The Government has definitely shocked property owners around New Zealand after it has proposed some major changes to property tax, much to the displeasure of landlords and investors. However, it comes with good intentions. The proposed rules are intended to encourage more owner-occupied housing and address the country’s long-time housing affordability problem. If these rules will indeed bring about sustainable house prices and a more competitive housing market, you’re probably thinking why not right? Everyone would seem to win?! Let’s take a deep dive and look at the proposals closely.
Property tax changes
Proposed new rules include a 5-year new build bright-line test, a new option for calculating FBT and clarity of the business continuity test for carrying forward losses.
What’s changing
1. The bright-line test shortened to 5 years
Firstly, what is the bright-line test?
The bright-line test is a way to tax the financial gains people make from buying and selling a house for the purpose of making a profit. Basically, if you sell a residential property you’ve owned for less than five years, you may be required to pay income tax. The bright-line test had undergone many changes over the years.
2. Limit in interest deductibility
Residential rental property owners can typically claim loan interest as a tax deductible – or at least they used to? Residential investment properties that can be used for “long term accommodation” (hint: not hotels) will unfortunately be subject to the proposed limit in interest deductibility rules starting (drumroll) 1 October 2021. The good news is that the proposed rules would exclude the following:
· the main family home
· new builds
· property development
· other types of residential property
· owner-occupied house with flatmates
· business premises
· nursing homes
· employee or student accommodation
· social housing
· and the likes.
Note: Interest deductions would still be allowed when you sell a taxable residential property. Interest on loans acquired on or after 27 March 2021 would be fully limited, with exemptions. Interest deductions for pre-existing property loans acquired before 27 March 2021 would be phased at 25% per year over four years.
3. Business continuity
The business continuity test (BCT) allows a company to carry forward tax losses to future years in case of a change in ownership but no major change in its business activities. However, tax losses incurred in earlier years are currently not allowed to be offset against a profit for prior to the breach – part-year. It is proposed that losses incurred in years before a breach in business continuity or change in ownership could still be allowed to offset against a profit.
4. Fringe benefit tax
The Government also proposes a new way of calculating FBT on fringe benefits from the 2021-22 tax year. It is proposed that employers would pay FBT at 49.25% for all employees with a total pay of not more than $129,681.For pay more than that, FBT would be payable at 63.93%. This would be employees earning over $180,000 pre-tax or close to that threshold.
Key notes:
Property development
Property developers will be exempt from the proposed rules as the “new build exemption” continues to apply to them.
New builds
New builds will be exempt from the proposed rules, subject to a 5 year bright-line period. A new build is a residence that received a Code Compliance Certificate, which confirms the residence was added to the land on or after 27 March 2020.
Note: Loan interest associated with work done to improve an existing property will be non-deductible unless it costs as much as a newbuild, in which case it will be exempted.
Stacking method
Under the proposed rules, a “stacking approach” will be considered when determining whether interest can be deductible or not. Interest will not be deductible to taxpayers who allocate the loan first to residential investment properties. Interest incurred in relation to a loan against a residential property, which was drawn down for non-residential property purposes will remain deductible. This recognises that taxpayers could structure their loans differently to maximise the deductible interest amount.
Disposal deduction
If the amount received on the disposal of a property is considered income under the bright-line test, deduction will be allowed for disallowed interest on property disposal. However, the interest deductions will be ring-fenced and applied only against residential property income such as rental income or proceeds of the disposal.
Ownership rollover
When ownership of land is changed but there is no economic change, the ownership transfer will trigger the bright-line test or disentitle the taxpayer to transitional interest deductibility rules. New rules will apply from 1 April 2022 to make sure the bright-line test is not triggered.
Anti-avoidance
Interest deductions are still allowed in loans used to buy other assets such as shares so to avoid taxpayers structuring their residential property investments through a company to access interest deductions, anti-avoidance measures are proposed. Residential property percentage determines how much interest is denied or the value of the property that’s subject to interest deductibility rules. Companies with less than 50% of total assets in residential property and Māori companies will be exempt from these rules.
Foreign currency loans
Income from hedges on foreign currency loans are exempt income so taxpayers will not be taxed but be unable to deduct interest in relation to the loan. The rules will be effective starting 1 October 2021 once they are enacted by Parliament retrospectively in March 2022. There are questions surrounding the rules’ effectivity in achieving housing affordability and how investment decisions will be influenced. The proposed rules will be discussed and refined until 9 November 2021.
Our Business Clients
Cam recently caught up with Grant Douglas, owner of Makers Fabrication, to get his perspective on a few things. If you want to chew the fat with Grant further – get in touch and we’ll set it up.
