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Interest Deduction And Bright - Line Confusion

Mark Withers takes a look at the IRD document: ‘Design of the interest limitation rule and additional bright-line rules’.

By: Mark Withers

1 October 2021

As I write this, we are two weeks away from October 1 when interest deductions on residential property lending will be reduced to a 75% claim.

That said, we have still not seen the legislation that will limit the interest deduction, modify the bright-line rules and define the all-important “new build”.

One suspects this may be because the Government is finding it more difficult than it expected to make law that is unfair, workable and equitable.

The initiative will use tax law to achieve a political agenda by singling out a particular sector for rules that undermine the building blocks of our tax system, namely, that expenses are deductible when funding an income earning asset. It is sure to create confusion, resentment, property market distortions and spiralling compliance costs as accountants wrestle with exactly how the rules will work in practice.

The fact that the rules will take effect right as interest rates are set to begin an increasing cycle appears to have escaped many investors. I've been amazed by the apathy investors have shown toward the changes thus far and the impacts they will have on their cashflows, and most importantly, their borrowing power. Yes, the banks new loan to income restrictions will factor in the extra tax payable when determining qualification for future, and potentially even, existing lending.

At present, all we have to guide us on these rules is the IRD released document: “Design of the interest limitation rule and additional brightline rules.", released in July 2021. The document exposes some of the practical difficulties the Government faces when implementing the rules and offers some insights into how the rules may work. Here are a few extracts from the question-and-answer document. Do not assume any of this may end up law, but its the best we have to go on at present.

IRD Document Q&A

Q3 Short-stay accommodation in residential property will not be exempted the way motels and hotels may be to ensure there is no incentive to convert residential accommodation to holiday let.

Q4 But exemptions will apply when short-stay accommodation is offered in the “main home”. Why, because this accommodation can’t be sold separately.

Q14 Will the limitation apply to purpose built rentals? No, developers of rentals will continue to be able to deduct interest as they do now.

Q17 Will property development be exempt? Yes, developers add to the housing stock and pay tax on their gains.

Q19 Will interest on debt funding the remediation of a property be deductible? Oh, hard one ... don’t know. Probably should be because it keeps a dwelling habitable but how do you define it? My pick, it will end up in the too hard basket.

Q20 What if land I didn’t intend developing, later gets developed? Another hard one, I think the rules will need change of use exemptions to make this equitable.

New Build Exemption

Q24 What is a new build? It will probably be a self-contained dwelling that receives its CCC on or after March 27, or is acquired on or after March 27 but received its CCC in the last 12 months.

Q29 If I convert one large house into separate dwellings will that be a new build? Yes, if they have separate entrances, you have added to the “housing supply”.

Q30 If I owned land prior to March 27 but build on it after March 27, will I get a new build exemption. Yes! No doubt this will sit well with the taxpayers that built their new build before March 27 who are denied an interest deduction.

Q36 If I buy land intending to do a new build can I claim interest? Only from the date your build gains a CCC.

Q42 Will rollover relief apply to interest limitations? Rollover relief disregards certain transfers in certain circumstances. This will probably be a feature of the rules, but it’s very complex to draft equitably and interpretation often carries high compliance cost.

Q48 Will any rollover relief apply to bright-line? Perhaps, the proposal is to offer bright-line relief to transfers to trusts, look-through companies, partnerships and Maori authorities. This is good news. The current rules that trigger bright-line due to simple related party transfers are unworkable.

Q62-70 How will interest be viewed relative to different properties in a portfolio? This is a tricky one. The proposal is to require debt to be tracked and traced back to specific purchases, but, where this is impossible, require apportionment based on cost or stacking/ordering based on market value.

The full document can be found on the IRD website www.ird.govt.co.nz.

Hopefully, this pepper-potted look at the issues being faced by officials designing the law gives you a sense of how complex life is set to become. We await the outcome in October certainty.

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

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