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

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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

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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.

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

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Don’t Miss The Boat

The 2012 tax year began on 1 April 2011 for most taxpayers and with it new tax rules in relation depreciation on buildings and LAQCs finally came into force.  We have written a number of times on the potential impact these rules may have on you if you have an existing LAQC and have long been encouraging our clients to make contact with us in order to have their circumstances reviewed so that appropriate action can be taken.

If you have an LAQC and have not yet obtained advice in relation to the impact of the new rules on you it is not too late but time is running out.  Contact us at GRA for a meeting immediately.

By way of summary, the key changes are as follows:

• Tax losses of an LAQC can no longer be attributed to shareholders.  This means if you have a loss making LAQC from the 2012 year onwards you will no longer be able to personally claim the tax losses produced by the LAQC.  If you are in this situation you need to take action. 

• Whilst LAQCs can continue to exist without the ability to attribute losses, no new companies can enter the LAQC or QC regime.

• In what can be regarded as a replacement of the LAQC regime the new Look Through Company (LTC) regime has been enacted.  An LTC is perhaps best described as a “cousin” of an LAQC.

• LTCs share some characteristics of the old LAQC regime in that tax losses can be attributed to shareholders and capital gains can be released from an LTC. 

• However, there are some significant differences including the fact that there are rules that effectively limit the amount of loss that shareholders can claim, profits are also attributed to shareholders rather than being regarded as company profits, shareholder salaries can not be paid from LTCs, and shareholders are regarded as owning the underlying assets for tax purposes, which means when you sell shares in an LTC you are regarded as selling the property which can have income tax implications for you if the LTC owns property that is on revenue account or depreciable property. 

There are a variety of options available to those who have LAQCs and we also see the new LTC rules as offering opportunities for clients with existing companies and offshore operations in certain circumstances.  Please contact us at GRA for a meeting to discuss the potential opportunities that the new LTC regime presents.

Matthew Gilligan
Director

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

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LAQC / LTC TAX CHANGES

As you will now be well aware the LAQC / LTC tax changes are fast approaching.  They take effect 1 April 2011.  If you have an LAQC and you have not yet discussed with us what course of action to take you need to contact us urgently and book an LAQC/LTC review meeting.  As a recap some of the key points to note in respect of the rule changes are as follows:

• If you do nothing your LAQC will remain an LAQC, but a rule change from 1 April 2011 means shareholders of LAQCs can no longer claim tax losses.  In other words the LAQC loses the ability to attribute its losses to shareholders.  In most cases doing nothing is not an option.

• In conjunction with the LAQC/LTC changes, depreciation can no longer be claimed on buildings.  In many cases this means that tax losses that are currently being experienced will turn to tax profits.  This means you need to ask the question as to whether your current structure is appropriate given this change in tax result?

Broadly speaking if you have an LAQC at present you have a number of options available to you including the following:

• Do nothing and remain in the LAQC regime - although as noted you will not be able to attribute losses to shareholders.

• Convert the LAQC to an LTC, but leave everything else the same.

• Convert the LAQC to an LTC, but at the same time examine whether the shareholding structure in relation to the company is appropriate.

• Convert the LAQC into an ordinary company and potentially restructure the shares as well.

In summary, the changes to the LAQC rules and the implementation of the LTC regime means that all existing LAQC clients need to have their affairs reviewed to determine what the best structure is for them from 1 April 2011 onwards.  We are offering LAQC/LTC review meetings at a discounted cost of $150 plus GST.  Do not delay in setting this meeting up as you need to have the advice in advance of 31 March 2011.

Matthew Gilligan
Director

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

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Since announcing in May that the LAQC regime was going to be the subject of an overhaul the property investment community has been anxiously awaiting the Government’s follow-up to the Issues Paper released at the time.  On Friday 15 October 2010 draft legislation was released.  As at the time of writing all practitioners, including myself, were poring over the draft to get to grips with the new regime.  The objective of this article is to provide an overview of the proposed rules.  Contact Us At GRA

Recap

In May sweeping changes to tax rules were announced with the ones of most significance to property investors being the prohibition on claiming depreciation on buildings after the end of the 2011 financial year and drops in personal income tax rates.  At the same time the Government announced that they wished to review the current tax rules in relation to LAQCs.  In the Issues Paper it was proposed that LAQCs would be treated as limited partnerships for tax purposes with the three main consequences of this being:

• LAQC profits would be attributed to shareholders (as well as losses).  Perhaps unsurprisingly the IRD had expressed concern that the existing tax rules allow an arbitrage in that shareholders of a loss making LAQC can offset losses against their personal income where the tax rate has historically been as high as 39%, whereas they could hold shares in a profit making LAQC and have the profit taxed at the lower company tax rate (historically 33%, now 30% and moving to 28% from 1 April 2011).
• Losses able to be claimed by shareholders to be limited to the shareholder’s “investment“ in the LAQC.  Broadly speaking this was proposed to include capital of the company, together with retained profit and any company debt guaranteed by the shareholders.  Shareholder loans were not included and many submissions were subsequently fielded on this point.  The objective here was to limit the ability of the shareholders to claim losses that exceed their economic exposure to the activities of the LAQC.
• Shareholders to be regarded as owning the underlying assets of the company for tax purposes.  This meant that upon disposal of shares there would be a disposal of the underlying assets potentially triggering depreciation recovery or tax on any “tainted” gains through association to dealers, developers etc.

Draft Legislation

With draft legislation now available it is clear that the Government is committed to implementing these changes and the outcome is largely as set out in the original Issues Paper albeit that the route chosen is simultaneously more complicated, but more friendly for taxpayers.

The headline of the draft legislation could well be “LAQCs are gone”.  From the 2011/2012 income year existing LAQCs will no longer have the ability to attribute their losses to shareholders which effectively represents the end of the LAQC regime.  Before readers with LAQCs that are going to produce tax losses post 2011 throw their hands up in despair let me introduce you to the new LTC structure.   Contact Us At GRA

The new LTC rules (LTC stands for “look through company”) are essentially the same as the proposed rules in the Issues Paper released in May.  In other words an LTC is a company that will be taxed as a limited partnership.  All profits and losses of an LTC will be attributed to shareholders in accordance with their shareholding interests.  If losses are produced the shareholders ability to claim those losses and offset them against other forms of income will be restricted if the losses exceed what is known as their “membership basis”.  Broadly speaking the membership basis is as noted above with the confirmation that shareholder loans are included in the calculation.  The sale of shares in an LTC will be treated as the sale of the underlying assets so that potentially issues like depreciation recovery will arise.  In saying that it is noted that there are thresholds and exceptions as to when there will be a tax cost. Contact Us At GRA

Transition Options & Relief for LAQCs

On a positive note the new rules contain extensive transitional rules that allow existing LAQCs to seamlessly transfer into the LTC regime or into an alternative limited partnership, general partnership or sole trader structure if desired without a tax cost.  This is an excellent outcome for taxpayers utilising LAQCs at present.

Perhaps the best way to sum this up, if you have an LAQC at present going into the 2011/2012 income year you have four options as follows:

• Do nothing which will see your company remain an LAQC but lose the ability for the losses to be attributed to the shareholders. 
• Transition into the LTC regime.  Under the draft legislation you will have six months to file an election with the IRD to convert your LAQC into an LTC which will then see it taxed as noted above.
• Take advantage of the transition provisions to restructure your LAQC into a limited partnership, partnership or sole tradership.  Any such transition will not come at a tax cost but there are restrictions as to when this is available.
• Revoke LAQC status and have the company revert to being an ordinary company. 

Comment

In my view, the new rules contain no greater issues for investors that currently operate LAQCs than were raised in the original Issues Paper.  It is fair to say that the introduction of the new LTC regime complicates matters in that investors will now have grapple with a new regime but it seems likely to me that most will choose to transition their LAQCs into the LTC regime.  Whilst an LTC has potential disadvantages in terms of the potential limitation of losses and the disposal of shares potentially triggering tax consequences these potential disadvantages may not be an issue for many investors.  In most cases the shareholders of an LTC will be guaranteeing the debt and therefore the shareholder’s membership basis will likely always be large enough to allow full ability to claim any losses produced.  The treatment of a disposal of shares as being the disposal of underlying assets is definitely an issue for those of you whom have properties that have been heavily depreciated and you should seek advice as to your options prior to 31 March 2011 if you are in a situation.

