Flow On From Tax Changes
For many the impact of interest deductibility’s phased removal is still sinking in. Mark Withers explores the consequences in more depth.
1 June 2021
Firstly, a recap on the Government’s announcement. For acquisitions of residential property after March 27, 2021 interest will only be deductible until October 1, 2021. Interest on debt funding residential property acquired prior to March 27, 2021 will be phased out over four years.
• Until September 30, 2021 100%
• 1/10/21 – 31/3/23 75%
• 1/4/23 – 31/3/24 50%
• 1/4/24 – 31/3/25 25%
• From April 1, 2025 0%
The Government also signalled that interest on lending that funds new builds may remain deductible.
Definition Not Drafted
The Government has not provided a definition of a new build yet. It has signalled that the definition may include a property acquired within a year of its code of compliance being issued. The Government has signalled a public consultation process that will include taking input on how a definition of a new build will read.
It’s too soon to assume interest deductibility will remain in perpetuity for new builds. The Government may impose a time limit on this deductibility.
By now, most investors will have considered the cashflow impact the removal of interest deductibility will have relative to the additional tax liability it will create. Those with unacceptable cashflow impacts will need to sell property to deleverage.
Carefully select property for sale relative to each property’s bright-line count. Triggering bright-line tax on a sale designed to deleverage non-deductible interest would be a blow. Bright-line generally runs from the date a change of title is registered until the date a sale and purchase agreement is entered into.
Provisional tax is paid once a tax liability of $5,000+ is generated. When becoming a provisional taxpayer for the first time the cashflow impact of the tax is magnified due to the need to pay not only last year’s terminal tax, but next year’s provisional tax in the same year.
Many investors use look-through companies (LTCs) to hold their property investments. Where a high-income earner was using income to support the investment it is usual to see shareholding biased in their favour. This ensured the funded losses were flowed to the highincome earner. But with the removal of interest deductibility, these arrangements could see those on the highest tax rates being streamed the artificial income from LTCs that have had interest deductibility denied. Investors should appreciate that selling shares in an LTC is a bright-line reset event.
There can be tax issues associated with changing QC shareholdings. These include a minimum QC continuity test of 50%. There are also rules that require dividends from QCs to be distributed to living beneficiaries if trusts are shareholders. Failure to do so or breaches of continuity Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz can cause QC status to be lost. If QCs pay tax on their new profits, they will accumulate imputation credits without having corresponding retained earnings due to interest costs still being met. These imputation credits must be attached and considered taxable dividends even when declared from capital profits.
Debt funding portfolios that contain commercial and residential property or properties that are split use contain challenges. Historically, deductibility was determined by what borrowed money was used for rather than what type of asset provided the security. Over many years most investors have changed and refinanced their funding mix and cross collateralised security arrangements making it difficult to undertake a track and trace exercise to determine what debt bought what asset. It remains to be seen whether the Government will expect these track and trace exercises to be done when considering deductibility of interest in mixed portfolios.
Investors with businesses may have legitimate debt restructuring opportunities where their trading businesses owe them money. This may be significant if retained profits were distributed prior to the personal tax rates rising without these dividends being paid in cash. It may be possible for businesses to borrow to repay shareholder loans, allowing the shareholders to retire nondeductible debt in their property entities.
Please take tax advice as you consider your options.
Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz