Articles by Matthew Gilligan

 Australian Budget Hits Offshore Property Investors

The recent Australian Budget announcements include a significant rule change which will affect any New Zealanders whom hold property investments in Australia.  Specifically, the 50% discount which was available when calculating capital gains tax on property that has been held for more than 12 months is removed. 

By way of background, most readers will be aware of the fact that Australia has a capital gains tax regime.  This applies to all property within Australia, whether or not the owner is resident there.  Broadly speaking up until 8 May 2012 offshore investors were subject to the same rules in relation to capital gains tax as Australian resident investors.  In particular, where an investor owned a property personally or via a Trust they could generally qualify for a 50% discount on the capital gains tax applicable to the sale of a property if it had been held for longer than 12 months. 

From 7:30pm, 8 May 2012, the 50% discount is removed for offshore investors with application to capital gains accrued after this date.  The result of this is that if you have a property you acquired prior to 8 May 2012 any gain that accrued up until that date still qualifies for the 50% discount, but gains from that date do not.  At this stage we are not aware of how pre 8 May and post 8 May gains are going to be calculated, but presume it will be incumbent upon the investor to determine that.  Accordingly, foreign investors will be incentivised to get optimistic valuations for properties placing a value on them at 8 May 2012.  We will follow this aspect of the rules closely and report once more is known.

As always, if you have queries in relation to the above please contact us. 

Matthew Gilligan
Director

Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.  Also what about joining us on Facebook.

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Matthew Gilligan
Director

Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.  Also what about joining us on Facebook.

To Gift or Not to Gift

Many of you will be aware that the Government have changed the rules on gift duty, repealing gift duty legislation from 1 October 2011.  The effect of this is that IRD will no longer have an interest in gifts made after this date, as the transference of wealth will no longer be subject to gift duty from this point.

The question then raises itself, should people who have a Family Trust whom have been conducting a gifting programme make a lump sum gift to their Family Trust after this date?  The answer to this question is not as obvious as it may seem.  From an asset protection perspective clearly one would like to make a lump sum gift to their Family Trust for creditor protection in the future.  If a person has gifted all of their assets to a Trust, this means that they no longer have assets and in theory makes it much harder for creditors to get the assets from their Family Trust.  Previous restrictions on gifting having been wiped away from a gift duty perspective would make it seem obvious that lump sum gifts to a Trust would be the logical path to take from 1 October 2011.

Significant Issue to Consider before Gifting

One significant issue to consider is your eligibility in the future for the residential care subsidy.  The Ministry of Social Development (MSD) administer the asset and income testing rules.  In particular, it is the MSD that determine how discretion in relation to adding back past gifting into the asset test is applied.  Current policy of the MSD is that all gifts within 5 years of applying for the subsidy are added back, with the exception of an allowance on $6,000 per annum.  In other words, if you gift all of your assets to a trust and then 1 year later require rest home the gifting will be added back and included in your asset base.  The MSD can also reverse gifts outside the 5 year period, but at this point current policy is to only add back any gift in any year exceeding the sum of $27,000.

For example let us look at an individual who had an outstanding loan balance from their Family Trust of $500,000 and on 1 October 2011 declared a gift to their Trustees for the $500,000 as a one off gift.  While IRD would have no interest in such gift and it would not be taxable under gift duty legislation thereafter abolished, the MSD perhaps 40 years later (or whenever it was that the person making the gift made application for the residential care subsidy on the basis that they had no wealth at that time because all of their assets were contained in Trust) would look back and say that on 1 October 2011, the applicant had made a gift in excess of $27,000 and add back $473,000 to the applicant's personal asset base.  In other words while the $27,000 gifting threshold is no longer relevant to IRD, it is still highly relevant in relation to your ability to claim aged care subsidy relief in the future.  In this case the $473,000 deemed available to pay rest home fees.  On the other hand the $473,000 would not be available for aged care fees had the person continued to gift at a rate $27,000 per annum.  In this instance, each year there would be no gift over $27,000 so no excess to add back. 

On the face of it, you may think it is therefore best to continue to gift at a rate of $27,000 per annum.  In some cases we would agree with this conclusion.  However, it will not be appropriate in all cases.  If the assets base is big enough that no amount of annual gifts at $27,000 per annum will see you fall below the asset threshold, then there is little point persisting with gifting at $27,000 per annum.  Second, if you are more concerned about creditor protection and having assets outside of your estate (i.e. so they are not subject to a challenge to the will) then you will want to do a one off gift.  Third, if it is going to be many years before eligibility for residential care is an issue, we consider it unlikely that the rules will be the same in, say, 30 years.  Following this, it may be an ultimately fruitless exercise to gift at $27,000 for 30 years only to arrive at the end and be subject to a different set of rules.

