowing more than what you might first anticipate. Renovating an existing property to turn it into more dwellings may count, as will an existing home which has been relocated to a new section, and consideration is being given to also including substantial renovations which take an existing uninhabitable building back up to standard to be lived in. All these scenarios arguably add to New Zealand’s housing stock.
• Given the extension of the bright-line test to ten years, it is also proposed to reform the rules to allow taxpayers to restructure their affairs without triggering the bright-line, provided there is no significant change to the overall economic ownership.
  

In mid-June we held a webinar to talk through these changes. As you might expect, given the breadth of properties and taxpayers impacted by these changes there were a lot of questions asked. Here we summarise some of the main questions and answers; noting of course, the answers provided are based on proposals only and are subject to change. Anyone wanting to know how the rules apply to their own situation should seek professional advice.

What the rules apply to

• Are boarding houses in or out of the rules? They could be used for long term accommodation but have shared services, kitchen, laundry etc, they are quite similar to student accommodation.
  A boarding house is likely to be treated similarly to a hotel or hostel and should be excluded from the rules - but it could be worth submitting to clarify this and to support these properties being exempted; particularly where they are used for short-term accommodation.
• If an owner-occupier rents out rooms (e.g. to flatmates or borders) does that count as residential rental or other rental income?
  Flatmate situations should be exempt from the rules. The rationale for this is that the Government doesn't want to discourage people from taking on flatmates (and therefore adding to housing supply issues) - this is covered at para 2.52 of the discussion document
• Do the interest limitation rules apply to farm houses which are rented out?
  Farmland is excluded from the rules and interest should be able to be claimed.
• Is farmland defined? If a large farmland property gets rezoned residential is it Farmland or Residential land for deduction purposes?
  The rules are not intended to apply to farmland, and this is a defined term. Generally anything which is ‘farmland’ is excluded from being residential land for tax purposes.
  
  Farmland means land that—
  (a) is being worked in the farming or agricultural business of the land’s owner:
  (b) because of its area and nature, is capable of being worked as a farming or agricultural business
  
• Is a home office exempt from or subject to the denial of interest?
  The expectation is that interest should still be able to be factored in as a potential deductible cost of a home office (assuming you are running a business from home and are not working from home as an employee).
• How does a holiday house (say owned by a family trust) fall for interest deductions if it is not rented out?
  If this is a private asset you cannot claim interest deductions under the existing rules.

What is a “new build”?

• Is a property with a CCC in December 2020 a “new build”?
  There is a transitional rule which may allow this to be treated as a new build, but only if the property is acquired on or after 27 March 2021 (and within twelve months of receiving CCC).
• Are there any exemptions considered for any property owners that have owned a rental property from when it was new? E.g. if the 27th March 2021 date was earlier, they would have been able to deduct their interest costs.
  Unfortunately not, the rules only consider “new builds” acquired on or after 27 March 2021 as being eligible for interest deductions. As mentioned above, there is a transitional rule proposed which will allow some properties which received a CCC within the 12 months prior to 27 March 2021 to be treated as “new builds”, provided that the property is acquired on or after 27 March 2021.

Different business types

• If 5 friends get together and make a company (so it won’t be a close company), then rent out property can the company claim full deduction for interest?
  A “close company” is a company where five or fewer natural persons or trustees directly or indirectly hold more than 50 per cent of the company, so you may need more than 5 friends to form a company. However, even if a company is not a close company, if it is “residential investment property rich” (50% percent or more of the assets are residential property) these rules will still apply.
• What’s the best ownership structure?
  Ultimately this comes down to what is best for your own facts and circumstances. Other than non-close companies which are non-residential investment property rich there no exclusions for any other types of entities.
• Are Māori Authorities subject to the interest limitation rules?
  Taxpayers will be impacted by these rules regardless of whether they are investing as an individual, through a trust, partnership, limited partnership or a close company. Only, non-close companies (e.g. widely held / listed companies) will be excluded from the rules provided they are not “residential investment property rich”. As a result, Māori Authorities will be subject to the interest limitation. The discussion document notes that the Government does not propose to exclude other entities from the interest limitation rule, but submitters are asked if there are other organisations that should not be subject to the interest limitation proposal and if so to provide details.
• If rental income from Māori land is not derived through a registered charity then will that Māori land be affected by the proposed interest limitation rules?
  Māori land may be affected by the proposed interest limitation rules. The Government is considering a carve-out for Māori land and is requesting submissions on the types of structures and financing used for providing housing on Māori land.

