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.
Property subject to the interest limitation rules (and not)
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:
- Residential property outside New Zealand;
- Employee accommodation;
- Care facilities such as hospitals, convalescent homes, nursing homes, and hospices;
- Commercial accommodation such as hotels, motels, and boarding houses;
- Retirement villages and rest homes;
- Income-earning use of an owner-occupier’s main home such as a flatting situation.
The discussion document also asks for feedback on possible exclusions for student accommodation, serviced apartments and Māori collectively owned land and housing.
How the interest limitation rules will work in practice
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:
- Borrowing solely for non-residential rental purposes will be unaffected.
- Interest deductibility will not be impacted if security or collateral for a loan is residential property. Instead the purpose of the borrowing will be the important feature.
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.
“New build” definition and period
The discussion document proposes a “new build” be defined as when:
- a dwelling is added to vacant land;
- an additional dwelling is added to a property, whether stand-alone or attached;
- a dwelling (or multiple dwellings) replaces an existing dwelling;
- renovating an existing dwelling to create two or more dwellings; and
- a dwelling is converted from commercial premises such as an office block converted into apartments.
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:
- A proposed exemption from the interest limitation rules for residential property development, including where a development is by a non-developer (e.g. where they undertake a subdivision, development or building to create 1 or more new builds). It also considers where remediation work (e.g. in relation to uninhabitable buildings) should qualify for the development exemption.
- Whether an interest deduction should be allowed at the time of disposal of a property that will be subject to tax (e.g. under the bright line test or the other land taxing provisions).
- Rollover relief (from both the bright-line test and interest limitation rules) where property is transferred to a trust and for transfers where there is no significant ownership change.
To read the full Discussion Document and summary sheets, please click here.
Our initial reaction
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.