Solvency At Time Of Gift Important To Document

The other issue that needs addressing particularly if you are making a one off gift to the Trust is solvency.  In short there are provisions under the Insolvency Act (sections 194, 195, 204 and 205) which broadly speaking allow the Official Assignee to set aside certain transactions made by a bankrupt before he or she was adjudicated bankrupt.  Largely these provisions apply if gifting occurred within 5 years of bankruptcy at a time the donor was insolvent.  Furthermore, there are provisions in sections 344 to 350 of the Property Law Act that allow transactions that prejudice creditors to be clawed back.  As a result you need to be very careful when documenting large gifts to Trusts if you want to mitigate the possibility of such gifts being clawed back under either of these statutes in the future.

We consider that best practice is to ensure that your solvency is evidenced at the time that any gift is completed.  This means that a solvency statement or certificate should be executed at the time of the gift referring to the fact that the donor is able to meet debts as they fall due.  In some cases this should be a certificate signed off by an independent qualified party such as an accountant.  In some cases it might be a simpler declaration by the donor.

At GRA we will be reviewing the circumstances of all clients that we complete one off gifts for and making sure that there is evidence of solvency maintained for the file.

Summary

You should not rush into making a one off gift of assets into a trust post 1 October just because you can.  In some cases there will be grounds for completing your gifting programmes as you would have done under gift duty legislation at $27,000 per annum per year, per spouse, to maintain the option of qualifying for the residential care subsidy under current MSD rules.  On the other hand you need to weigh this against creditor protection and estate planning issues. 

To see me talk more about this in detail watch "The Beat Goes On."

If you would like to discuss this matter with the writer, please contact  Matthew Gilligan at Gilligan Rowe & Associates LP, mg@gra.co.nz, +649 522-7955.

Matthew Gilligan
Director

Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.  Also what about joining us on Facebook.

New Tax Rules Proposed for Holiday Homes

The IRD has recently released an issues paper in relation to the tax treatment of mixed-use assets.  Whilst the issues paper will apply to a range of assets including yachts, launches, aircraft for example, its application to holiday homes is likely most relevant to readers and clearly the main intended target of these proposed changes.

Current Rules

Currently one is entitled to a tax deduction for expenses incurred in deriving taxable income.  In the case of a holiday home where there are periods during which the property is rented the law is very clear in that the income is taxable and the expenses incurred during that period deductible.  When the holiday home is used privately the law is equally clear in that no expenses are deductible during that period.  In between the holiday home may well be available for rent and the current IRD position in relation to expenditure during this period is that a deduction may be available if genuine attempts are made to rent the property. 

Proposed Changes

The IRD want to change the rules in relation deductibility of expenditure during periods in which a holiday home is available for rent but not actually rented.  The proposed rules will apply to holiday homes that are unused for at least two months of the year and owned by individuals, trusts, companies that are close companies, qualifying companies, look through companies and where the holiday home is used both privately and for income earning purposes.

If these criteria are satisfied the IRD are then proposing one of two methodologies for determining whether expenditure will be deductible.

First option is something of an all or nothing option in that either all expenditure during the downtime will be deductible or none of it will.  In order for all of the expenditure to be deductible the holiday home would have to have been used for income earning purposes for 62 or more days during the income year and the actual personal use be less than 15% of the income earning use.  For example, if a holiday home were rented for 80 days during the year then provided the private use were no more than 11 days all expenditure during the remaining days of the year would be deductible provided there was genuine efforts to earn income during that period. 

The second option includes a more complicated formula that allows for a partial deduction of expenditure during the downtime periods based on the proportion that the income earning use of the property bears to the private use.  Under this test in order to get a deduction for all of the expenditure, once again the asset will have to be used for 62 days or more in a year, but the threshold of private use to income earning use drops to 10%. 

GRA Comment

The first point to note that these rules are at proposal stage only.  Public submissions on the rules can be made to the Inland Revenue before 30 September 2011.  A link to the issues paper can be found by clicking HERE.

Whilst the rationale for this overhaul of the rules is relatively sound in that the desired outcome is to tighten deductibility of expenditure in relation to assets that ultimately are more about private than investment use, the proposed thresholds will likely have a significant consequence for owners of property that are genuine investments but used privately from time to time.  A typical holiday home investment may well produce more rent on an annual basis if rented periodically to short-term stay occupants rather than on a long term lease.  In such a case there may not be a large number of days where the property is occupied meaning that the private use threshold whether it be set at 10% or 15% is relatively low.  It seems unfair to us to then disallow deductibility of all expenditure during downtimes on the basis that it is essentially of a private nature when the asset arguably has a predominant business use. 

