Taxation (Bright-line Test for Residential Land) Bill

Transcription

1 Taxation (Bright-line Test for Residential Land) Bill Report of the Specialist Tax Adviser to the Finance and Expenditure Select Committee Therese Turner Turner & Associates September 2015

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3 Table of Contents 1.0 Introduction Summary of the proposed bright-line rule for residential land Key decisions that the Committee will need to make Submissions Main home exemption Specific deductions Ring-fencing losses Order and placement of new section CB 6A Status of Section CB 6A International tax issues Start date for two-year period Sales off the plan Farmland Exceptions for circumstances outside of seller's control Deduction for holding costs Trusts...15

4 1.0 Introduction I have studied and analysed all submissions and have discussed them with officials. I have paid particular attention to "matters raised by officials" as these have not been subjected to the scrutiny of the submissions process. The formulation of this report follows extensive discussions with officials in which we have attempted to arrive at workable solutions to any problems identified with the proposals contained in the Bill. I would like to commend the officials for their co-operation in this regard and for their willingness to consider views which differ from conclusions that they may have already reached. It has been a pleasure working with them. In this report I have commented only on those submissions where either: My views differ from those of officials; or I concur with the officials view but wish to provide further comment or suggestions. In respect of all submissions on which I have made no comment, I concur with both the officials view and the reasons that they have set out in their report to this committee. Where I have identified issues that were not the subject of submissions, I have noted these as being a matter raised by advisor. 1

5 2.0 Summary of the proposed bright-line rule for residential land The bill proposes to tax the proceeds of the sale of residential land that is sold within two years of acquisition. Only residential land would be taxable. Residential land would include bare land on which the owner planned to erect a dwelling. It would not include farmland or business premises. These would remain subject to the existing land sale rules which can tax them in certain circumstances. There would be an exemption for a person's main home. Where the person has more than one home, it is the home with which they have the greatest connection that would be exempt. The sale of a second home, such as a beach property or flat in town would not be exempt. In order for a home to be exempt, the home would be required to have been occupied as the person's main home for the majority of the period over which it has been owned. It is possible, however, for a person to concurrently own two homes both of which would be exempt. This would occur, for example, where a person had vacated their main home having purchased another home, but were awaiting settlement of the sale of the first home. Under some circumstances, trusts would qualify for the main home exemption. There is an exemption for inherited land. Land transferred pursuant to a relationship property agreement is also exempt from the rules but a subsequent transfer would fall within the rules. Where a loss occurs, it would be ring-fenced and would be able to be offset against only income from land sales which was subject to tax under any of the land sales provisions. Loss ring-fencing occurs only where the transaction is taxable under the brightline rule and is not also taxable under any of the other land sales rules. The proposals contain anti-avoidance rules for land-rich companies and trusts. 2

6 3.0 Key decisions that the Committee will need to make The key decisions that the Committee will need to address are as follows: Turner & Associates 1. Whether the brightline rules should be subservient to or, alternatively, over-ride the existing land sales rules. The answer to this question will derive from the decisions that the Committee makes in respect of the other issues. 2. Whether the brightline rules should be incorporated into the existing intention test in section CB 6 or whether they should stand alone in a new subsection (currently drafted as section CB 6A which precedes section CB 6). Again, the answer to this question will derive from the decisions that the Committee makes in respect of the other issues. 3. Whether the exemption from the brightline rules for a person's main home should be the same as, or tighter than, the exemption for a person's residence under the existing land sales provisions. 4. Whether or not a specific deduction in addition to the cost of the land should be allowed under the brightline rules where it is allowed in an otherwise applicable provision of the existing land sale rules. 5. Whether or not losses from the disposal of land that is subject to the brightline rules should be ring-fenced under some, any or no circumstances. These matters along with other important, but less fundamental, questions are addressed below. 3

7 4.0 Submissions A number of submissions were made on the technical detail of the proposal. These are discussed below. 4.1 Main home exemption Some submitters were of the view that the principal residence exemption in existing section CB 16 should be used instead of the proposed main home exception. They felt that this would align it with the intention test which bright-line test is intended to supplement, and remove uncertainty and be more simple. Officials are of the view that the existing test would apply to any dwelling that was used by the person as a residence, including a bach or holiday home. It would also allow exemption of multiple homes that the person owned but did not reside in. They recommend that the submissions be declined. I agree with the officials' recommendation and their reasons for it. That the submissions be declined. 4.2 Specific deductions (Matter raised by advisor) There are many circumstances under which both the brightline rules and another existing land sales provision could apply. One of these circumstances relates to section CB 14 which taxes gains from the sale of land within ten years of acquisition where the value of the land is affected by a change. The types of change that are covered by the provision are, for example, changes under the operative district plan (such as zoning changes) and changes under the Resource Management Act to allow or disallow certain activities to be conducted on the land. The change does not need to have occurred, it needs only to be likely to occur. Twenty percent or more of the gain in value needs to be attributable to the change in order for the provision to apply. Where it does apply, a deduction of the greater of $1,000 or 10% of the gain for each year or part year (up to a maximum of ten years) that the land has been held is available in addition to the original cost of the land. 4

