Income tax returns for taxpayers without Extension of Time
GST payments & returns for Period ended 30 June 2021
1st provisional tax payment for 31 March balance date
RESIDENTIAL RENTAL PROPERTIES & INTEREST DEDUCTION LIMITATION & ADDITIONAL BRIGHT LINE RULES
Last week IRD released its discussion document on the application of the new interest deduction limitation. Whilst this is a discussion document only it gives good indication where the Government is heading. The Government is blindsided by the illusion that these draconian rules will somehow reduce the upward pressure on housing prices. Whilst these rules are designed to reduce the incentive for non-owner occupiers to invest in existing residential properties, the rules provide a great incentive for investors to invest in “new build”, which will do nothing more than drive up prices for the “new build” making it once again impossible for the first home buyer to climb on the property ladder.
Few takeaways from the 143 page document are provided below.
The new rules will apply from 01 October 2021 restricting interest deduction on rental properties acquired prior to 27th March 2021 where finance has been drawn down prior to 27th March 2021 as follows:
- 01 Apr 21 to 30 Sep 21 – 100% interest can be claimed
- 01 Oct 21 – 31 Mar 22 – 75% interest can be claimed
- 01 Apr 22 – 31 Mar 23 – 75% interest can be claimed
- 01 Apr 23 – 31 Mar 24 – 50% interest can be claimed
- 01 Apr 25 – 31 Mar 25 – 25% interest can be claimed
- From 01 Apr 25 – Zero % interest can be claimed.
It is also proposed that refinancing of an existing loan after 27th March 21 be afforded the same concession as pre 27 March loans. Although new borrowings (i.e. financing of extension/ renovations to the existing rental property) will be subject to the interest deductibility limitation.
Residential properties acquired after 27 March 2021, will be subject to Zero % interest deduction, unless these are properties that qualify for development or the New Build exemption.
Government is proposing that the following be excluded from these rules: land outside of NZ, so the interest you are paying on your Australian rental property will still be deductible. These rules would also not apply to any income earning activity of a home owner occupier’s main home such as a flatting situation, Airbnb, board and lodging, provided that it is not provided in a separate dwelling on your home title. If there is a separate self -contained unit or a flat on the same title as the main home the interest limitation will apply.
Residential properties that are vacant or are used solely to provide short term accommodation are specifically captured under these rules. The Government is of the view that the interest deduction limitation should apply to these types of properties.
The Government is proposing to override the automatic interest deduction enjoyed by companies. This means that residential rental properties owned by close companies (companies where 5 or fewer natural persons or trustees hold directly or indirectly 50% or more of the shares in the company) or residential investment property rich companies (companies where the residential property investment by reference to the total value of assets is greater than 50%) will be subject to the interest limitation rules.
The purpose of these rules is to disallow or limit interest deduction on borrowings used for residential investment purposes. Interest on borrowings that has nothing to do with residential property investment will remain unaffected by these proposed rules.
Whether or not an interest deduction will be allowed at the time property is sold and subject to bright line rules remains to be seen. The Government has proposed four options with strongly favoured approach being deduction denied! This would be a rather draconian outcome as rental property would be heavily overtaxed in comparison with other investments.
New Build Properties – What are they?
Government has decided that New Build residential properties should be exempt from the interest deduction limitation rule and should only be subject to 5 year brightline test rather than 10 year bright line test.
Government considers that a property should only qualify as a new build where housing supply has increased and CCC has been issued. These would include the following:
- Adding a new dwelling to bare land
- Replacing existing dwelling with one or more dwellings
- Adding a standalone dwelling to existing dwelling
- Attaching new dwelling to existing dwelling
- Spliting an existing dwelling into multiple dwellings
- Commercial to residential conversions
Whether or not the New Build exemption will apply will depend on when a new build is added to the land.
If the CCC is issued on or after 27 March 21 then the new build exemption will apply to the early owner (a person who acquires a new build off the plan prior to CCC being issued; acquires a new build already constructed no later than 12 months after its CCC is issued) and possibly a subsequent owner (person who acquires a new build more than 12 months after a CCC is issued).
Government is proposing that this combined new build exemption for early and subsequent owner be capped at 20 years provided that the property is used for investment income purposes and not owner occupied.
In case where CCC is issued prior to 27th March 21 but property acquired after 27th March 21 and no later than 12 months after CCC has been issued, the new build exemption will apply to the early owner.
It is proposed that the 5 year brightline test in relation to new Builds applies to early owners only.
As with other land taxing provisions a few rollover relief provisions are being considered, some quite helpful in fact.
Currently the rollover relief from brightline test is only available to settlements pursuant to relationship property agreement or for amalgamations, and full exemption is granted to property transferred under the will.