It was also interesting to note that the IRD issues paper referred to the fact that there are 15,000 holiday homes available for rent in New Zealand based on a survey of eight leading New Zealand websites.  One would not be surprised if you had a property advertised on such a site that you attract the attention of the taxman in the future. 

As always if you have a holiday home and are concerned about the application of the current rules to you please contact us.  Once again these rule changes are proposed only and if you feel strongly about them we encourage you to make a submission or provide GRA feedback and we can accumulate your feedback and submit on your behalf. Please send feedback to info@gra.co.nz

Matthew Gilligan
Director

Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.  Also what about joining us on Facebook.

GST Issues for People Buying and Selling Property/Property Traders

Whilst it has almost been six months since the new zero rating provisions for land transactions came into force, at GRA we are still seeing quirks and issues emerge as practitioners and property traders / investors come to grips with the new rules.  In today’s article I want to examine two scenarios that those of you who are property trading should be wary of.

Scenario One

In scenario one a property trader has identified a potential trade property that is on the market for $200,000 including GST (if any).  The trader thinks that they could spend $20,000 making renovations and then sell it for $260,000.  The trader understands that they will need to return GST on the $260,000 but anticipates making GST claims on the $200,000 purchase price and the $20,000 renovation costs leaving a margin of circa $35,000 after GST and before income tax. 

Following this the trader submits an offer for $200,000 including GST.  The offer is accepted and our trader starts to look forward to renovating and making the $35,000. 

However, prior to settlement the trader seeks advice in relation to the GST treatment of the purchase and discovers that the vendor is a GST registered trader themselves.  This means the transaction of selling the land from the GST registered vendor to our GST registered trader is a zero rated transaction for GST purposes.  The $200,000 purchase price "inclusive of GST (if any)" now includes GST applying at a rate of 0%.  As a result our trader who anticipated having a GST refund of $26,000 in relation to the purchase of the property now has no GST refund.  Suddenly the $35,000 pre-tax profit is eroded because GST still has to be accounted for on the sale (note that we are assuming that the sale here does not occur to yet another GST registered party but it is a retail sale to an owner occupier / residential investor).

Possible Solutions

The moral of the story here is know your vendor.  If the vendor is GST registered and selling the property as part of their taxable activity and you are similarly GST registered and buying it for a taxable activity the GST component is zero.  In such a scenario you need to offer what you perceive as the GST exclusive value of the property to you - which in this case is $174,000 (being the $200,000 less the anticipated $26,000 refund that you are now not getting).  You can also consider including a clause in a contract making them warrant that not only are they not registered now but they will not be at the time of settlement and should they breach that warranty then the purchase price is reduced to reflect the fact that you will not get your GST input claim.

Scenario Two

In scenario two we are looking at a property trader whom is selling a property bought for trading purposes.  Our property trader is approached by a prospective purchaser who explains that they are GST registered and looking to buy the property in order to apply it towards a taxable activity (for example use as a commercial premises).  The purchaser therefore explains that they are willing to offer $400,000 inclusive of GST.  Our property trading vendor wants to clear $400,000 excluding GST and therefore had anticipated selling it to a retail investor for circa $460,000 so that after they had paid their $60,000 GST they still had $400,000.  This GST registered purchaser convinces our vendor that because its going to be a zero rated transaction they can sell it for $400,000 "including GST" because the GST component will be zero and our vendor will clear $400,000.  The vendor accepts the purchaser’s overtures and enters into the sale and purchase agreement.

Subsequently the purchaser changes their mind in terms of the use of the property they advise the vendor that they are now nominating a non-GST registered entity that will be buying the property for non-GST purposes (i.e. residential rental or to occupy as a residence).  This is disastrous for the vendor because now the $400,000 which was anticipated to include zero GST in fact includes GST at a standard rate meaning that our vendor has to account to the IRD for $52,000 in GST out of the $400,000 sale price.

Possible Solutions

If you are a vendor you could make the price “plus GST” instead of “inclusive of GST”.  If the contract is plus GST then a purchaser will have to pay GST at the standard rate if they change their mind (having initially said they will be GST registered).  Another strategy is to include a clause in the sale and purchase agreement whereby the purchaser warrants that they will remain GST registered at settlement and the transaction will be a zero rated transaction, and if they breach that warranty then the sale price is increased by 15% to compensate you as vendor for the fact that you will now need to account for GST.

