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Hot off the tail of the extension to the bright-line test (extended from 2 to 5 years from 29 March 2018), came an Official Issues Paper released in March 2018. Submissions on the Official Issues Paper were made….and ignored. Now, draft legislation has been introduced in the Taxation (Annual Rates for 2019–20, GST Offshore Supplier Registration, and Remedial Matters) Bill. The Bill was introduced on 5 December 2018 and will see investors lose the ability to offset rental property losses from their income.
The Government considers that the playing field between property investors and home owners needs to be levelled taking issue that rental property investors benefit from tax losses whilst capital gains are derived tax-free. This will, according to the Government, make the tax system fairer, improving housing affordability.
We strongly disagree that the playing field will be “levelled” and consider the ring-fencing to be an unnecessary measure. According to Inland Revenue, approximately 40% of residential rental properties run at a loss and enjoy a $2,000 annual tax benefit circa $6,000 tax loss. This is by no means significant. In fact the Regulatory Impact Assessment to the Bill states “evidence supporting housing market impact analysis is limited, and suggests significant uncertainty as to the net impacts of the policy, especially on the rental market”.
The proposals contained in the Bill largely mirror that from the issues paper. Loss ring-fencing will apply to all “residential land” excluding a person’s main home, property subject to the mixed-use asset rules (such as a bach rented on occasion and also used privately), and land that is held on revenue account, i.e. land that is taxable on sale. This also extends to overseas land used as residential rental investments.
There are some catches with regard to land held on revenue account however. Firstly the exclusion only applies to land that is “taxable”, regardless of when the disposal occurs. Consequently where a person holds revenue account property that is only subject to tax if sold within a 10 year period, the revenue property exclusion will not apply. Secondly, a person must notify the Commissioner that the land, if disposed of, will be taxable. There is no indication at present as to how this notification is made.
In addition, the rules will not only apply to individuals but will also apply to interposed entities (being a “residential land-rich entity”, but only where over 50% of that entity’s assets consist of residential rental property. Interest limitations will also apply to quarantine interest deductions taken against an acquisition of an interest in a “residential land-rich entity”. So for example, where a person borrows to acquire shares in a residential land-rich company, a calculation will be applied to determine the quantum of that interest deduction.
Ring-fencing can be calculated on a “portfolio” approach or a “property by property” approach. The portfolio approach is the default position. So that means where an investor has more than one property, losses of one property can offset against the income of another. So calculating their overall net profit or loss across the portfolio.
The rules around the calculation of the carry-forward and subsequent offset of losses are a bit of a dog’s breakfast and require review of complex and confusing calculations. On disposal, the rules will provide either a partial or full release of the loss, depending on various factors.
The Government has ignored the suggestion of staggering the ring-fencing of losses over a two to three year period. Instead, the legislation will apply in full from 1 April 2019.
Although investors do receive a cash flow benefit, over the long term, tax will be payable as eventually, interest-bearing debt will be paid down. So it is only a matter of timing. If however these rules are introduced, what happens to all the investors? Will rental property investment be depleted? The answer is yes. Investors assist with providing much-needed housing stock to the market. Stock that the Government will have trouble providing on its own.