Eyes on Tax
24 June 2021
What we now know: Proposed restrictions to interest deductions on residential investment properties
We all enjoy a good surprise. But residential property investors are unlikely to be celebrating the Government’s proposed restrictions to interest deductions.
In March of this year, the Government announced an extension of the Brightline test for taxing residential property sales from 5 –years to 10-years, albeit with an exclusion for “new builds” (yet to be defined).
At the same time, it was unexpectedly announced that interest deductions for residential properties were to be restricted. The framework of the proposed legislation was, at that time, unknown.
What we now know - A brief overview
We now have more detail with a recently released Discussion Document and a call for public feedback. Here is a non-technical overview of what is proposed and is not yet law:
- Legislation objectives: There are many. Specifically, the rules are designed to reduce demand for non owner-occupied residential properties, and therefore control price rises. They aren’t designed to disincentivise supply, hence a carve out for “new builds” (which would not be subject to non-deductible interest). The framework shouldn’t be unduly complicated.
- Phased implementation: From 1 October 2021 interest deductibility is to be restricted on borrowings drawn down before 27 March 2021 and for residential property also acquired prior to this date. It’s not an immediate restriction with interest deductibility phased out over time and in full from 1 April 2025 onwards (100% deductibility until 30 September 2021, reducing to 75% between 1 October 2021 and 31 March 2023, 50% from 1 April 2023 to 31 March 2024, 25% from 1 April 2024 to 31 March 2025).
- Concession for new builds: There are no interest deductions for circumstances that do not meet the above date deadline requirements, other than the concessionary treatment permitted for “new builds”.
- Three new build categories are contemplated; simple, complex and commercial-residential conversions. In principle, if the activity increases the housing supply, then it should qualify for the concessionary treatment (i.e. the interest is deductible).
- New build definition: It is proposed that a “new build” will be defined with reference to the Code of Compliance Certificate (“CCC”); for example, a new build is one that is acquired within 12 months of issue of the CCC. The proposals further raise the question as to whether subsequent purchasers would qualify for the concessionary treatment and interest deductions permitted. The paper calls for views on whether the exemption should extend (on a reduced basis) to properties acquired within 10 or 20 years from CCC.
- Further exclusions: Residential property excluded from the rules is proposed to include land outside of New Zealand, farmland, employee accommodation and others.
- Income tax implications: The Document considers a sale of property that is subject to income tax and whether the non-deductible interest should be available as a deduction under these circumstances.
What we think
While the initial proposal unfortunately landed (back on 27 March 2021) without any prior discussion, we now have a short window before 12 July 2021 to make submissions. Some aspects of the proposal likely to benefit from further discussion and review include:
- Ring-fenced loss rules: We already have ring-fenced loss rules. Will we have any losses to ring-fence if (when) the restrictions are enacted as proposed?
- An opportunity to simplify: Regardless of objectives, the proposed new rules appear overly complicated. There are 143 pages of Discussion Document trying to work out what would be fair, what wouldn’t, how to define “new builds”, what should be excluded, dual purpose buildings, tracing of borrowings (what was the borrowing actually used for to work out restrictions?)…it doesn’t feel uncomplicated. Perhaps the use of the word “unduly” means that the Government [or the officials] can make it complicated?
- Previously forgone interest: Should there be a deduction for interest previously forgone in the event of a future taxable sale? Absolutely. Otherwise - the Government are double dipping and taxing more than the economic increase. This really wouldn’t be fair.
- Roll-over relief provisions: The inclusion of roll-over relief provisions is welcomed (although they too come with some complications), and it is helpful that the restrictions will be phased in over a four/five year period for existing investments. The immediate application of these rules to the Kiwi who invested in residential property and worked out their retirement plan based on the legislation of the day could be disastrous. The four year transition period at least allows time for those who made acquisitions based on the status quo. Particularly if interest rates rise in the medium to longer term, as is indicated by financial commentators (RBNZ signalling a view that that OCR may rise to 1.75%, as compared to 0.25% currently, by mid-2024).
- A change in taxation strategy: Finally, the proposal is a significant departure from the core fundamentals of our tax system. We deduct (yes, subject to certain limitations granted) those expenses which are incurred in driving taxable income. Why is there no deduction for this income earning process? Clearly, for some taxpayers, the proposed limitation could result in tax paid on what would ordinarily be an economic loss.
Stepping back, one might ask; “If we had to do something to deal with demand, could there have been a better way to help solve the housing problem through the tax system?” Something that increased the cost of acquisition, was uncomplicated, uncluttered and is used across the world? A stamp duty on residential property was previously discounted…but is this now worth a further look? If you want to make a submission, we’d love to hear from you. Make sure to have your say before 12 July.