Both of these scenarios illustrate the importance of understanding the circumstances of the other party in land transactions.  They also show that if circumstances change you can be placed at a disadvantage. 

As always we recommend you seek advice on your particular transaction.  Every transaction is different and you need to be vigilant in checking the terms of your sale and purchase agreement.  The above is comment of a generic nature only and should not be mistaken for specific advice in relation to any transactions you are involved in.  Contact us at GRA for advice on 09 522 7955.

If you are worried about any of these issues I have mentioned email or come and see me.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

RECENT GST CHANGES

In our last newsletter I talked about the new zero rating rules that apply to land transactions between two GST registered parties.  In this edition I’m going to look at the new apportionment rules that were brought in at the same time and apply from 1 April 2011 with certain exceptions.  First a bit of background.

"Old" Rules

Historically the GST rules that apply to claiming GST on purchase have applied on a principal use test.  If the principal purpose in acquiring the asset was to apply it towards a taxable activity then a GST claim on the full purchase price was permitted.  For example if a car was being acquired with the intention of it being used 51% of the time for business purposes then full GST could be claimed.  The sting in the tail of the old regime then came in as the car was applied towards non business purposes as there were then relatively complicated adjustment rules that required GST output adjustments (i.e. payments to be made) each GST return period. 

The same rules applied in respect of property, whereby if a property was bought with the principal purpose of trading a full GST claim was available.  If the property was then rented residentially (which is an exempt use for GST purposes) adjustments were made each GST return period based on the rules set out in a judgment known as the Lundy case.

New Apportionment Approach

The new approach applying from 1 April 2011 allows for proportionate claims of GST.  Intuitively this does seem sensible.  If a car, for example, is going to be used 75% for business purposes and 25% for private purposes it makes sense that 75% of the GST be claimed at the outset rather than applying the old principal use test.  Where the complication in the new rules comes into play is that you then need to monitor the use of the car over time and if it transpires that it is only used 50% for business purposes then an adjustment will need to be made to repay some of the GST claimed so that the net amount claim equates to 50% of the GST paid originally so that it reconciles to the 50% business use.

Bob & His Car

To illustrate by way of example let's take Bob whom is a plumber and buys a vehicle that he expects will be 75% used for business purposes.  He pays $23,000 including GST.  The GST component of this is $3,000.  Initially Bob claims a refund of $2,250 being 75% of the GST paid reflecting the intended 75% business use.  The car was bought in June 2011. 

Bob now needs to monitor the actual use of the car over time and potentially make an adjustment in what is known as his first adjustment period.  The first adjustment period is either the end of the financial year in which the car is acquired or at the end of the next financial year.  For example Bob could choose his first adjustment period to either the period that ends 31 March 2012 or 31 March 2013.  Whatever adjustment period he chooses, as at that date he will need to calculate the actual business use for the adjustment period and compare it to the intended use.  If the actual business use at the end of the first adjustment period turned out to be 50% rather than 75% then Bob would have $750 GST to pay which then effectively means his net GST claimed is $1,500 (being the $2,250 originally claimed less the $750 adjustment paid back) which in turn equates to 50% of the original GST paid.

Application to Land

Many readers will be interested to know how these rules apply to property bought for dealing and development purposes where 100% of the GST has been claimed initially but the property is then rented residentially because an appropriate buyer cannot be found.  The first point to note is that these new rules only apply to property acquired on or after 1 April 2011.  If you own property at present in a GST registered trading entity and you are renting that residentially you make adjustments according to the old rules if acquired pre 1 April 2011.  In other words, if you have historically been making GST adjustments according to the formula set out in the Lundy case then you continue to do so. 

If you have acquired the property on or after 1 April 2011 and after claiming GST have not been successful in finding a buyer then you apply these new rules.  The starting point to apply the new rules is to determine what your first adjustment period is going to be.  Assuming a 31 March balance date this will either be the period that ends 31 March 2012 or 31 March 2013.  In short, if you have acquired a trading property on or after 1 April 2011 and end up renting it residentially you do not make periodic adjustments each GST return but rather will assess the actual use of the property as at 31 March 2012 or 31 March 2013.  If at that time the property has not sold you will look back and determine during the period of ownership how long it was rented for and how long it was applied towards the intended activity of property dealing (in other words how long was it on the market for).  Without going into detail if the property has been rented and not marketed for sale then its business use in terms of a percentage will be very low which will mean at the first adjustment period a potentially significant amount of GST will need to be repaid. 

