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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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

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A common question that I get asked is – what impact do rental losses have on my entitlements to Family Assistance? Before I answer that lets just go back a step and talk about Family Assistance...

First, the technical name is now Working for Family Tax Credits (WFTC). They are entitlements that families with children may qualify for depending on the number of children you have, the household income and the hours each week you work. As a rough guide a family with three children can qualify for payments under this scheme with household earning of up to $105,000.

As your entitlement to WFTC is dependent on your level of income the question then is – can you take into account rental losses in calculating your income for WFTC purposes?

The answer to this is not as straight forward as you might think. If the rentals are owned in an LAQC then the answer is no, the losses are not taken into account. This means even though your attributed loss from the LAQC will reduce your taxable income and the income tax that you pay thereon, it will be disregarded when assessing your income and eligibility for WFTC purposes.

Now whilst that may or may not surprise you I am sure that this will. If you own a rental property personally the losses are taken into account for WFTC purposes. This means if you have a loss-making rental property owned in personal names you will qualify for more WFTC support than you would if you owned the same rental via an LAQC.

Now to further confuse things, if you have a business and the business produces a tax loss, that loss is also ignored for tax purposes. What this means is that if the IRD regard the rental activity that you conduct personally as a business then the losses are ignored, just as the LAQC losses are.

This begs the question as to what qualifies as a business. It seems clear to us that one rental property does not qualify as a business and therefore you are safe to assume that the losses from one rental property can be offset against your income for WFTC purposes. If you own two or more rental properties personally then it may be that the investment activity constitutes a business and the losses are ignored. Each case needs to be treated on its own merits.

As we have been pondering this here we have been trying to work out the policy rationale behind the rules. It can not be that the government did not want depreciation deductions in respect of rental properties influencing WFTC payments as if that were the case the law should not allow a single rental property owned personally to be taken into account for those purposes. It seems on the face of it to suggest a policy whereby investment and business activities are discouraged. However, even this does not explain why tax losses from an LAQC and businesses are excluded and rental losses from a single rental property are not is puzzling.

It is also worth noting that the exclusion of the LAQC losses for WFTC purposes contrasts with assessments in relation to child support, which do include LAQC losses. Obviously the policy issues are somewhat different, but the contrasting treatment is worth noting.

Given the law is what it is, this begs the question as to whether you are better off owning rental properties personally or in an LAQC. If you do qualify for Family Assistance there may well be benefit in owning the property personally but you need to weigh up the impact that this will have in terms of additional WFTC support versus potential downside of owning personally as opposed to an LAQC in terms of loss of ability to stream the tax losses through the higher income earner, ability to pay shareholder salaries and potentially the ability to structure debt in an advantageous manner.

It may well be that the flexibilities and rewards of LAQC ownership outweigh the marginal increases in WFTC but again each case should be judged on its own merits.

If you have any queries or concerns regarding to the interrelationship between WFTC and rental losses please contact us at GRA.

Matthew Gilligan
Director

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

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Warning To Solicitors, Accountants and Trustees/Trust Advisors...

BEWARE THE APPOINTOR IN NEW ASSOCIATED PERSONS RULES

(11 August 2009)

While the Finance and Expenditure Select Committee managed to weed out much of the over-reach of the new associated persons definition there still appears to be a glaring problem in relation to the Trust to Appointor test in section YB 11.

In the Official’s Report to the Finance and Expenditure Committee on submissions on the bill, the Committee was made aware of the potential for s YB 11, when coupled with the tripartite test, to lead to otherwise unrelated Trusts being associated when professional advisors are nominated as Appointors. This valid concern was raised by Tomlinson Paull and whilst accepted by the Committee, not enough has been done to prevent the undesirable outcome of otherwise unrelated entities from being associated to each other.

As background, this is about association rules between dealers in land, developers or builders and other entities in the business of buying and holding property that are ‘related’ by the associated persons rules. The concern is that if associated, an entity buying property to hold will be taxable on capital gains on properties sold within ten years of acquisition, if at time of acquisition the buy to hold entity was associated to a dealer, developer or builder.

The rules are changing and are much wider than they were, introducing the prospect of:-

Section YB 11 in the new Taxation Remedial bill associates Trustees of a Trust with the person or people who hold the power to appoint and remove Trustees. In short, a Trust is associated with its Appointors. The tripartite test at s YB 14 associates two parties where there is a common associate of both provided that the common associate is not associated to the two parties under the same rule.

For this reason, if a professional holds the Power of Appointorship in respect of a Trust (being Trust “A”) and then holds the Power of Appointorship in a second Trust (Trust “B”), there will not be association between the two Trusts under the tripartite provision as the common associate (being the advisor) is associated to both Trust A and B under the same test.

The Select Committee held this limitation out as being the reason why there would not be unintended Trust to Trust association. Whilst it is true this will prevent an advisor who holds this power in respect of multiple Trusts from creating inadvertent association between the Trusts, the door is still left wide open for there to be association on a far wider scale than surely could have been intended.

To explain further, consider the situation where an advisor accepts a role as Appointor in relation to a Trust that is going to buy an investment property. The Appointor is related to the Trust under s YB 11. The same Appointor might also own shares in a development company, perhaps be Settlor of a second Trust (otherwise unrelated to the first) that is involved in property development or might even be deemed to hold shares in a company involved in development under s YB 3.

What this demonstrates is that there is a raft of other provisions that might associate otherwise unrelated Trusts or companies to the Appointor then leading to association between these other entities and the first Trust under s YB 14. This is obviously not a problem that is fixed by the exclusion of not being able to apply the same rule twice in s YB 14.

