I write on behalf of the New Zealand Property Investors’ Federation Inc in response to an officials’ issues paper on suggested changes to the definitions of associated persons in the Income Tax Act.
The Federation, established in 1983, comprises nineteen local associations located throughout New Zealand, and is the national body representing the interests of over 4500 property investors.
The Federation represents and promotes its members’ views on all matters affecting property investment and tax issues.
While the issues being addressed in the IRD paper are aimed at builders, traders and developers (traders), some of our investor members may be inadvertently and adversely affected by some of the proposals. Our submission is based on the affect that the proposals will have on property investors, not traders.
We believe that structures currently available to our members that enable them to differentiate rental properties from trading properties are beneficial. The rental market (including tenants, landlords and Government) benefits from the current tax structure as it reduces volatility, promotes long term investment decisions and enables stability and affordability in rental properties for tenants.
Property investors need the flexibility to use different strategies to ensure the viability of their rental property investments. The ability to make occasional property trades and use the tax paid income to reduce debt in rental property is beneficial to the tax system as it improves rental property income.
The Federation is opposed to the main emphasis of the proposed changes to the associated persons rules where it targets traders, developers and builders but can unwittingly affect other private taxpayers.
There are real benefits to the rental property market in having rental property treated as an income activity. As an example, if all increases in rental property value were taxed, investors would likely trade them more frequently. Not having such a tax encourages investors to hold the property for the long term which reduces volatility and helps to ensure stability of tenure for tenants.
Rental prices are also a reflection of the costs involved in providing rental accommodation. For example, the absence of a capital gains tax and allowance of claiming losses against personal income reduces the cost of providing rental accommodation and allows rental prices to be lower than if these policies did not exist. Rental property is not treated any differently than other forms of investment as these rules apply to other investment options as well.
The Federation believes that the income from any activity purposefully undertaken to generate the income should be taxed. We believe that this should apply to all investment options. Apart from Managed Funds, all investment options are currently treated equally and this is good.
The focus of the IRD proposals is to remove the ability of traders to be able to hold rental property in separate structures from traded property. The background to this is based in previous legislation aimed to ensure that rental property owned by traders really was a long term investment and not a way for traders to avoid paying tax. The original intent of legislation was to force traders to hold the property for ten years thereby ensuring that it was not bought with the aim of on-selling at a profit.
The Federation contends that it is reasonable for traders to be able to hold rental property as other citizens can, as this situation is beneficial for all stakeholders in the rental property industry. Rather than withdraw the ability of traders to be able to structure their rental properties separate from their traded properties, we believe the original legislation should be investigated with a view to allowing traders to hold rental property in separate structures from their traded property.
We believe that it is beneficial to the New Zealand tax system to provide the ability to hold traded and rental property in separate and identifiable structures. This system allows property investors the ability to occasionally purchase property to trade, pay tax on the income generated and apply this income in reducing debt on long term rental properties held in other structures. This has the benefit of reducing debt on these properties and increasing income, thereby positively affecting the taxation system.
Without the ability to differentiate rental property from trading property, many investors will not have the ability to provide long term rental property. This would result in a reduction of rental property, increasing rental prices and potentially a reduction in the number of people who will be self sufficient in their retirement.
The negative implications of having to own a rental property for ten years can be too onerous. An investor may be forced to sell a property through situations such as bankruptcy, divorce or the property being compulsorily required by local or central government.
There are also examples where having to hold a property for ten years removes the ability of the investor to make prudent business decisions. As an example, a property in one location may have gone up in value to such a degree that the rental return is reduced and it makes better sense to sell it and purchase a property in another higher yielding area. By selling a property it may allow an investor to reduce overall dept and therefore make a higher income. Both of these examples will have a positive affect on the tax take.
The Federation is not in favour of tax payers avoiding paying tax on income they earn through trading property. However if property traders flout current laws, their rental property structures can be deemed invalid and they will be taxed on income they make through trading. This ability was demonstrated through the targeting of developers and investors in Queenstown, Wanaka and some parts of Auckland. It was announced that some extra $100million in tax was collected from those investigations.
In summary, the Federation believes that there is a real benefit in treating rental property differently from traded property regarding tax. All investors should have access to the same tax treatment. Under the proposal, property investors who make one or more property trades will not have the ability to avoid tainting their long term rentals. This will negatively impact the industry and lead to a reduction in supply of rental property and an increase in rental prices. Restricting investors ability to differentiate rental property from traded property will also reduce investors ability to improve their income from property and therefore lower the tax take.
For these reasons we believe that the status quo should remain in the interests of the rental property market, affordable rental prices and increasing the tax base.
Two aspects of the proposals which we believe are beneficial are limited partnerships and one definition that limits associated person blood lines from four to two. These are practical solutions that will provide better clarity and ensure that the tax laws are fair.
Regarding an implementation date, the proposal indicates that should the proposed changes be adopted they are to apply from the 2008-2009 income year.
The Federation submits that the implementation time frame is unreasonably short and likely to be insufficient for affected persons to review, understand and if necessary reorganise for the consequences of the new rules. Because of this, the Federation suggests any changes be commenced in the 2009-2010 income year.
The issues’ paper does not discuss the impact of the changes on existing entities or whether the changes apply retrospectively or only from 2008-2009.
The Federation would be opposed to any backdating of the proposed changes to properties already owned and to existing arrangements. The existing structures are extremely costly to establish and maintain and backdating these proposals would be unfair to these investors.
The Federation is not opposed to the principle of paying tax on land transactions but considers that the IRD may have underestimated the unintended consequences of capturing unintended persons in its proposed changes.
Often there may be Federation members who may wish to develop some spare land and in doing so taint their passive rental property investments and inadvertently be caught in the expanded tax net.
The proposed changes will restrict investors ability to prudently manage their rental property which will restrict the tax take.
Federation members seek some certainty that they will not be liable for tax on sales gains of their separate and private property investments when they are not a trader/developer/builder.
1.Retain the status quo with the exception of limited partnerships and one definition that limits associated person blood lines from four to two.
2.Investigate the legislation that confirms traders should own rental property for ten years and seek to change it, thereby allowing structures to differentiate trading properties from rental properties.
3.Should the proposals be made into legislation, delay the implementation of any changes to the 2009/2010 tax year as many investors caught by the changes have long lead times for these types of projects.
4.Should the proposals be made into legislation, this legislation should not be retrospective, as many property investors and traders have made large investments establishing and maintaining structures under the current rules.