To illustrate by way of example let us say that a property is bought in June 2011 for $460,000 with a $60,000 GST claim being made in the period covering the purchase.  The client decides that their first adjustment period will be period that ends 31 March 2012.  At that point the property has been owned for nine months.  Outside of the first two months of ownership where the property was renovated and then marketed for sale the property has been rented.  Without going into the detail of the calculation applying the formula shows that the property has only been 20% applied towards the taxable activity and 80% applied towards the exempt activity of residential rental.  The result of this is that there will be GST to pay of $48,000 for the adjustment period (being 80% of the GST claimed).

For those who are familiar with the far smaller but regular adjustments that are made in applying the Lundy calculation, you will immediately recognise that the adjustments under the new rules are going to be far more significant if a property is rented residentially for a significant period of time.

Conclusion

In summary, new apportionment rules mean that GST is not always claimed in full when an asset is acquired.  Rather you will need to ascertain what the business use percentage is and then claim that relevant percentage.  You will then need to monitor the actual use of the asset over time and decide on what period of time you are going to choose to be your first adjustment period.  At the end of the first adjustment period you will compare the actual use to the intended use and there may be GST to pay (or to claim) as a result.  In relation to property this GST adjustment could be very significant if the property is rented residentially.  Those with property acquired prior to 1 April 2011 can ignore these rules and continue to apply the existing rule.

As always please contact the team at GRA with any queries in relation to the above on 09 522 7955 or click here.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

Sunday Rant....

Labour intend to ring fence property losses to future property income. This will send thousands of investors broke fast. Take investors tax refunds away, property values crash. This is well documented overseas. Sweden property values dropped 35% when they ring fenced losses and the following govt reversed the policy, with values immediately there after recovering.

 Accountants would get a mountain of pre change planning work and we would have years of work to do.  While lots of New Zealanders will go broke with ring fenced losses and inolvency revenue will grow to. I'm not going to sit by and have to charge my clients for work that is going to make them go broke.  Labour are you thinking this through?
 

I would not want to be a banker though with losses ring fenced...will make an already difficult environment treacherous and property investors would want to be selling sooner than later.

This really is playing with fire by labour with little short term upside, given the global backdrop of deleveraging, and capital growth prospects in NZ with higher interest rates on their way, - next year or sooner, and potential for major problems globally as Asia and Aussie come off the boil and Europe and the USA choke on their indebtedness. This must put pressure on interbank lending rates within 2 years, especially if we see sovereign default in the PIIGS or USA.

The massive bureaucracy they built and squandered our money on, the buy back of kiwi rail,  now CGT, to name but a few blunders. 
  

Back on Tax

If you want instant cash flow targeted on property - it's simple. Introduce stamp duty like the rest of the world. Instant 3- 5% tax on the turnover in the property sector dampening speculation and raising major govt revenue, without the complexity of CGT.

If you are worried about any of these issues I have mentioned email or come and see me.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

Tax Changes – Are you making a mistake with LTCs – Look Through Companies

Many of our clients come to us because they are not getting advice or they are not satisfied with advice they are receiving from other accountants.  In recent times the tax changes introduced by the National Government regarding property investors have created quite a stir and presented some challenges to investors in regard to making a decision as to whether to (a) convert their LAQC (Loss Attributing Qualifying Company) to a Look Through Company (LTC); (b) remain a QC (ie LAQC without ability to attribute losses); (c) revert to "ordinary" company status; or (d) migrate out of the company into individual ownership of the assets.

As a practice we have found varying levels of advice from our peers.  On occasion we have been somewhat disappointed for investors with the level of advice they have been receiving, and in this vein I introduce a number of common issues which we discuss with clients that we hope will assist you in making a decision as to whether to turn your LAQC into an LTC or follow an alternative path.  If any of these questions are not answered in your affairs, you are welcome to contact GRA and book a no obligation review of your LTC and get some answers to these quite tricky questions.

1. Quick overview of the changes – what should you be thinking about

With the introduction of the new LTC regime, LAQCs lose their loss flow through from 1 April 2011.  This puts you in a position where you will not be able to get tax refunds if your portfolio is negatively geared for tax.  In addition to losing loss flow through with LAQCs, depreciation has been removed from buildings from 1 April 2011.  For many investors that are near to breakeven cashflow in the current environment the removal of depreciation claims on buildings will see them tax neutral - rather than producing a tax loss.  For this reason they may consider not electing to become a Look Through Company and instead remaining a qualifying company or reverting to ordinary company status.

