The Government’s housing policy announcements today include some significant tax changes.
The bright-line changes are in a Supplementary Order Paper (“SOP”) to the Taxation (Annual Rates for 2020-21, Feasibility Expenditure, and Remedial Matters) Bill (the “Bill”). The Bill is expected to be law shortly. The interest deduction restrictions will be legislated later this year, with effect from 1 October 2021.
In addition, the SOP to the Bill:
The current bright-line test applies to residential investment property that is bought and sold within five years. However, the test does not apply if the property is predominantly used as the owner’s main home.
The SOP to the Bill:
The bright-line extension is a missed opportunity to undertake a more comprehensive stocktake and review of the land taxing rules. Instead this continues the trend of ad hoc tax measures by multiple Governments. In our view, they detract from the overall coherence of the system. Debate will also rage as to whether increasing the bright-line test period is contrary to the Government’s election tax policy pledge.
The change of use rule is more understandable. It produces a fairer result than the current “predominantly used as a main home" test for bright-line property. (It is also consistent with a legislative clarification to the “dwelling” definition in the Bill to include unoccupied property for bright-line and rental loss ringfencing purposes). This will however mean that, depending on the property’s acquisition date, different tests will apply. So extra care will need to be taken when applying the tax rules.
Interestingly, the regulatory impact statements accompanying the SOP highlight stark divergences in view between Inland Revenue and Treasury on extending the bright-line period. Inland Revenue was opposed to any extension, whereas the Treasury’s view was that the bright-line period should be 20 years (with no concessions for new builds).
The Government will introduce legislation later this year which, with effect from 1 October 2021, will:
The Government intends to consult on a number of design issues, including how to ensure interest deductibility where loans secured against residential property have a business purpose and whether interest deductibility should also be restricted for new rental builds.
This is a significant change to the structure of the tax rules. The current rules do not require any apportionment for dual purpose (i.e. rental and capital gain purposes). There is a policy argument that interest should not be deductible to the extent it is used to derive non-taxable income or gains. Where the return comprises a mix of rental yield (taxable) and capital gain (non-taxable), the appropriate response is an apportionment of interest deductions. The question is how much should be deductible? This might vary with the gain actually made but this would not be known until a sale is made. An arbitrary 50% would acknowledge the dual purpose of the borrowing. However, such policy nuances have not been accepted – the Government has landed on a default 100% deduction denial.
This means all interest will be automatically non-deductible in the case of residential rental properties acquired after this Friday (and for any new lending after this date on existing properties) and over the next four years for existing residential rental properties. The only area where the Government is still weighing up its options is whether interest deductibility restrictions should also apply to new residential rental builds. The interest deductibility rules are unchanged for developers and builders.
There are a number of detailed design issues that will need to be resolved. Some questions that immediately spring to mind are:
In addition to the tax changes, the Government has announced:
More on these policies can be found here.
The SOP to the Bill also contains draft legislation:
Tax Policy Officials have indicated the Government intends to exclude new builds from the proposed interest deductibility restrictions. Consultation on the detail of this will be undertaken later this year.