8 The provision applies only where no other provision of the existing rules applies. Turner & Associates The brightline rules will apply in situations where previously no existing provision would apply. For example, a sale of residential land that is not the person's main home will be caught even though the person may not have acquired with the intention of resale and nothing exists which would bring it within the scope of the other existing land sale provisions. The reason that I raise the issue of deductions under section CB 14 is that I am not privy to any plans that the Government or local authorities may have in relation to the current housing shortage. However, it is feasible that an owner of land that is intended to be held for future development or commercial use may be rezoned to residential and leave the owner unable to use it for its intended purpose. It may also be subject to compulsory acquisition. The question is not whether the sale should be taxable. To exempt such circumstances would give rise to argument that there are many more circumstances under which a person is caught by the brightline rules where previously any gain would have been on capital account. The question is merely whether the person should be able to get the deduction that is currently available where zoning or other changes have given rise to a greater gain than is attributable to normal market value increases. That the Committee considers the matter. 4.3 Ring-fencing losses Under the proposed ring-fencing rule, losses that are attributable only to the brightline test (and not any other existing land sales provision) would be ring-fenced and only be available to be offset against income from land sales either in the same year or a future year. Most submitters did not support the proposal to ring-fence losses arising from sales taxable solely under the bright-line test. Their reasons were as follows: Gains and losses that arise under the bright-line test should be treated in the same manner as other gains and losses that arise under the other sections of subpart CB. Taxpayers will have an incentive to argue that they had an intention of resale for any losses, which will increase compliance costs and render ring-fencing ineffective. Ring-fencing losses will distort investment decisions and will encourage economically inefficient behaviour. The bright-line test will capture many situations where the taxpayer is forced to sell due to financial strife. Losses in these cases should be dealt with on the same footing as gains. Ring-fencing would mean that many people will have unusable losses. 5

9 Turner & Associates Taxpayers are unlikely to accelerate property sales to realise losses as the benefit from the tax losses would give rise at most to a 33 percent recovery, while the true economic loss is much greater. Ring-fencing creates a one-way bet for government. Officials have recommended that the submissions be declined. Their reasons, as outlined in their (draft) report, are as follows: A significant revenue risk if unrestricted losses were allowed. An incentive for people with unrealised losses to accelerate sales and an incentive for those with unrealised gains to defer sales. It is unlikely that anyone would intentionally realise a loss merely to take advantage of a tax deduction. At best, a deduction of 33% would be obtained, leaving the remaining 67% of the loss to be borne by the seller. It is more likely that taxpayers would hold in an effort to recoup the loss as the market rose again or at least postpone the sale until the two years had passed so that the loss would not be ring-fenced. The taxpayers who would be more likely to be caught by the ring-fencing are those who have no option but to sell before the expiry of the two-year period for which the brightline rules apply. This could be due to financial hardship, or to other circumstances such as a single rental property that had become chemically contaminated by a bad tenant and had to be demolished. As these taxpayers are unlikely to invest in another property having had the bad experience, the loss will be unlikely to ever be utilised. Under the existing land sales rules, such a loss would be on capital account. However, a gain would also be on capital account. Under the brightline rules as drafted, a loss will be ring-fenced and possibly never be deductible, while a gain will be taxable in full. In other words, it may become a black-hole loss. To avoid this consequence, taxpayers are likely to argue that they acquired the property with the intention of resale. This is because ring-fencing applies where the brightline rules are the only land sales provision that applies to the disposal. The reason that the brightline rules are being introduced is that the intention test is difficult to enforce and often leads to lengthy disputes. That the Committee consider whether losses should be ring-fenced in circumstances where a gain on the same sale would have been taxable. 6

