The Government has today released its housing tax discussion document following the 23 March announcements. It has further detail on the proposed interest limitation rules and related bright line tax issues.
The discussion document runs to a weighty 143 pages and there is a lot of detail. Feedback is requested by 12 July. This Taxmail covers the key design issues subject to consultation.
Generally, the new interest limitation rules will apply to residential property which is rented to tenants. However, there are a number of proposed exclusions including:
The discussion document also asks for feedback on possible exclusions for student accommodation, serviced apartments and Māori collectively owned land and housing.
Tracing rules are proposed where a loan is used for multiple purposes. These will determine whether interest is subject to the new rules. Alternative approaches are considered as transitional measures.
Under the proposed tracing approach:
Close companies (i.e. five or fewer shareholders owning more than 50%) and widely held companies whose assets are more than 50% residential land will not be able to apply the automatic interest deduction for companies. They will instead need to apply the tracing rules. An “interposed entity” rule will apply to residential rental property held through companies, trusts and other entities.
Refinancing a loan entered into prior to 27 March 2021 will not result in loss of interest deductions from 1 October 2021 (instead the phased approach will apply).
Special rules are also proposed to deal with revolving credit facilities and offset loans offered by banks. The discussion document proposes “high watermark” rules to limit interest deductions based on the level of borrowing that was in place as at 27 March 2021.
The discussion document proposes a “new build” be defined as when:
The discussion document proposes that early owners (i.e. those who acquire a new build no later than 12 months after its Code Compliance Certificate (CCC) is issued or add a new build to their land) would be eligible for the new build exemption from the interest limitation rules. It also seeks feedback on whether subsequent purchasers (those who acquire a new build more than 12 months after the new build’s CCC is issued) should also qualify for the exemption. It seeks feedback on whether the exemption should be in perpetuity for early owners or for a fixed period (totaling 10 or 20 years) for both early owners and any subsequent purchasers.
The discussion document covers a range of other technical and transitional issues including:
To read the full Discussion Document and summary sheets, please click here.
We will be working through the detail of the discussion document and the impacts in greater detail over the coming weeks, but some initial thoughts.
While the additional detail is welcome, the length of the document again highlights to us the complexity of these new rules in practice.
Residential property owners will have to get their heads around tracing, apportionment, high watermark rules, rollover relief and the new build exemption. Our reaction? It is one thing to design rules, but the rules must be workable and they must be understood and complied with.
Based on our understanding of the proposed legislative track, legislation will be introduced later this year, for changes that will apply from 1 October. In effect, this means that the design of the rules could still be being worked through when taxpayers will already be subject to them. This will present challenges for provisional tax payments and record keeping, for example. To give certainty, we strongly urge the Government to defer the application date of the interest limitation rules to 1 April next year.
More generally, if the rules are not simple, particularly given the target audience, there is a real risk of non-compliance. In our view, the risk of non-compliance is further heightened given that these rules will potentially sit alongside existing restrictions (such as rental loss ring-fencing and the mixed-use asset rules). The short legislative time frame, and risk of errors as a result, could further erode compliance.
Additionally, some of the proposed detail may add to the overall sense of “unfairness” that residential property investors may already feel. For example, one of the options is that no interest deduction is allowed where a gain is subject to the bright-line test (or taxed under other land rules). This will over-tax the actual (economic) gain. Another quirk hidden in the depths of the discussion document is the potential non-application of the new build exemption where a property initially qualifies, but the early owner temporarily occupies it prior to sale. The proposal is that any subsequent purchaser will not be able to apply the new build exemption. This will have practical impacts, for example, if a person develops two properties – one to live in and the other to rent – and lives in the latter while the former is being completed. Again, this seems unfair and contrary to the new build policy.
Finally, the detailed design could have significant economic and social impacts. For example, the new build exemption may create “lock in” for the first owner and/or uncertainly for developers around the economics of new residential developments. It will be critical that these decisions do not end up undermining the intention of the policy.