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.

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

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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

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.

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

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.

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

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As a structuring advisor to investors and business people, one very common mistake with many  business and property structures is a spouse being offered as a guarantor to the banks, landlords or creditors of a business.

Their personal guarantee is often not required to get a deal done, yet it is provided because the advisors around you do not stand up for you and say 'hey, don't let your spouse sign that - you don't need too'. The result is that if total business or investment failure occurs, both spouses are fully liable instead of just one.

Of course the creditor, banker or landlord requesting your spouses guarantee will insist it is necessary 100%, because it is in their interest.

But it is contrary to your interests.

My advice is NEVER give your spouses guarantee in business or property dealings if you can avoid it. I have developed over 80 million dollars in property, and guaranteed numerous business and banking obligations, purchased multiple investment properties, - and my wife has never signed a personal guarantee on the loans.

Why ? To shelter her from the obligations.

How did I avoid her being liable? By saying no to the banks and creditors when they asked. Did it hamstring her legal or matrimonial rights to recover the property if we divorced? No, - she still gets the assets because she jointly controls the Trusts and various entities borrowing. So this is not about stripping power off your spouse and potentially wealth, it is purely about minimising risk to your household.

Examples of this include:-

1. Borrowing money from the bank to purchase an investment property or even your home. If one spouse is a homemaker, has no income or their income is not required to meet debt servicing criteria of the bank, - then why allow the bank to take their guarantee? The only use of the guarantee will be to apply more pressure to your family if you have a problem, and both spouses go bankrupt instead of one ( which could be viewed as malicious in this light).
   
   One point to note here is that you may need to use a mortgage broker to manage the negotiation with the bank, - and the broker will have to work a bit harder to achieve this. If you deal with a bank direct, they will likely tell you 'no spouse guarantee is impossible in your circumstances'. It may be true if your borrowing position is not strong, but how do you know unless you have a lot of banking and commercial experience?
   
   The answer is use a broker who has the experience, and who is willing to try hard for you. I have found many brokers lazy, or unsophisticated - they are just not equipped for these sorts of discussions with bankers or do not value asset protection concepts. Remember they get paid on commission, and asking for tough things from the bank means more work and time for the broker, with no more money. For this reason it may be appropriate to pay your broker to deal with the complexities, if your affairs are complex. Otherwise they may put you in the 'too hard' basket. If you need a good broker, email me mg@gra.co.nz . We have contacts all over the country, and for the record we do not get commission from these relationships. We just want our clients better protected.

2. Dealing with landlords over commercial leases and guarantees: always try to divide leases out into separate 'tenancy companies' and make one spouse a director of this company, Your opening position should be no personal guarantee, and if 'no personal guarantee' is a deal breaker with the landlord, - then only the director/one spouse gives a guarantee. Try not to give an unlimited guarantee, - limit it to say 6 months rent, or a fixed sum as a cap.
   
   For example my rent is around $260,000 per annum for our premises, on a 3+3. If I guarantee it for an unlimited amount, that is a $780,000 personal obligation. Firstly, I limited the guarantee to 6 months rent ( $120,000) and secondly made sure that the shareholders (a Trust) and my spouse did not guarantee the loan. This turns a potentially disastrous obligation into a manageable commercial obligation.

3. Dealing with creditors over personal guarantees: creditors in business will generally ask for a personal guarantee. Refuse to give it if you can get away with it, and most of the time you can. Where you have to give one, just as with a landlord 'limit the guarantee'. Only this week I was arranging some advertising with Fairfax, and they asked me for two GRA directors personal guarantees over the obligations of our supply relationship with them for advertising. I was so annoyed, I told the salesman I did not wish to advertise with Fairfax if a personal guarantee was required. I told him clearly his company's view was that my company was unreliable in character, if they were not willing to deal with the company without the director's guarantee.
   
   He got the message - I really cared more about the guarantees than the advertising and they would not get our money unless they backed away from the guarantees. He rang later to advise the guarantees would not be necessary. To my knowledge, GRA directors have not guaranteed a single supplier obligation (apart from the limited guarantee to the landlord). So it can be done, but I do acknowledge that some suppliers just won't deal with you without providing a personal guarantee.

Summary

Keep your spouse out of the liability chain if you can. Personal guarantees and spouses should not mix.

If you are dealing with a landlord or creditor in business and have to provide a guarantee, try not to give a guarantee at all, or limit the guarantee to a fixed sum Eg: 6 months rent.

If your spouse has no income, you should be able to avoid their guarantee being given to the bank. Consider using a mortgage broker to achieve this. Generally the banks (if dealing direct) will be very hard to manage on this point, especially in this recessionary environment.

I hope you have found this information helpful.  If you require assistance with any financial matters, please fell free to request an interview.  We are here to help.

Have a good month!

Partnership really means two or more people or entities coming together in a common undertaking or enterprise.

You can trade your partnership through various trading vehicles including companies/LAQC's, joint ventures, general partnership, special partnerships, limited partnerships, or Trusts. Each trading vehicle should have an agreement created between the partners to the investment defining their rights and obligations. In a company for example, this is done in the shareholders agreement. In a partnership, the partnership agreement. In a joint venture, the joint venture agreement etc.

Which Trading Vehicle ?

Choosing the right structure is a combination of assessing many factors and choosing the vehicle that delivers maximum benefits for your particular circumstances. While a more detailed discussion on these issues are explored elsewhere on this site, a brief review of things to consider would include the following (looking at partnerships from a property investor's context):-

1. Asset protection implications (including limited liability vs unlimited liability for actions of the partnership, and liability for the banking obligations of the partnership by the partners) LAQC's for example require shareholders that are electing into the LAQC regime to personally guarantee the IRD for income tax.

This can be managed for small shareholders, but is one asset protection consideration in the mix. Another thing to review, - is your proposed structure creating wealth outside of a trust, and if so is it possible to both have your losses accessible and contain capital gains inside your Trust for asset protection and avoiding future gifting problems ?

2. Flexibility of ownership; (Ccan you change partners without triggering depreciation recovered ? 'Yes' for an LAQC, 'No' for most partnership circumstances.

3. Flow through of tax losses: will the trading vehicle let you access the losses?

4. Flow through of capital gains: will the trading vehicle allow easy access to capital gains at the end of the investment, or do you have to liquidate (for example a company will require liquidation unless it is a qualifying company to access capital gains tax exempt in NZ).

5. Cross border tax considerations: for those investing off shore or cross boarder, have you thought through the complex tax issues that arise? Like capital gains tax, non resident withholding tax, the implication of the New Zealand Accrual rules and foreign exchange movements, and double tax on dividend income.

Generally there is a simple and effective structure for most circumstances. Contact me if you require assistance with any matter above.