GIFT DUTY TO BE ABOLISHED
On Monday Revenue Minister Peter Dunn confirmed that the government intends to abolish gift duty.  Earlier this year the Minister had signalled that a review was being undertaken as to whether or not the gift duty regime should be repealed or amended.  Subsequently that review has occurred with the Inland Revenue producing a report assessing the impact of a repeal of gift duty across other governmental and legislative areas.  One of the prime concerns that was raised when the review was announced earlier in the year was whether or not repealing gift duty would have an adverse affect on creditor protection and rules in relation to qualification for social assistance. Contact Us at GRA.

The Review

The outcome of this review is that the various governmental bodies have concluded that there is little or no risk to their areas of operation if gift duty were to be repealed.  The Inland Revenue have confirmed that approximately $1m of revenue is collected annually in terms of gift duty.  Interestingly they note that much of that revenue collection seems to be a result of timing mistakes where donors accidentally gift more than the $27,000 allowable in the 12 month timeframe.

From our perspective the areas that we were most interested in was whether a repeal of the gift duty regime would lead to any suggestions for new legislation in respect of creditor protection or access to social assistance such as residential care subsidies, family assistance, student allowances etc.  In short the review has concluded that existing legislation is adequate and no changes are proposed as a result. 

As a result of the above legislation is to be introduced later this month which will see gift duty abolished from 1 October 2011. 

The Outcome

Overall we see this as positive development for taxpayers.  Abolishing gift duty will reduce compliance costs in that those of you that have outstanding gifting programmes will be able to bring those to an end post 1 October 2011 and thereafter not have to worry about the annual gifting process.  We also think it is encouraging that rules in relation to eligibility for residential care subsidies for example are not proposed to be altered so that there is at least some degree of certainty as to how those will apply.

What Should You Do Now?

The obvious question that arises out of this is – what do you do if you have annual gifting due between now and 1 October 2011.  Although it depends on the circumstances, in general we recommend that gifting continues as usual. 

Certainly we note that any transfers of assets to Trust prior to 1 October 2011 will still have to take place at market value with the usual sale and purchase agreement and deeds of acknowledgement of debt in place.  Gift duty still applies up until that date so still needs to be dealt with.  In terms of forgiving any outstanding debt our inclination is to encourage our clients to continue to execute gifts between now and then on the basis legislative provisions in terms of the creditor clawback apply such that gifting inside certain time frames is automatically reversed.  Thus the sooner a gift is executed the sooner it falls outside the timeframe.  We also note that until the legislation is drafted and passed into law there is always the prospect of it being amended or altered although we do see this as likely.

Summary

In summary, when transferring assets to a Trust at present it is business as usual at this point as gift duty will apply if the assets are not transferred at market value so there still needs to be valuations, sale and purchase agreements and deeds of acknowledgement of debt in place.  If you are currently gifting and have a gift due in between now and 1 October 2011 we encourage you to complete that gift, particularly if it is in the immediate future.  Post 1 October 2011 we will be contacting clients with existing outstanding gifting programmes and putting in place documentation to bring those gifting programmes to an end. 

Please contact us at Gilligan Rowe with any queries in relation to the above by clicking HERE

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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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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Dear Reader,

The tax report seems to reveal a concern/realization by the group that any tax change causing a significant drop in values in property, will be politically unacceptable. This was a view that I formed and I generally disregarded this option as too radical when I read and recently commented on the report HERE

But it is the government's actions and decision that counts.

Risk Free Rate OF Return

• Rents non assessable, costs non deductible
• Pay tax on equity ( not debt)
• Tax payable irrespective of market going up or down
• Tax payable despite asset not being sold - you have to find the tax out of cash flow
• Leveraged investors relying on tax refunds to survive / get to break even cash flow, will go broke.
• Westpac's estimation that house prices will drop 34% if this option comes in, is in line with Sweden’s experience where they ring fenced tax losses and house prices fell 35% and mass insolvency enveloped the nation.  The policy was reversed and the government thrown out at the next election. Sorry I don't know the year this happened. I am told that similar experiences have happened in Aussie with state taxes trailed targeting property.

Example Application Of RFRR Tax and Outcome

Here's an example scenario for little Joe Bloggs...

He has a rental property and earns $65k, has 2 kids and a spouse who works part time earning $15k. All household income is required to survive. The rental property is negative cashflow before tax refund $7,000, break-even cashflow post tax refund. The market value of the property is $400k, and the debt $350k. Currently Joe and his family get by - paying their living costs and mortgage payments (just). The market equilibrium assumes the tax refund and hundreds of thousands of Joe Bloggs' are doing this.