10 4.4 Order and placement of new section CB 6A Some submitters questioned the placement of section CB 6A which contains the brightline rules. Some were of the view that it should follow, rather than precede section CB 6 (the existing intention test). Others were of the view that the brightline rule should be contained in a paragraph of existing section CB 6 in such a way that it would contain words to the effect of for the purposes of this section, residential land disposed of within two years of acquisition is treated as having been acquired with the intention of resale. They were of the view that, where the exemptions from the brightline rules differed from the existing rules, they could simply be dealt with in the same way as currently applies with other exemptions from the various provisions of the existing land sale rules. The new provisions are included in new section CB 6A which precedes the existing intention test which is contained in section CB 6. The placement of 6A before 6 is correct under drafting convention. Treating the brightline rules as a deeming provision within the intention test seems logical, particularly in light of the fact that, as stated in the Regulatory Impact Statement at page 4, the first objective of the brightline rule is to provide an easier to enforce rule to supplement the current intention test. The officials are of the view that, if the exemptions are different from those applying to the existing intention test, it may be clearer if the brightline rules stood alone in their own section. However, stating an exemption to apply for the purposes of a particular paragraph of a section would be unlikely to cause any confusion for users of the Act. Therefore, the decision that the Committee will need to make regarding the structure of the legislation will depend mainly on the decisions that are made in respect of the other matters set out above, being: The main home exemption. Deductions for gains arising under, for example, a district plan or Resource Management Act change. The ring-fencing of losses. In summary, if the Committee decides: That tighter exemptions for the brightline rules should apply, That deductions should not be allowed; and That losses should be ring-fenced and potentially never be deductible in circumstances where a gain would have been taxable, a separate section for the brightline rules is justified. 7

11 Turner & Associates That the committee's decision on the section numbering be based on its decisions regarding the other rules that should apply to the brightline rules. 4.5 Status of Section CB 6A Some submitters were of the view that the brightline rules should apply only where other provisions under the current land sales rules do not apply. In most cases, it will not matter which provision brings the transaction into the tax net as the outcome would be the same in terms of whether or not the amount of a gain is taxable, the quantum of the gain for tax purposes, and the treatment of a loss. In no cases can a gain be taxed twice or a loss be deducted twice. However, if the exemptions differ, or if the existing provisions give greater deductions from a taxable gain than would be available under the brightline rules, it will be important that a strict hierarchy is established. Therefore, the Committee needs to decide whether the brightline rules should be subservient to the existing provisions (as is the current drafting of the loss ring-fencing) or whether the brightline rules should over-ride the other provisions where the tax result would be different. If it is decided that the brightline rules should take precedence, all of the existing provisions, including the intention test, should be stated as applying only if section CB 6A does not apply. If this was not done, users of the Act who are not tax specialists would be likely to find the application of the brightline rules difficult and confusing. An exception would need to be made for the loss ring-fencing rules if it proceeds in its current form. I have discussed this issue at length with officials. They agree that more certainty is warranted to avoid confusion. Officials have stated their preferred option is to make the brightline rules subservient to sections CB 6 to CB 12. This means that it would be subservient to all of the existing land sales provisions other than two provisions. These are: Section CB 13 which relates to major subdivisions and developments which would, in any case, be covered by section CB 12 which relates to development and subdivisions undertaken within ten years of acquisition. Section CB 13 is also subservient to section CB 14 and, is therefore, the last possible section to apply to any disposal of land; and Section CB 14 which taxes gains from the sale of land within ten years of acquisition where the value of the land is affected by a change. 8

12 Officials concede that making the brightline rules subservient in this manner would leave open the opportunity for taxpayers to argue that ring-fencing did not apply as they had acquired the land with the intention of resale. However, they are of the view that taxpayers would be unlikely to argue intention as it would expose them to a challenge that any earlier disposal which resulted in a gain should also be looked at under the intention test, thereby rendering those gains taxable. I agree with their analysis but have pointed out to them that it would apply only where a person had other land transactions which could be caught under the intention test. It would still leave the argument of intention available to the one-off transaction such as the beach house. The number of taxpayers involved in this potential dispute is could be quite significant. To summarise: Making the brightline rules over-ride the existing provisions would remove the intention test as an argument against the application of ring-fencing of losses and would not change the tax outcome under any of the existing provisions other than section CB 14 being a change in the value of land that is affected by a change. Making the brightline rules subservient to to all other provisions other than sections CB 13 and CB 14 would have the same result but would leave the door open for taxpayers to argue intention in order to circumvent the loss ring-fencing rules. That the Committee consider whether it wishes to leave open the argument that the loss ringfencing rules do not apply due to the land having been acquired with the intention of resale. 4.6 International tax issues Some submitters were concerned about the international tax implications of the brightline rules and, in particular, the potential for income to be taxed twice. They were of the view that the rules should apply only to land situated in New Zealand. They were also concerned that including land situated outside New Zealand could result in a foreign tax resident being taxed in New Zealand on the proceeds of land situated offshore. New Zealand tax residents are taxable on their worldwide income. Persons who are not tax resident in New Zealand are taxable only on income that has a New Zealand source. Under international tax convention, the country of source has the first right to tax. The country of residence (if different) can also impose tax. However, the country of residence will normally give a tax credit for the amount of tax paid in the country of source up to the amount of the domestic tax. A simple example to illustrate: 9

