Housing tax – final pieces of the puzzle revealed?

Draft legislation released yesterday fills in some important gaps relating to the Government’s housing tax announcements from earlier this year:

• how proposed interest limitation rules will apply to residential property from 1 October 2021; and
• the design of the “new build” exemption from the interest limitation rules and the 10-year bright line test for residential land. 

The legislation is contained in a Supplementary Order Paper (SOP) to the Taxation (Annual Rates for 2021-22, GST, and Remedial Matters) Bill released earlier this month, along with fact sheets on the changes – available here.

These rules are complex and there is much devil in the detail. Submissions on the SOP (and the Bill) will likely be heard by the Finance and Expenditure Select Committee in the coming weeks.

The SOP also contains a FBT rate change so employers can elect to pay FBT at 49.25% (the 33% marginal tax rate equivalent) for all employees with all-inclusive pay under $129,681 (i.e. those earning below the 39% marginal rate equivalent). This is rather than having to apply the highest 63.93% FBT rate. This fixes the problem that was created when the FBT single rate was raised to reflect the new 39% marginal tax rate, regardless of whether that rate applied generally. FBT will still be payable at 63.93% for employees with all-inclusive pay of $129,681 or more. This is a welcome change, to reduce FBT over-taxation. 

In March this year, the Government announced:

• an extension of the bright-line taxing period to 10 years (from five years) for residential land acquired on or after 27 March 2021. While this change has been enacted, it was proposed that “new builds” would be subject to the previous five year bright-line period, with the design of this exemption to be consulted on later in the year.
• interest limitation rules for residential property, with the detailed design of these rules (including a new build exemption) to also be consulted later in the year.   

A June Government discussion document canvassed these design issues and presented various options. The SOP contains the Government’s decisions on these issues and options. 

• The SOP confirms the 1 October 2021 application date and general approach to interest limitation. Broadly, there will be no interest deductibility from that date for borrowing relating to property acquired on or after 27 March 2021 with phasing out of deductions over five years for borrowing relating to pre-27 March 2021 property.
• The interest limitation rules will not apply to a new build for a maximum period of 20 years, regardless of the owner.
• A new build is generally defined as a residence that receives a Code Compliance Certificate on or after 27 March 2020. This is for both bright-line and interest limitation purposes.
• In addition to the new build exemption, there are a range of general exclusions from the interest limitation rules (such as for retirement villages and rest homes, student accommodation, hotels & motels, B&Bs) as well as for Māori collectively owned land and housing and for social housing.
• Close companies (those with five or fewer shareholders owning more than 50%) and residential land rich companies will also be subject to the interest limitation rules. This removes the current automatic interest deductibility for such companies.
• Refinancing of pre-27 March 2021 borrowing will be eligible for the phasing out of interest deductions over time. This will be limited to the loan balance as at 27 March 2021. Special rules are proposed for variable loans, such as revolving credit or overdraft facilities. New borrowing on or after 27 March 2021 relating to pre-27 March properties will generally be subject to full interest denial from 1 October 2021.
• Limited rollover relief (where there is no change in economic ownership) is proposed for residential property transfers for bright-line test purposes. 

At the time of the March announcements, there was much debate about the effectiveness (or not) of these tax measures in addressing general housing affordability, particularly for first home buyers. Our view was that the tax system is not the appropriate mechanism to try to achieve these non-tax objectives. Interest limitation complicates the tax system, making it less coherent. It is not the first best option. Our view is unchanged.

As the Government is proceeding with interest limitation rules, our comments are focused on the SOP and the workability of the proposed rules. However, the SOP’s accompanying Regulatory Analysis is worth a skim:

• It makes clear the wide divergences in views of the various Government agencies involved, with Inland Revenue strongly against interest limitation, Treasury supportive but with no exclusion for new builds, while the Ministry of Housing was concerned about the effect on new housing stock and, therefore, in favour of the new build exemption.
• Inland Revenue estimates that approximately 250,000 taxpayers are likely to be impacted with the interest limitation rules expected to raise $1.22 billion in additional revenue over four years.  

Disappointingly, but not surprisingly, the 1 October 2021 application date for the residential interest limitation rules remains. This means that the rules will apply whilst the legislative process to enact them is underway. A 1 April 2022 application date would provide greater certainty. We hope the Select Committee will revisit this.

A total 20-year new build exemption period appears to have been favoured to give certainty to both initial and any subsequent owners about its availability. (Options canvassed in the June discussion document included an exemption in perpetuity for the initial owner only or a time-based cap across all owners, and some variants thereof). From an overall certainty, compliance cost and equity perspective, a time limited exemption appears reasonable, albeit there will be different views about the appropriate time period.

The proposed exclusions from interest limitation for residential accommodation that does not compete with first home buyers are sensible. And whilst not explicitly carved out, the Ministerial statement notes that more work is being done to see whether a wider exemption should be available for so-called “purpose built rentals” (also known as the “build to rent” sector).

Due to the short timeframe from Government decisions on the June document to draft legislation, we understand the “commentary” on the SOP has been delayed. The commentary will be critical in deciphering the draft legislation. (The fact sheets, while helpful, do not provide all the detail. Yet another reason, in our view, for shifting out the application date). 

With the final missing pieces of the housing tax puzzle now seemingly in place, the SOP and Bill will be considered by the Finance and Expenditure Select Committee. We expect the Select Committee to call for public submissions, which will give another opportunity to provide feedback. The likely legislative track means the Bill (including the SOP) will not be enacted until early next year.