Enter this tax. Now Joe does not get a tax refund. He has to pay tax on 6% of $400k(mv)-$350k(debt)=$50k which is $3k times 33%, $1k tax. So previously he was getting $7k tax refund, now he pays $1k, he is $8k worse off.

The outcome is he has to sell in a market that is flooded with other Joes. He goes broke and is mortgagee sold. He stops spending and kicks off another recession with the thousands of other Joe Bloggs in the same predicament. They all vote labour for the rest of their lives and everyone blames National for the massive blunder. The next government throws out the unpopular tax, and the market reverts to where it was before...WHICH IS EXACTLY WHAT HAPPENED IN SWEDEN WHEN THEY RING FENCED LOSSES.

Banking would also be destabilised and credit would stall again.

So this tax would cause huge loss in property values, hardship, destabilize banking, reduce consumption (credit will tighten and consumption drop), and kick off another recession....

I ignored it in my overview above as a clever idea that does not work in the real world. A cynic would observe that it makes the other options seem more palatable.

Also RFRR requires a lot of work for IRD, is subject to abuse (through manipulating valuations) and will stimulate heavy leveraging.

Example Of Potential Abuse Of the Tax

Example 1

1. Little Jonny owns a rental worth $300k with debt of $250k.

2. He pays RFRR tax on $300k-$250K=$50k times 6%*33%, $1k tax. 

3. Little Jonny's friend has a similar house, similar suburb.

4.  They sell each other their respective houses at $250k each, now 100% financed.

5. They achieve 100% financing by cross securing their respective investments to their homes, so they can borrow 100%. Valuers will now tend to view the market value of the houses as $250k, - cost.

5.  Now Little Jonny has zero tax to pay, under RFRR, $250k(MV)-$250K(debt)=$0 equity times 6%*33%=$0 tax - ie no tax.

Is this tax avoidance?  Probably, but the point is, the tax is open to abuse.

Example 2

1.  Little Jonny owns a rental worth $300k with debt of $250k.

2.  He pays RFRR tax on $300k-$250K=$50k times 6%*33%, $1k tax.

3.  Little Jonny's friend has a similar house, similar suburb.

4.  They sell each other their respective houses at $350k each, and loan each other $50k - now they are 100% financed and pay no equity tax.

There are a hundred permutations of ways to do this via Trusts etc. Is this tax avoidance?  Probably - but the point is again, that the tax is open to abuse.

I give Key and the Nats more credit than to bring in something this radical, this dangerous. They are pro-business and clever people - no question about that.

They understand that undermining consumption by destabilising banking, kicking off another recession and causing mass insolvency, is political suicide and not in the public interest. There is a better way in the other options of getting there (to a level playing field and weaning Kiwis off property investment – if that is what the Government wants), and the change needs to be more gradual.

Summary

Gilligan Rowe & Associates are 100% opposed to Risk Free Rate OF Return. We see it as a clever idea that does not work in New Zealand at this time. We don't believe the government will bring it in - we give them credit for being rational.

Someone might like to email this to Mr English or Mr Key if they agree with our thoughts, or create their own version. My advice is to please be respectful and constructive in what you send them.

Use the following email addresses:

bill.english@national.org.nz

john.key@national.org.nz

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.

In recent times the Tax Working Group reviewing New Zealand’s tax system has received increased attention. 

This is no surprise as it gets closer to making its recommendations, which now appear likely to come out early in the New Year.  The Tax Working Group is a collection of academic, government and industry tax professionals charged with reviewing New Zealand’s tax system. 

Part of their brief is to look at the equity and fairness of the system and look for ways to broaden the tax base, ideally so as to fund drops in the personal, trust and corporate tax rates. 

Many readers will be aware of some of the options they are considering in respect of the taxation of property including capital gains tax, a land tax and a tax focused on property investments (which imposes a deemed income based on a risk free rate of return).  My thoughts on this process are as follows: 

I think that stamp duty should be considered.  It is progressive in nature (taxes volume) so satisfies the fairness and equity requirement.  It is also a system that is relatively easy to legislate for, hard to avoid, and easy to enforce.  I

If targeting the property sector and reducing the risks of a speculative bubble are a goal, then stamp duty on land transactions would also seem to achieve these goals. It dampens speculation (taking the margin off traders, leaving only the long term investors to prevail).

In the meantime we wait with baited breath as to what the next move is. Naturally GRA will keep you abreast of developments.  I

If we can help with advice with investments, structures or business planning, please contact us.

Matthew Gilligan
Director