In closing, I see the LTC as effectively replacing LAQCs and see them as being widely used by investors.  Having said that, the transition process presents both opportunities and risks for investors and I urge you to get advice in relation to your existing LAQCs and the transition options prior to 31 March 2011. Contact Us At GRA

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.

Now that the dust has settled on what was one of the most anticipated budget announcements in recent memory, now is time to reflect on the impact of the announced and proposed changes on property investors.  In doing so I am going to focus on the specific impact of the tax changes and leave aside for the moment the wider macro effects of the impact of this budget on the economy.  Broadly speaking there are five areas where the tax changes will impact on property investors.  They are as follows:

• The drop in personal marginal tax rates;
• The removal of depreciation claims on buildings;
• Proposed changes to the LAQC regime;
• Raising GST to 15%;
• Extra funding for audit activity at the IRD.

For advice on how the changes impact you contact us.

Depreciation vs Tax Cuts

Let’s take an example of a typical property investor that has taxable income from their job of $75,000 per annum and owns two rental properties that are currently worth circa $700,000 but were bought in 2002 and 2006 for $550,000.  For the 2011/12 income year if depreciation was still able to be claimed on buildings they would have been expecting to make a circa $6,800 depreciation claim which would have a maximum tax benefit of circa $2,200.  At the same time due to the cuts in personal tax rates there is an increase to their after tax income of circa $2,400.  Following this, the investor is $200 better off in the 2011/12 year.  It is also worth nothing that of course depreciation is usually claimed on a diminishing value basis so the amount that would have been claimed on the building moving forward would be reducing over time.  Finally, there is also the fact that in many instances depreciation claims produce a timing benefit only in that it is then recovered on sale.

Following this, we see the removal of depreciation claims as being mitigated by the drop in income tax rates (of course there will be additional private GST costs).

LAQC Regime

The budget announcement also signalled that there will be changes from the 2011/12 year to the LAQC regime.  At the moment the proposals are at issues paper stage only which means they are open for public submission until early July 2010.  The philosophy behind the proposed changes are to align the tax treatment of qualifying companies and loss attributing qualifying companies with limited partnerships.  This means that some of the same aspects that LAQCs have now will be retained in that tax losses will continue to be attributed to shareholders in proportion to their relative shareholding.  However, it also means a number of changes to other aspects of the LAQC regime.  It will mean that taxable profit is attributed to shareholders rather than taxed at company level and there is also a proposal to limit the amount of tax loss that can be claimed to the shareholders’ exposure in the investment. 

If you have an LAQC that may become tax profitable, then contact us for advice.

At this point in time the rules are not finalised but we will be watching this closely and it may well be that many investors who currently have properties in an LAQC will need to consider whether this is the appropriate structure for them moving forward. 

If you have an LAQC with property in it, contact us for advice on restructuring prior to the rules changing.

The fact that depreciation on buildings has been removed, which may lead to a decrease in the tax losses (or perhaps even some properties even becoming profitable), along with the proposed changes to the LAQC regime mean that a review of structures is necessary.  If the changes continue to proceed as proposed affected investors would be best placed to restructure prior to 1 April 2011.

If you are selling property and want to know about the impact of depreciation recovery then contact us.

Likewise if you are buying property and want to know if the LAQC is still the right structure then contact us.

The rise in the GST Rate & Audit Activity

The rise in the GST rate will not have a discernible effect on residential property investors other than expenses that they currently incur that attract GST will increase without the ability for the GST to be reclaimed.  There will be an impact on property traders and commercial property investors however.

If you are a property trader you need advice on transactions occurring around 1 October 2010 when the rate changes.  Please contact us for advice.

It is also worth noting that extra funding is going to be provided to the IRD with one of the focuses being the property industry.  As a result we encourage property investors to make sure that they are involving professionals in the preparation and filing of their tax returns and making sure that they are getting appropriate tax advice in relation to property transactions.

If you are concerned about tax treatment on past transactions or need advice on current ones, then contact us

Overview

Overall we think the budget was a largely positive one for property investors even in respect to the tax changes.  Certainly leading into the budget there was talk of ring fencing of losses, which has not come to fruition and would have had a much more significant impact on the property investment sector.  As it is the removal of depreciation claims on buildings from the 2011/12 year will definitely impact on property investors, but perhaps for property investors any impact of this will be matched by gains to the drop in personal tax rates.

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.