Inside this edition
• Tax Treatment of Lease Inducements
• GST – Land Sold with a Dwelling
• Upcoming Changes to Foreign Pensions
• Passing Out Capital Gains from an LTC
Tax Treatment of Lease
The Inland Revenue recently released an officials issues paper in which they raise concerns over the tax treatment of lease inducement payments. These payments are generally made by landlords to prospective tenants in order to entice the tenant to sign up to a commercial lease. The Inland Revenue’s concern is that the landlords making these payments generally get a deduction, while tenants in receipt of such payments, do not ordinarily pay tax on them.
The Inland Revenue see this as a significant risk to the tax base and are proposing to introduce legislation to treat lease inducement receipts as taxable to the tenants. There are other forms of inducement offered by landlords but they do not have the same asymmetrical effect, such as reduced rents or fit-out contributions.
A landlord is entitled to a deduction for a lease inducement payment where it is made in the course of carrying on their business and the tenant is entitled to treat the amount as a capital receipt where it relates to the structure of their business.
The proposed change is to apply mainly to commercial leases and it will include both lump sum cash benefits and non-cash benefits such as contributions to a tenants cost of relocating or the forgiveness of a tenants liabilities. It is proposed that timing rules will be introduced and the tenant will be able to allocate the income over the period of the lease or up to the first rent review (whichever is shorter).
It is proposed that the application date for these new rules will be from the date the officials issues paper was released, being 26 July 2012. Note that the Inland Revenue will not be introducing any rules confirming that lease inducement payments are deductible for landlords, such payments will only be deductable provided they meet the general permission in section DA1 of the Income Tax Act 2007.
GST – Land Sold with Dwelling
The new GST rules that apply to land transactions have been in force for well over a year now. However, we are still finding that practitioners and clients are finding certain aspects to these new rules difficult to interpret.
Consider the following common scenario – a husband and wife have owned a farm for a number of years through their family trust. The couple look to sell their farm as they are near retirement and they are looking to move closer to the city centre.
Under the new GST zero rating rules, provided both the vendor and the purchaser are GST registered, the sale of the farm will be zero rated provided the criteria in section 11(1)(mb) of the Goods and Services Tax Act 1985 are met. These criteria require the purchaser to use the property in making taxable supplies and not as principal place of residence.
On the face of it, there could be an issue here as the farmland contains a dwelling in which the purchasers intend to reside. However, ordinarily section 5(15) applies and the sale of the farm and the dwelling are treated as separate supplies i.e. the sale of the farm will be zero rated for GST purposes and the sale of the dwelling will be treated as an exempt supply (i.e. no GST charged).
However, issues can arise when the vendor has claimed a full input tax credit on the purchase of the property which includes the dwelling. The standard sale and purchase agreement contains a warranty whereby the vendor warrants that the dwelling and curtilage supplied with the sale of the property are not a supply to which section 5(16) of the Goods and Services Tax Act 1985 applies.
If the vendor has claimed GST on both the dwelling and land when initially purchased then section 5(16) applies and the supply of the dwelling is a taxable supply. In this case the vendor will be liable to return output tax on the consideration received for the part of the supply that relates to the dwelling.
If the farm and house sold for $1.3 million (where the value of the dwelling is $300,000) and the vendor has claimed input tax on both the dwelling and land, the supply of the farm land will still be zero rated under the new rules. However section 5(16) applies to the supply of the dwelling and the vendor is liable to pay GST, being $39,130.43 (3/23rds of $300,000).
Upcoming Changes to Foreign Pensions
Recently the Inland Revenue released a discussion document whereby they are proposing to simplify the taxation of Foreign Superannuation Schemes. The proposal is to simplify what were a complex set of rules in relation to interests in overseas superannuation schemes held by New Zealand tax residents. Under the current rules, Foreign Superannuation Schemes are potentially caught by the Foreign Investment Fund (FIF) rules however in some cases an exemption from the FIF rules apply.
Issues can arise where a transfer or withdrawal is made from a superannuation scheme which is not a FIF. In some cases the withdrawal is treated as a dividend from a unit trust or as income derived from a foreign trust depending on the nature of the scheme.
Under the proposed new rules pension payments will remain taxable when received and lump sum withdrawals or transfers will be taxable or partly taxable depending on how long a person has been resident in New Zealand. The longer a person has been in New Zealand, the more tax they will pay on a withdrawal or transfer.
The proposal recommends that Foreign Superannuation Schemes are specifically excluded from the FIF regime. A percentage of any lump sum or transfer from a Foreign Superannuation Scheme will be taxable depending on how may years a person has been resident in New Zealand.
The Transitional Residency Rules will still apply and any withdrawals or transfers made by a person as a transitional resident will be tax free.
The proposed application date for these rules is from 1 April 2011 i.e. the 2011-2012 income year. Taxpayers that have returned FIF income in relation to their Foreign Superannuation Schemes in the 2010-2011 year will continue to apply the FIF rules and any subsequent withdrawals will not be caught by the new rules.
We understand that some taxpayers may have made withdrawals or transfers from their overseas superannuation schemes and not correctly treated these as income in their tax returns. The Inland Revenue is proposing to give taxpayers two options for withdrawals or transfers made between 1 January 2000 to 31 March 2011.
The first option is for a taxpayer to make a voluntary disclosure before 1 April 2014 and return 15% of the withdrawal or transfer as income. The Inland Revenue has advised that no use of money or shortfall penalties will be charged if this option is chosen.
The second option is that the taxpayer can return income under the rules applying at the time of the withdrawal or transfer and use of money will be applied.
Taxpayers should calculate which option will result in the least amount of tax including interest and penalties having to be returned before they chose an option to proceed with.
Passing Out Capital Gains from an LTC: BEWARE
We have identified a potential issue which could arise when passing out a capital gain from an LTC.
Consider the following simplified example:
A company’s balance sheet for the year ended
31 March 2012 shows assets consisting of
$1.5 million in cash and a property worth
$500,000. The liabilities are a loan from the shareholder of $500,000 and the equity in this company consists of $1.5 million (being capital reserves made on the sale of a property to a non-associated person and share capital of $100). The shareholder (an individual) wishes to access the cash from the company without having to liquidate the company as it still currently owns a commercial rental property. If the cash is taken out of the company, this will lead to an overdrawn current account of $1 million on which interest will need to be charged in order to avoid deemed dividend issues.
If the company was a qualifying company there would be no issue as the capital gain could be paid out tax free without having to liquidate the company. But as this company is an ordinary company one solution might be to elect the company into the LTC regime before the start of the 2014 income year and after 1April 2013 pay out a dividend which will be exempt in the hands of the recipient owner (note that fully imputed retained earnings are required to avoid any entry tax on becoming an LTC).
So far the solution seems to solve the issue as the cash can be accessed from the LTC however consideration should be given to the owner’s basis calculation required to determine what level of deductions the owner is allowed in an income year. The formula for calculating the owner’s basis is:
investments – distributions + income – deductions – disallowed amounts.
Assuming the rental income from the commercial property is $50,000 a year and the annual expenses are $30,000 the shareholders owners basis would be:
(100 + 500,000) less 1,499,900 million + 50,000 less 0 less 0 = -$949,800.
The first part of this formula in brackets is the investment part being $100 share capital plus the shareholders credit current account. As the owner’s basis is negative the owner is not entitled to any deductions in the 2014 income year.
We note that while electing into the LTC regime gives a potential solution to accessing cash from a company without having to liquidate it, careful consideration should be given to whether the owner will have a sufficient owner’s basis to claim deductions. There are potential solutions to this problem if you or your clients have already entered into the LTC regime or are considering such an arrangement.