Against the reduction of depreciation claims as a result of the tax changes, is the artificially low interest rate currently being enjoyed by many investors with floating interest rates near to 5.75%.  The average 10 year interest rate in New Zealand is around 7.25% and investors are better to be planning for such rate in planning their long term cashflow and tax position and when making the decision as to whether to become an LTC or not.  If for example you currently have $500,000 worth of debt in your company/LAQC, your interest rate is 5.75%, each incremental increase in interest rates of 1% will cause you to pay another $5,000 of interest potentially causing you to become tax negative.  If interest rates spike up above the 10 year average investors could be paying a lot more than this at certain parts of the interest rate cycle and in such a higher interest rate environment they will be seeking to access the tax losses and without being a Look Through Company may not be able to do this. 

1. Common advice around the country varies.

It interests the writer that different practitioners in different regions in New Zealand seem to be giving different advice.  In the smaller towns around the country we have seen one view prevailing that investors are better to avoid the complications of Look Through Companies and simply use the transition rules provided under the new legislation to move assets from your company to individual ownership or partnership ownership.  In our view this is short-sighted because you end up paying conveyancing cost twice.  Firstly, because you need to transfer the assets physically and refinance with your banker when you make such a transition from an LAQC to individual / partnership ownership.  Secondly, later when you ultimately seek asset protection over your assets, you will then need to convey the titles again to a Family Trust which results in double conveyancing cost, whereas in LTC you can simply shift the shares and avoid conveyancing cost completely.

The alternative view therefore is to simply fill in a form and send it to the IRD electing to be a Look Through Company.  Such election magically converts your LAQC to be the new structure known as the LTC.  The LTC status then allows you to claim losses as if the assets were owned individually by the shareholders. In other words the IRD treat the LTC as being "transparent" for tax purposes and allow you to claim the tax losses - subject to deduction limitation rules.  These deduction limitation rules essentially require you to have real assets exposed to the company in order to get access to your tax losses.  For example if your company is 100% financed and you have personally guaranteed the debt, in theory you should be able to get your tax losses out as you formerly did with an LAQC.  However, IRD limit the deduction which you can get out of the company to being a combination of cash introduced to fund the losses and guarantees given by the shareholders to the company to support the banking facilities.  However, if such guarantees are not supported by real assets, the deduction limitation rules may not allow the shareholder to claim all of the losses of the LTC. 

I realise this sounds a bit complicated and the reality is that it is complicated - and the IRD are not forthcoming in resolving some of the uncertainties.  In the end, the best I con do in terms of simplifying is to say if you fund cash losses in a company you automatically get full flow through of such losses.  If you have losses in the company that you haven’t funded, for example losses from chattels deprecation, you need to have either an existing shareholder current account to take the loss out of the company or a guarantee provided to the banker that is supported by real assets within your group.  For most investors the deduction limitation rules will not be an issue in our opinion and therefore while rather complex to get your head around, in practical terms an LTC will provide for loss flow through and will become the new stable investment vehicle for property investors who are negatively geared for tax, just as the LAQC was.  Long term benefits of LTCs just as you could with an LAQC, are flexibility in the transfer of the owner of the asset because you can simply shift the shares of the company and thereby shift the underlying assets.  For example, if one spouse owns 100% of the shares of the property LTC, and enters into divorce proceedings.  If that spouse chose under the divorce proceedings to transfer the rental properties to their spouse, such assets could be transferred with a share transfer rather than paying for conveyancing cost.

This gives rise to one downside of LTCs which was not there for LAQCs, that being the issue of depreciation recovered.  Depreciation recovered occurs where the disposal value of an asset is greater than the book value, and such asset has been depreciated.  For example, if you have claimed depreciation on buildings and chattels life to date and you transfer a rental property to another person, then where the disposal value is at least original cost you end up paying tax on the depreciation you have claimed life to date.

Moving to the LTC point, because LTCs are transparent for tax purposes where you shift the shares of the company you are deemed to be shifting the underlying assets themselves.  You therefore have a disposal for tax purposes creating the potential for depreciation recovered.  This was not the case with LAQCs and is therefore a disadvantage of an LTC, but exactly the same disadvantage exists with general partnership or individual ownership of assets.

On balance we therefore like the Look Through Company structure over the alternative forms of investment being individual ownership or partnership ownership, for negatively geared investors.  By negatively geared the writer means negative for tax purposes. 

1. Common issues we see.

• Advisors not looking at asset protection when transitioning assets. 

When considering whether to trade as a partnership or a Look Through Company as two options that are commonly reviewed in the transition of LAQCs, one thing you should have your eye on is how will you protect your assets over Trust over time.  The ultimate outcome you should be seeking is good asset protection structures while achieving tax efficiency.  Tax efficiency looks at a number of different things but clearly if you have got tax losses emanating from your portfolio, you need to make sure your tax losses are accessible to the person or entity that earns the money such that you can get tax refunds and utilise the losses.  While a sole trader ownership or partnership ownership of the assets directly obviously gives personal access to the losses, it does make asset protection nigh on impossible because how do you get the equity into a Trust without conveying the title?  