Treatment of borrowing

• Can I refinance my borrowing to a new bank?
  Yes, you should be able to do this. Provided the new debt is equal to or less than the debt at 26 March 2021 it should not be considered “new borrowing”. We recommend fully documenting all banking transactions to ensure there is a clear evidence trail around residential property debt.
• What’s the best way to allocate debt across different assets?
  The primary proposal under these rules is for taxpayers to trace what borrowing relates to. Any debt which can be traced to residential property will be subject to the interest limitation rules. We recommend going forward that separate loans are taken out for separate assets & purposes to make this process simpler.
• How is borrowing treated if it is to make improvement to an existing property? For example, substantial renovations, a new roof, or paint job etc?
  Interest will be denied regardless of whether it is for the capital cost or ongoing operating and maintenance costs.
  If you are treated as a property developer for the purposes of making the improvements (i.e. the improvements make a building habitable or extends the life of a building) then interest may be deductible for any additional debt acquired for the development activity. The interest exemption would only apply in this case until the improvements are completed.
• Is a foreign currency loan (from offshore bank) on a non-New Zealand residential property caught by these changes?
  No, foreign properties are excluded from these interest proposals. However, all other existing rules (e.g. the bright-line test, residential ring-fencing, and financial arrangement rules) apply to all property owned by a New Zealand tax resident regardless of where in the world it is.
• I have a mortgage free commercial building, also I have 100% mortgaged residential building. Both buildings are owned by the same family trust. Can I refinance and move the loan to the commercial building? Both buildings values are relatively similar.
  The proposals will allow people to refinance in a commercial way. However, the discussion document does not provide any commentary as to whether Inland Revenue would consider refinancing to move debt from residential property to other property to be 'tax avoidance'. This is something taxpayers should consider on a case-by-case basis; for example, Inland Revenue may consider it more reasonable to have each property 50% debt financed.
• If we refinance the existing loan on a rental property that was already in place prior to 27 March 2021, up to the total value of the original loan, we can deduct the increased interest over the phase out period. But we cannot refinance to above the original loan amount?
  You can refinance up to the amount of borrowing at 26 March 2021, any borrowing in excess of this amount should be "new borrowing”.

The bright-line test

• If a property held by a trust is rented as an investment property for say 3 years and then is moved into by the trust beneficiary as a family home, so no longer an investment property, would this change of use generate a notional taxable gain under the bright-line test even though no actual sale has taken place?
  No, provided you have not sold the property there should be no need to consider the bright-line test. Depending on whether the property is acquired pre or post 27 March 2021, this scenario will impact on the application of the main home exemption if the property is in fact sold at a later date. If acquired post 27 March 2021, apportionment may be required for the main home exemption if the property is subject to the bright-line test on an eventual sale.
• How do I help my kids?
  The discussion document acknowledges that the bright-line test can impact on parents and children who jointly buy property together (for example the parent’s name is required on the mortgage to secure the lending and at some point the property is transferred to the child as a gift or at cost). These types of transactions are not being dealt with as part of the discussion document. It is noted that the Government is interested in undertaking work in this area at a later date.
• Rollover relief from the bright line test is proposed for trustees of a trust, will this also apply to a Māori Authority that is a company?
  While it is proposed that broader “rollover relief” is provided for transactions which might otherwise trigger the application of the bright-line test or change interest deductibility, at this stage the rollover relief would only apply to Māori Authorities that are trustees and not to companies. The discussion document acknowledges that this may be too narrow for the way Māori Authorities are typically set up and used. As a result this is an area that Officials have raised a number of questions and are seeking feedback.

Other

• Have the opposition parties given their policy position about these new property rules?
  Both the National Party and ACT Party have said they will repeal these rules.

Where to from here?

Submissions on the proposals are open until 12 July 2021. Given that interest deductions will begin to be disallowed from 1 October, it is not feasible for submissions to be considered and then legislation drafted and enacted before that date. What we expect to occur is that final design decisions and draft legislation will be made available prior to 1 October. The legislation will be added to a taxation bill and go through standard parliamentary processes, including a select committee process. The legislation is likely to be enacted in late March 2022 and have retrospective effect.

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