Updated interest deduction legislation
21 March 2022
In March 2021, the New Zealand Government announced sweeping changes to the tax rules that impact residential property owners. Following public submissions, an updated Bill has been drafted ready for submission in parliament this month.
Tax changes proposed by Government that impact residential property owners
When the government announced the changes, the headlines focused on the extension from a five-year bright-line period to a ten-year bright-line period as well as the removal of interest deductions from most residential properties. A key exception to both rules was the concept of ‘new builds’ as the government tries to increase housing stock and decrease the attractiveness of residential property investment.
High-level policy is one thing, but the devil is always in the detail. Legislation to help shape how these rules would work and interact within our existing legislative framework is key to understanding how these rules will impact.
Due to the nature of what is trying to be achieved, some overly complex legislation has been proposed for what has traditionally been a simple undertaking. Inequities have become more pronounced and so have the rules that deal with them, turning these into a very complex set of rules to apply.
For instance, the bright-line rule has morphed from a simplistic rule that only applied if property was sold within two years with straight forward exemptions, such as a simple main home test. The rules had some inequity but with a two-year bright-line period these were limited. With a ten-year period, those inequities become more pronounced as have the rules that deal with them, turning these into a very complex set of rules to read, let alone apply.
The interest deduction rules are also relatively complex, which is largely due to their incompatibility with the basic tenets of New Zealand’s tax system.
Despite these negatives, there were some positive changes proposed. Most notably, roll-over relief for certain associated transfers, which would make it possible for a person to transfer their property to their trust without re-setting the bright-line period.
Updated Bill to change tax rules that impact residential property owners
In the intervening five months between the Government proposing the legislation in October and drafting the Bill, the rules have fundamentally not changed to what was presented. There is still a:
Ten-year bright-line period for non ‘new builds’.
Loss of interest deductions for residential property unless a new build.
Here are some of the headlines from the Bill that has been drafted.
New build and renovations
One of the key considerations being raised was whether a property could be considered a new build if it was largely renovated or updated, especially if required to comply with healthy home standards.
Officials have considered this and determined this would not be appropriate in most cases. Rather, it will be limited to those that were affected by:
Earthquake prone properties that have been fixed.
Leaky homes where at least 75% of exterior cladding has been replaced.
Bright-line relief for transfers to and from trusts
In the Bill as introduced, there was only a proposal for not re-setting the acquisition date under the bright-line rules if the transfer of land went from an individual to a trust. Officials have agreed that it should also encompass a transfer from a trust. With this change, it would be possible for a trustee to transfer property to an individual, provided it is provided to a principal settlor of the trust. Therefore, for those looking to wind-up a trust, there is some scope for relief provided the criteria is satisfied.
However, it’s important to note that it won’t allow a transfer to any beneficiary. The requirement for roll-over relief is about whether the underlying economic ownership has remained the same, hence the requirement for it be to transferred to a principal settlor .
Helping to illustrate how complex these rules are, this portion of the rules are still being finalised. There is an intention that trust resettlements could also be covered by this relief, which hasn’t been captured in the Bill..
This change will be effective for transfers from 1 April 2022.
This is in addition to changes that allow transfers into or out of a partnership or look through company, provided this is done in proportion with the underlying ownership.
One of most common ways for Mum and Dads to help their children into property is to co-own the property and sell down their interest over time. It was suggested that such transactions should also be eligible for roll-over relief_,_ but this was denied.
One change was adopted to the drafted rules, which proposed parents who sold down their position would re-set the bright-line purchase for the child at the time of each sell down. This is not how the rules should have worked and has been corrected so the bright-line date is the original purchase date.
Tracing rules for untraceable loans
One of the issues with the interest deduction rules is how to trace certain loans to determine how much interest is limited. For instance, what if a person owned an old property and a new build and couldn’t differentiate between how much borrowing related to each?
The rules proposed ‘stacking’ which would put most of the borrowing on the new build and might provide a greater benefit than those who had the ability to trace their loans. Upon feedback, officials have extended the application to use stacking to those who cannot reasonably trace their loans rather than the original test of those who can’t.
Foreign currency loan
One of the rules outlined in the changes is that any foreign currency loan relating to a New Zealand property will not be eligible for deduction from 1 October 2021. This was due to it being complex and therefore, easier to just not allow the deduction.
Despite objections this has not changed. We continue to disagree with this approach as it prejudices those with overseas loans and, if the aim is to reduce complexity, the Government could re-consider how they finance their loans. Keeping in mind that non-residents cannot always secure loans in New Zealand.
Repeal of ring-fencing
It was submitted that the ring-fencing rules were not required anymore with the removal of the interest deduction.
Officials have rejected this notion stating that it will still be relevant for new builds and should remain. However, it is possible these rules could be reviewed in the future but, in the interim, they remain yet another set of rules to comply with.
Construction time – impact on main home period
One of the issues with the bright-line rules has been its reliance on the use of the house as a main home.
Previously, it required that a person use the house for most of the time it was owned as a main home. This created issues for those who bought off the plan waiting for title to be issued and/or those needing the house to be built. Both took considerable time and could count as part of an ownership period while not being a main home because they couldn’t be occupied.
This is an increasing problem with the new main home test because it doesn’t look at whether it was used as a main home for most of the time of ownership, but rather whether it is used as a main home for 100% of the time of ownership. If not, then to the extent not used, it will be subject to tax on sale.
If the non-use is temporary (less than 12 months – subject to some criteria), there is an exclusion. This has now included a period for construction, provided the length of time is reasonable to construct a house. As such, it should follow that the time taken to build your house should still count as being a main home for the purposes of this test.
It is possible this could extend to the time waiting for title, given that is a necessary part of the construction process. However, it is not explicit whether this is the case in the Bill and commentary provided.
One additional type of property that will be exempted under the rules is a boarding establishment. The reasoning behind this is that many boarding house style properties are not suitable replacements for being a residential dwelling.
Therefore, a newly defined ‘boarding establishment’ has been exempted from the rules. To apply, the premises needs to have:
At least ten boarding rooms that are not self-contained.
Shared living facilities available to all residents.
While a narrow exemption, it will provide some comfort to those affected.
Overall, not a great deal has been changed between the initial proposal and the Bill. Unfortunately, the reality is these rules are vastly more complex than what was previously in place. For residential property owners they must now contend with several complex rules in any given situation. In our view, the Government’s objectives could have been achieved in a less complicated approach had more consultation and thought been given to the issues earlier on.
Register for our property tax webinar
Join our tax experts on 30 March from 12pm - 1pm NZT to discuss the updated legislation that will bring into force the changes to the bright-line rules and the removal of interest deductions for certain residential properties.