With a Look Through Company you can acknowledge a debt for any equity advanced to the company or recognise capital growth within the company and declare a capital dividend resulting in a shareholder current account for unrealised gains, which can then be assigned to a Family Trust which thereafter provides for asset protection.  In other words you can distribute the capital gain from an LTC to the shareholders, assign that to a Trust and gift it into a Trust to achieve asset protection over the assets, while continuing to enjoy accessing the tax losses - subject to the limitations outlined above.  In this way your legal goals of asset protection is being achieved as well as your tax planning goals of accessing the tax losses.  The alternative of individual / partnership ownership does not achieve any asset protection and therefore is an inferior option in our practice’s view.  LTCs are much better for asset protection and provide the tax benefits. 

If your advisor has given a different view and you would like to discuss this with us, CLICK HERE for an interview.

• Who should own the shares? 

With LAQCs a typical shareholding structure was 99/1 in favour of the higher income earning spouse.  This was common in the investment property community and allowed the payment of a shareholder salary to the homemaking spouse where that spouse is managing the rental portfolio.  Such salary must be market value for work actually done and could be declared at year end.  The result was the spouse receiving the salary and being subject to a lower tax rate than the spouse getting the loss from the company.  A tax advantage emerged where normally the taxpayer would claim 33% tax on the salary while the homemaking spouse only paid perhaps, say, 11% on receipt of the salary.   

With Look Through Companies any salary paid must be subject to PAYE, shareholder salaries are not possible.  Secondly, where the salary is paid to an owner of an LTC engaged in property investment or trading such salary is non-deductible to the company (yet it is assessable revenue to the spouse).  For this reason it would be ludicrous to pay a salary in such circumstances. 

Where an investor does want to remunerate the work done of a spouse, they will only be able to do it and gain some sort of tax effectiveness from it where the spouse is not a shareholder in the company.  Therefore we believe it will become common practice for the previous 99/1 structure to become 100% held by the working spouse and the homemaking spouse will not hold any shares whatsoever.  This will enable spouse salaries paid on PAYE if the investors wish to do this, provided that it is market value for work actually done, a written employment contract is put in place and the other abovementioned factors are satisfied.

• What about debt deductibility? 

A common issue we see with accountants and advisors talking about choice of structure and LTCs with their clients is they fail to look at the long term issue of debt deductibility.  Common problems with debt deductibility that we see are the mixing of private debt with business debt, leading to business debt not being deductible.  This becomes particularly problematic where the family home is held by the partnership alongside the rental investments.  Separation of the rental investments in an LTC, with the home held in a Trust makes it much easier to clearly separate private and business debts, and preserve interest deductibility.  LTCs also allow you over time clearly identify the cash input to the portfolio as a separate shareholder current account and in some circumstances investors may be able to refinance private debt from their home into their LTC.  Strict criteria need to be met to achieve this and we recommend taking advice from an appropriately qualified person before looking at doing this.  We also note that this more difficult to achieve with partnerships and therefore another reason why you might want to go LTC instead of being in a general partnership.

If you would like to discuss debt deductibility issues or LTC issues CLICK HERE to book a meeting with Gilligan Rowe.

• Dealing with Gilligan Rowe / Booking a Meeting

Many of our clients around the country have their own accountants and lawyers but use us as experts to review their affairs and make sure they have good asset protection, optimise estate plans and the most tax efficient structure.  With the removal of gift duty coming up and anticipated to occur on 1 October 2011, the changes to depreciation rules and the LAQC / LTC changes, many people around the country are booking a meeting with Gilligan Rowe to meet by Skype or telephone, or in person if they live in Auckland, and take advantage of our very specialised practice that deals in optimising commercial structures for property investors. 

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

Capital Gains Tax

Once again the topic of capital gains tax (CGT) has reared its ugly head.  Speculation is that Labour will unveil a property investment targeted capital gains tax when it announces its tax policy in the next two weeks.  The Greens have thrown their not so considerable economic muscle behind the proposed tax.  In light of this, let’s examine some of the arguments that proponents of CGT put forth:

• Capital gains should be taxed because there should be no difference in outcome between a taxpayer whom generates a gain of $50,000 through the sale of a capital asset and one whom earns $50,000 through salary.  In other words, taxing capital gains is fair and would create a more “pure” tax system with less incentive to direct investment into assets where there will be no tax to pay on gains.  This argument falters, however, when it seems inevitable that if there is a capital gains tax it will exclude one’s private residence and furthermore it seems as though Labour have their gun sights fairly and squarely set on property investors as opposed to share investors, for example.  There are also suggestions that there will be a threshold so that smaller capital gains are exempt.  Where is the fairness and purity in the tax system if the tax does not apply across all investment classes and furthermore there are exemptions within property?