Government is considering that a rollover exemption should also apply where property is transferred between an LTC or partnership and its owners so long as the beneficial ownership of the property remains the same or where the Settlor settles property on a Trust provided that the Settlor is also a beneficiary of the Trust and a principal settlor of the Trust and that every beneficiary of the Trust is associated with the Principal Settlor (person providing most money to the Trust).
DID YOU KNOW
RING FENCING OF RENTAL LOSSES & CHANGE IN USE
The ring fencing rules pose few challenges. A question recently arose as to whether ring fencing rules apply to deductions where there was a change of use from residential rental to main home.
Whilst the purpose of the residential ring fencing rules is to disallow deductions in excess of rental income, the answer to this will depend on when the change occurred and how long the property was used as main home vs residential rental property.
As a general rule s EL4 of ITA 07 states that the residential ring fencing rules do not apply to residential land of a person for an income year if more than 50% of the land is used for most of the income year by a person as their main home.
If the property is not unoccupied for 62 days or more in an income year then Mixed Use Asset rules will also not apply, using their own deduction limitation rules.
Consequently, the excess deduction incurred in the year of change from residential rental to main home are not subject to ring fencing rules for that income year and can be offset against other sources of income if the land is used for most of the income year in the year of change as a main home.
The situation with carried forward ring fenced deductions/ losses is different. These remain to be ringfenced until such time as the property is sold and the sale triggers taxable income, unless the taxpayer has taxable income from other residential properties that are in the pool. In this case the ring fenced deductions/ losses can be utilised/ offset against rental income.
10 YEAR BRIGHTLINE TEST & HOW TO COPE WITH IT
Have you been wanting to invest in residential property but are too afraid to commit due to the extended 10 year brightline test? If the answer to these questions is yes, you can be sure that you are not the only one.
The use of a Look Through Company (LTC) could potentially avoid brightline rules applying on transfers whether between related parties or otherwise.
Not so long ago we all thought that this choice of ownership entity is somewhat obsolete due to the various recently introduced and proposed draconian regulations such as ring fencing of residential rental losses or the recently proposed interest deduction limitation rules. The later is still a discussion document which will be subject to further refinement as it goes through the submission process, although the Government’s intention is for these rules to be effective from 01 October 2021.
Whilst the LTC provides limited liability protection, from the commercial perspective it applies the principle of transparency for income tax purposes that work on the premise that the assets of the LTC are that of owners of the LTC with resulting tax consequences flowing to the respective owners of a Look Through Interest.
Whilst navigating through these rules can be somewhat daunting the design of these rules enable the owner of the look through interest to potentially circumvent the application of the brightline test.
If you have a residential land in an LTC that is subject to brightline rules and would like to transfer that land to another taxpayer without giving rise to income tax liability give us a call.
OTHER TAX MATTERS
GST: COMPULSORY ZERO-RATING OF LAND & COMMERCIAL LEASES
Most supplies made under commercial leases are excluded from CZR rules by s 11(8D)(b). S 11(8D) applies to “interests in land”and agreements for supply of “interests in land”. A lease is in effect an interest in land.
However in some cases commercial leases with characteristics making them substitutable for land sales and transactions involving assignment, surrender or procurement of commercial leases may be subject to CZR rules if conditions in s 11(1)(mb) are met.
Commercial leases to which CZR rules will apply are as follows:
- The assignment or surrender of a commercial lease;
- A supply made under a commercial lease where the consideration includes a non-regular payment ( i.e. lump sum) of more than 25% of the term consideration, and any subsequent supplies made under the same lease;
- The reverse surrender of a commercial lease ( where a lessee pays a lessor to take back the lease);
- A supply of lease procurement services; that is a supply made under an arrangement that involves the lessee’s surrender of a commercial lease and the grant of a new commercial lease by the lessor to another person.
PURCHASE PRICE ALLOCATION
Purchase price allocation rules apply to disposals of property / assets from 01 July 2021.
Brief summary of the rules:
- If the parties agree on allocation, they must follow it in their tax return.
- If the parties do not agree on allocation, the vendor is entitled to determine the allocation by notifying both the CIR and the purchaser within 3 months. The vendor must allocate amounts to taxable property (depreciable property, revenue account property, financial arrangements) such that there is no additional loss on sale of that property.
- If the vendor does not make an allocation within 3 months, the purchaser is entitled to make the allocation by notifying both the vendor and the CIR.
Purchase price allocation rules do not apply where the total consideration for the purchased property is less than $ 1 Million or less than $ 7.5 Million in case of residential land including chattels. The CIR cannot challenge purchase price allocation where the original cost of the item to the vendor is less than $ 10,000, and the total value allocated to that item does not exceed $ 1 Mil, and the amount allocated to the item is between original cost and its tax book value.
We would like to welcome Catherine Kemp and Crystal Wu who have recently joined our team. We are glad to have you on board.
Level 1, 10 Manukau Rd, Epsom, AKL