13 Taxpayer A is a tax resident of New Zealand and earns $100 income in country X. Country X is the country of source and has the first taxing right. Tax is levied at the rate of 20% being $20. The taxpayer's marginal tax rate in New Zealand is 33%. New Zealand will impose tax of $33 less the $20 paid in country X. If the tax rate in country X was 40%, New Zealand would give a credit for tax of $33 being the amount payable in New Zealand. If a person who is not tax resident in New Zealand earns income in New Zealand, New Zealand has the first right to tax and a credit will normally be given in the person's home country for the New Zealand tax paid. Where the subject of the tax is land, the situation is a little more complex. In many countries, the disposal of land is subject to capital gains tax. Where the capital gains tax is incorporated into the country's income tax legislation (such as in Australia) the double tax relief works as outlined above. However, if the country has a separate capital gains tax with its own taxing statute separate from income tax, the credit for tax paid in the country of source is unlikely to be applicable, resulting in double taxation. This effect arises because the credit for tax paid in the country of source is generally only available for tax of the same kind as that payable on the gain in the country of residence. To illustrate: Taxpayer B is a tax resident of New Zealand and disposes of a residential rental property in country Z. The property has been owned for less than two years. Country Z is the country of source and has the first taxing right. Capital gains tax is imposed. New Zealand will impose income tax under the brightline rules. New Zealand would not give a credit for the capital gains tax paid in country Z as it is not tax of the same kind as that imposed in New Zealand. The result for a resident of another country selling land in New Zealand would be likely to be the same. The problem will not arise for new immigrants to New Zealand as, under the transitional residence rules, they are not subject to tax in New Zealand on foreign-sourced income for the fist 48 months following their arrival in New Zealand. However, it could impact quite harshly on New Zealand tax residents investing overseas or foreign tax residents investing in New Zealand. This is not a new problem. Capital gains tax can apply to many things other than land depending on the scope of the CGT regime in a particular country. Art works and other collectable would be subject to capital gains tax under some of the regimes with the result ususallybeing the same as above. That the submission to include in the brightline rules only land situated in New Zealand be declined. 10

14 4.7 Start date for two-year period Several submitters were of the view that the start date for the two-year bright-line period should be the date that a person enters into an agreement to purchase the land rather than the date on which they obtain registered title to the land. The reasons given for this included: The current land sale rules regard the acquisition date as the date a person enters into an agreement to purchase the land. Using the date of registration unfairly shortens the bright-line period; Consistency with existing rules would give a fairer result under the bright-line test; There is no difficulty in accessing the data for the date on which the contract was entered into; Using it as the start date would mean that there does not need to be a separate rule for sales off the plan ; Using the registration date is a policy reversal from the section CB 15B approach enacted in Officials have recommended that the submissions be declined. Submitters are correct when they state that using the date on which the transfer of title is registered for the acquisition and the date on which an agreement for sale and purchase is entered in to for the disposal date does result in the shortest possible period of ownership for the brightline rules. This is likely to result in more transactions being taxed than would otherwise be the case. However, as the only date recorded on Landonline is the registration date, using this date would make it easier for officials to enforce the brightline rules. An exception is proposed for property acquired off the plan where registered title is subsequently obtained (see 4.8 below). Therefore, the Committee will need to decide whether consistency with other land sales rules and fairness for taxpayers is, or is not, more important than having easy to enforce brightline rules. As one of the objectives of the brightline rules is to provide an easily enforced rule, I would recommend that the legislation as drafted be accepted as the preferred position. That the submission be declined. 11

