A consultation document released this week considers the tax treatment of “holding costs” (such as interest, rates, insurance, and repairs and maintenance) associated with owning land that is taxable on sale, and considers the tax deductibility of these costs for a range of “use” scenarios.
Submissions on the consultation document are due by 1 November 2019.
The key question is what land holding costs would be deductible if the land is used privately (either partly or wholly) before sale? An example is a holiday home, which if sold within the bright-line test period will be taxable.
The consultation document seeks feedback on three possible options for the treatment of holding costs when land is used privately:
Officials’ preferred option (“proposal”) is to deny all deductions, even though apportionment of the costs is recognised as the most accurate option.
A related question is the tax treatment of holding costs for any period the land is vacant (i.e., unoccupied). Officials’ preference is to relate the tax treatment for any unused period(s) to any other uses of the land, when it is owned. For example, if the land is used privately when owned, the vacant period would also be treated as private use (so no holding costs would be deductible). In contrast, if the land is wholly vacant or unused, and is held for a land dealing, development or building business or to erect a rental property, the vacant period would be considered income earning (and holding costs would be deductible).
The proposal to deny deductions for land holding costs for private use would apply consistently to individuals, partnership, trusts, and look-through companies.
For ordinary companies, the proposal is that the current interest deductibility provisions would remain, as any private use of land by shareholders is already subject to market value rental or deemed dividend consequences.
The consultation document also proposes legislatively to clarify that the cost of any capital improvements and acquisitions to land is deductible, if the gain is taxable (notwithstanding the general permission and private limitation on expenditure).
This latest consultation document follows an earlier consultation on strengthening the rules for taxing land when there is a regular pattern of sales.
The general proposition of the recent consultation document is that when costs are incurred in deriving income, those costs would be deductible. The complexity is when there is a combination of taxable, private and (in some cases) no use of the land, while it is owned.
Officials’ preferred approach is to give prominence to any private use. The justification for this is any apportionment of holding costs is likely to be complex and inconsistent with other parts of the tax system when apportionment is not required. Officials' also point to the Tax Working Group’s capital gains tax design recommendation to disallow deductions when land is used privately.
This appears to ignore the general proposition above. When land will be taxable (under the bright-line test or the other land provisions), the costs associated with holding that land (in particular any interest costs) must at least partly relate to an income earning use (i.e., will be incurred to derive any taxable gain on sale). This is notwithstanding any private use. Tax professionals believe this strongly suggests that some apportionment is justified. While an exact apportionment may not be feasible, a 50:50 apportionment of costs appears to be a reasonable starting point.
Read an October 2019 report prepared by the KPMG member firm in New Zealand
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