• Capital gains tax will generate revenue to allow for tax cuts, possibly a tax free threshold.  The difficulty here is that a proposed capital gains tax may not generate the revenue expected and certainly not in the short term.  Again there is suggestion that property acquired prior to the introduction of the tax will not be subject to tax.  Furthermore, a capital gains tax may create a “lock in” effect whereby investors defer selling assets in order to avoid triggering the gain. 

• Capital gains tax will make property more affordable particularly for first home buyers.  It seems a bit defeatist to me to seek to solve the housing affordability problem by depressing house prices rather than raising real incomes.

• A capital gains tax will rebalance investment and redirect investment away from property and into more productive forms of investment.  In response to this may be tax is not the answer?  With finance companies failing and questionable practices from some in the financial advisor industry in the past, it is perhaps little wonder that property is such a popular form of investment.  Obviously there have been recent changes in relation to the regulation of financial markets, and it will be interesting to see what impact this has on investment biases of Kiwis moving forward. 

Some other points of concern in relation to the introduction of a capital gains tax include the fact that it is inevitably complex.  Once you move to exempt private homes or other classes of assets (for example, farms?) you exponentially increase the complexity of the proposed law.  You create incentives for people to structure their affairs to work around the capital gains tax.  There is also the issue of an immediate impact on property values.  This point often raised how desirable would it be for property values to take a material hit when off the back of a global recession many property owners are already heavily geared and would end up with negative equity.  What would be the knock on effects for lenders?

In the end, I can’t see how a capital gains tax will produce the outcomes that its proponents seek.  However, one outcome which I do see as a certainty is defeat for Labour at the ballot box if they proceed. 

If you require help with your property portfolio or tax return please get in contact with us at GRA we are here to help, CLICK HERE and fill in the form and we will be in touch otherwise call 09 5227955.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.

New GST Regime

On 1 April 2011 new GST rules came into force.  Perhaps the change of most significance to many of our clients are the new rules around zero rating of land transactions.  These rules were brought in to address concerns the Government had about GST leakage where land was being sold from one GST registered party to another, with the GST registered purchaser making a GST claim that was funded by the IRD, only for the GST registered vendor to turn out to be insolvent meaning the IRD were not able to collect the GST from them.

As a result new rules now apply to transactions involving the supply of land between GST registered parties.  Put simply, any supply which involves land is zero rated for GST purposes which means that GST applies at a rate of 0%.  A registered purchaser does not pay nor claim GST and the registered vendor does not return it.  This prevents the IRD from ending up in a situation where they are out of pocket.

If you are a vendor or purchaser of land you need to be very careful.  Consider the following situation from a purchaser's perspective:

• You are buying a property for trading purposes.  You are an experienced trader and have a GST registered Trading Trust through which you conduct your trading activity.  You generally buy properties for around circa $230,000 and are accustomed to claiming GST in respect of these purchases which then means the net cost to you after your GST claim of $30,000 is $200,000.

• You find a new property that fits your criteria and eventually negotiate a price of $230,000 inclusive of GST anticipating a refund of $30,000.  However, it transpires that the vendor is GST registered and themselves selling the property as part of their trading activity.  Under the new rules you are not able to claim $30,000 GST as the transaction is zero rated, meaning that the applicable GST rate is 0%.  As the purchase price was $230,000 including GST and the GST is nil, the net cost to you is $230,000 and you will still have to account for GST on sale – unless you sell to another GST registered party buying the property for taxable purposes.

There is an addendum that has been added to the standard sale and purchase agreement but we are aware of instances where vendors are not filling this out or it is being filled out when it isn’t required to be. 

The result of all of this is that you should act with the upmost caution if you are a GST registered purchaser or vendor of land.  Please contact us at GRA for specific advice on your transactions as required.  Make sure you do this before contracts go unconditional so that you have certainty around the GST treatment before you are committed.

Matthew Gilligan
Director

Learn More about Matthew
Contact Matthew at mg@gra.co.nz
or call +64 9 522 7955

P.S. Did you like this article? Go ahead and sign up to our free newsletter and receive tips, updates and useful information to help you protect your assets and grow your net worth.  GRA are accountants who provide expert accountant advice both in NZ and offshore.