Update on Government’s property tax changes

Further details and Government consultation on property tax changes

In late March amid much publicity, Finance Minister Grant Robertson announced major changes to the tax rules applying to residential property investors.  These changes were somewhat of a blindside to many investors and their advisors and will result in significant additional tax costs for many.

While that initial announcement was big on impact it remained short on detail in a lot of the areas that will determine exactly what the effects are for many investors.

Specifically, the major changes can be summarised as an extension to the bright-line rule for residential property, which makes sales taxable if they occur within 10 years of acquisition (currently five years), and the removal of interest deductions for property investors.

The changes were proposed to take effect from the date they were announced (27 March 2021), however the legislation implementing the full extent of the changes has not yet been introduced.

More detail on changes to interest deductions

Policy officials yesterday, released a consultation document outlining further details of the proposed changes, particularly in respect of interest deductions and the concessions for ‘new builds’ and seeking feedback on a number of aspects of the rules. The sheer size of this document (143 pages) is a sign of just how complex many of these issues are.

At a glance, the changes proposed by IRD officials will include:

• Denying interest deductions from 1 October 2021 for all “non-grandparented interest” – meaning interest on lending drawn down on or after 27 March 2021 on residential property that is not a new build.
• Phasing out interest deductions over a four year period for all “grandparented interest” – meaning interest on borrowings drawn down prior to 27 March 2021 on property acquired prior to 27 March 2021.
• Interest deductions are proposed to be permitted on “new builds”, but feedback is being sought on the definition, how long interest deductions will be allowed for, and whether a subsequent owner should also be permitted deductions.
• Some residential land is proposed to be excluded from the interest limitation rules – including land outside New Zealand, employee accommodation, farmland, care facilities such as hospitals, convalescent homes, nursing homes and hospices, commercial accommodation such as hotels, motels and boarding houses, retirement villages and the main home (to the extent it is used for income generating purposes).
• Tracing rules are proposed to be introduced to determine what portion of the interest is deductible where loans are used for multiple purposes – these rules will apply to certain closely held companies as well as other types of entities. An interposed entity regime is also proposed to be introduced to ensure the rules cannot be circumvented by using an interposed entity.
• New builds will be subject to a five-year bright-line test and it is proposed to allow rollover treatment where property has been transferred in an internal restructure (to a trust, for example).

The consultation document is a first draft and it seeks feedback on a number of areas.  The final rules are likely to be quite different to what has been released yesterday.

More questions raised…

Frankly, the details released raise a lot of unanswered questions.  For example, concessions are made for purchasers of “new builds” after 27 March 2021, but it appears that new builds acquired prior to this (say January 2021) have no exemption and will face phased out interest deductions similar to owners of existing residential property.  Also up for discussion is whether interest deductions should be permitted if the property is taxable on sale.  Not allowing deductions on a taxable sale would mean tax is payable on an amount that is higher than the actual economic gain.  There are a number of technical aspects to the proposals on which feedback is sought, and when finalised are likely to be complex and not readily understood without seeking specialist advice.

While this discussion document is aiming to provide a somewhat transparent process, it is frustrating for many taxpayers that the rules are already in force and legislation that has not yet been drafted will apply retrospectively. Those making decisions now do not have any certainty of what these changes will mean for them.  “Certainty” has long been seen as a fundamental principle of good tax governance, and an important part of encouraging taxpayer voluntary compliance.

The trouble with this tinkering around the edges style of tax policy, is that it creates unintended consequences and is often overly complex. Rules introduced to fix one problem, invariably result in unintended consequences for other areas.  The Government is attempting to fix the housing crisis and ensure that New Zealanders have access to safe, warm and affordable housing.  This goal is certainly noble and few would disagree with the underlying intent.

That being said, we cannot help but wonder whether complex tax changes are the best way of achieving those objectives.  A change in the loan to value ratios on investors would have surely achieved a similar outcome with out the complexity of the current proposals.

It could be argued that increasing the supply of affordable housing may have had a greater impact on affordability for both renters and owners, however, little progress appears to have been made in this area.

Closing date for submissions is 12 July 2021

The closing date for submissions on the discussion document is 12 July 2021 which leaves a limited time frame for adding your voice to the public response.  If you are interested in making a submission, or have particular points you would like added to any response, please contact us as soon as possible, as we may be able to assist you in this process.

A link to the full discussion document can be found here, along with some shorter summary sheets.