Negligence Prospect

Of course reading this you might say that the advisor in that instance would be negligent in accepting the role of Appointor given that they should be aware that they are associated to a development company, and you may be right. What taxes could arise from this on other client’s assets as a result of this oversight?

Thirty percent of capital gains in the next ten years, on assets acquired during the period of association would be an approximation of the answer. However, there might be situations that arise where the advisor has less control over the matter.

Whilst uncommon it is not completely unheard of for an advisor to be a “back up” Appointor in respect of a Trust when the original Appointors die. Or what if a client decides to start trading / developing / building property in their Trust that you are appointor in and does not tell you ? Or what if IRD deem such activity to have existed ?

Summary

It seems clear to us that this is a flaw in the associated persons provisions that was quite rightly raised before the Select Committee but their proposed solution does not work.

The moral of the story clearly is to be careful whom you nominate as an Appointor in respect of your Trusts both now and in the future. It can lead to unwanted consequences. 

A brief background on the new associated persons rule changes (if you are interested) is here.

Remember these blog articles address the general public and are therefore simplified in the blog for the intended reader.

If you would like help with understanding how this affects you, or have a question, we are here to help.  You can Request a Free Interview or use our Ask the Experts service.

Until next time,

Matthew Gilligan
Director

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

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The much talked about new Association Rules are back before Parliament and unfortunately for those in the business of dealing in or developing property or erecting buildings, the Bill has not been substantially changed.

The new expanded definition of association has largely survived the Select Committee process and the new rules are likely to come into force in August, potentially from early August.

We are currently working through the rules so if you are looking to buy a rental property in August please contact us for advice if you are concerned about potential tainting.

Important Note for Builders

If you are in the business of erecting buildings this is the one activity that could lead to tainting of existing properties. To explain, if you are a dealer or developer only (ie. not involved in the business of erecting buildings) any rental property that you own now and that was not tainted under the existing rules will not be affected by the new rules. Further purchases could be, but your existing rentals will not be.

On the other hand, if you are in the business of erecting buildings, existing rental properties that you have could be tainted if you carry out improvements on those properties. If you are in the business of erecting buildings and are looking at making improvements to a rental property then contact us immediately as you need to know the implications of this.

Changing Use on Existing Stock

The other major impact that the change in Association Rules has is for those of you who have property bought for dealing and development purposes where you are considering a change of use. If you have a property bought for dealing and development purposes and you are considering holding it (ie. making a complete change of use in respect of that property) you need to contact us urgently.  You should consider restructuring the ownership of that property in the next two weeks before the new rules come into play.

Summary

In summary, the new Association Rules are coming in and as feared they are wide reaching and going to make it very difficult for those engaged in a business of dealing in or developing property or erecting buildings to prevent future rentals from being tainted.

More immediately than that though, if you have property owned by your dealing and development entity that you now wish to hold long term you may need to take action within the next two weeks to restructure the ownership of that property before the rules change. If you are in the business of erecting buildings you also have to be extra careful if making improvements to existing rental properties.

If you want tax advice in relation to these issues please contact Anthony at GRA on 09 522 7955 or at anthonyl@gra.co.nz.

Thank you.

Matthew Gilligan

In a welcome development for taxpayers, the Minister of Revenue, Peter Dunne, has recommended to the Finance and Expenditure Select Committee considering the new associated persons rules ( for dealers in land, developers, and builders) that the implementation date of these rules be delayed.

To recap, legislation has been drafted which is proposed to apply to land acquired on or after 1 April 2009. The proposed legislation includes new associated persons rules which drastically widen the existing definition of an associated person, - causing developers/traders / builders other entities (and potentially their relatives) to have their capital gains taxable, no matter what structure they adopt.

Executive Summary

The legislation is currently before Select Committee but has been significantly delayed due to the intervention of the election. The Select Committee is only due to report back to Parliament on 30 June of this year. This has raised the issue of the legislation having retrospective effect which would mean that taxpayers would not know when they acquire property after 1 April but before the enactment of the legislations whether property that they have is tainted under new associated rules or not. For example despite the legislation not being passed, if a builder, or dealer in land or developer acquired a property in an LAQC not associated to their Trading Trust on the 1 of April, - they may or may not have been tainted under previous indications from IRD. It was unclear as to the position taxpayers were in Now it is clear – the old rules still apply until at least July, but possibly later ( perhaps even next year).

Background

Fortunately it seems that common sense is going to prevail and that the implementation of these rules is going to be delayed. In his recommendation, Peter Dunne has suggested that the new rules apply to land acquired on or after the date of the Bill’s enactment or, where there is association to a builder, applying to improvements on or after the date of enactment.

This is a potentially significant development for taxpayers and one which GRA welcomes. What this means is that taxpayers will have certainty on transactions that occur post 1 April but prior to the enactment of the new rules as to how they are going to be treated.

As the original application date of 1 April 2009 has loomed we have been dealing with a number of clients in relation to moving property between entities prior to that date to make sure there is no tainting. We now note that there is further opportunity for that to be done and we encourage you to contact us if you have any queries in this regard.

In terms of the implementation of the rules, at GRA we still see it as almost inevitable that there will be amendment to the associated persons provisions. Our pick is that the breadth of the rules as proposed will be narrowed, but we certainly expect them to be wider than the current form in relation to land tax provisions.

As to a potential application date it seems that it will be no earlier than the enactment date which is likely to be mid to late this year and we also note the prospect of it being delayed further and we are aware of submissions to the Select Committee that strongly suggest that it be delayed until at least 1 April 2010. Naturally we will keep abreast of these developments and let you know any progress.

There are pre-rule change planning opportunities for those in the business of dealing, developing and trading. Feel free to call us if you have queries in this regard, contact Matthew Gilligan mg@gra.co.nz