15 4.8 Sales off the plan Submitters were of the view that the proposed separate rule for sales off the plan leads to unduly harsh outcomes that are likely to cause confusion for taxpayers.they give the following example: 1 July 2016: Person enters into a contract to purchase 1 September 2018: Person obtains registered title 1 March 2019: Person enters into contract to sell In this situation the person will be captured by the proposed bright-line rule because they entered into a contract to sell (1 March 2019) within two years of obtaining registered title (1 September 2018). In contrast, if the person had entered into a contract to sell on 1 August 2018 (which is earlier), they would not be covered by the proposed bright-line rule because they entered into a contract to sell (1 August 2018) more than two years after entering into a contract to purchase (1 July 2016). Following our extensive discussions, officials now agree that the situation outlined by the submitter would be anomalous. They have suggested that the start date be amended for situations where a person has acquired a property off the plan and they later obtain registered title for the property. This amendment would result in the two-year period starting on the date on which the person entered into a contract to purchase the property. This is what submitters have asked for in respect of all acquisitions (see 4.7 above) and may impact on the Committee's decision regarding the general rule. s 1. That the submission be accepted and that the officials' proposed amendment be agreed to. 2. That the general rule outlined in 4.7 above be considered in light of the decision made in respect of this proposed change for sales off the plan. 12

16 4.9 Farmland Submissions regarding farmland included: Lifestyle blocks should be eligible for the farming exclusion. This is consistent with the current taxing rules which treat small farm ventures as businesses. The proposed definition is uncertain and many farms currently would not earn sufficient income to meet the test. If officials main concern is to exclude hobby farms and lifestyle blocks, then it should be defined by reference to that rather than using this definition. If the current definition of farmland is retained, there should be further guidance provided in the Tax Information Bulletin.Farmland should be defined simply as land that is capable of being worked on as a farming or agricultural business. Officials have agreed economic unit is not the appropriate test for farmland. The propose that, instead, it be defined as land that is capable of being worked on as a farming or agricultural business. Following intense discussions they have further agreed that the exception should be available where a person is operating a farming business on several plots of land, but the individual plot of land that they own is not capable of being used on its own for a farming business. The example that I outlined to officials was of a farmer who owns a small plot of land on which they run a farm. The plot of land by itself is too small to be capable of being enough to support a farming business. However, the farmer is able to run a successful farming business on the land because the farmer s neighbours allow the farmer to use their land for the business. This farmer would not be able to use the current farming exclusion for the block that they own even though they are actually running a successful farming business on it. Officials have suggested that an amendment be made to the effect that the farmland exclusion be available where the owner of the land uses the land for a farming business. That the submission be accepted and the officials' recommended solution be accepted. 13

17 4.10 Exceptions for circumstances outside of seller's control Turner & Associates Submitters sought exceptions from the bright-line test for various circumstances where the seller is forced to sell property due to circumstances outside of their control. These included: Sales due to financial hardship; Compulsory acquisitions; Mortgagee sales; and Corporate and personal insolvencies. Officials have recommended that the submissions be declined. Most of the sales that will be subject to tax under the brightline rules will result from sales in circumstances outside of the control of the person concerned. Most people would, if possible, hold the property for the full two years to ensure that they were not caught by the rules. In circumstances of insolvency or bankruptcy, falling within the brightline rules would impact on the funds available to pay creditors. However, providing a list of exceptions for circumstances outside of the control of the person would lead to complexity. Inevitably, there would be calls for more and more exceptions. It will be important to monitor the situation to ensure that taxpayers are not being too adversely affected. That the submissions be declined but that officials be asked to monitor the situation carefully Deduction for holding costs A number of submitters were of the view that holding costs for property subject to the bright-line test should be deductible. Their reasons were as follows: This would be the result if the standard deductibility rules applied to the property An explicit provision would be consistent with how deductions are treated for other revenue account property and would ensure that only the gain on the sale is taxed. 14

18 Holding costs are incurred irrespective of whether the property was used or available for use for private purposes. Current rules provide a deduction for holding costs as holding costs do not exclusively relate to living as an individual and therefore are not subject to the private limitation. Officials are of the view that current deductibility rules would not allow for holding costs to be deductible for revenue account property when the property is used only for private purposes. They state further that the deductibility of holding costs is a current issue, which is not created or limited to the bright-line test. Officials intend to consider this area further. Holding costs are incurred over the same period as the increase in value of the property occurs. Therefore, there is some argument that it is a cost necessarily incurred in deriving the income. However, as the issue is currently being considered from a policy perspective for all tax purposes, I believe that the issue in respect of the brightline rules should be resolved as part of that review. That the submission be declined Trusts Officials and I are in agreement regarding the proposal to exclude non-active trusts from the requirement to file tax returns where they have acquired land had have been required to obtain an IRD number. The officials' report covers a number of issues that have been brought up by submitters. Officials have recommended that, in the main, the submissions be accepted subject, in some cases, to changes in the details such as dollar amounts. I agree that the officials have reached a workable position on all of these issues. That the officials' recommendations be accepted. 15