On March 29 an issues paper was released outlining Labour’s tax loss ring-fencing proposals. While it is designed to generate public feedback and therefore doesn’t represent the final form of the rules, it’s worth considering some of the detail provided. The detail is at a relatively high level, but these are the highlights:

Application Is Residential Land Only

The proposed rules will apply to residential land only. This aligns the ring-fencing rules with the bright-line rules, which also apply only to residential land. Generally, residential land is land with a dwelling on it, or capable of having a dwelling built due to zoning. Excluded from this is commercial property, a person’s main home, mixed used assets (e.g. a bach used privately and to generate income) and residential land that is on revenue account for tax purposes (land bought as part of a property dealing business, e.g. for development or trading).

Losses Ring-Fenced Internationally

Application is not restricted solely to land in New Zealand. The proposals are intended to apply to rental properties outside of New Zealand that are owned by NZ tax residents, eg a rental property purchased and owned in Australia by NZ tax residents.

Portfolio Basis Offsets Allowed

The rules will see tax losses produced by a residential rental property unable to be offset against non-property income. There was a suggestion that the tax losses should be ring-fenced on a property-by-property basis, meaning a loss produced by a particular property can only subsequently be offset against taxable income produced by that property, but that is not the current proposal. Instead, the paper talks about ring-fencing applying on a “portfolio” basis, so profits and losses of different rental properties can be offset against each other. Any surplus loss is then ring-fenced and offset against future property income. Property income includes taxable income on selling a residential property, eg under the bright-line rules.

Start Date April 2, 2019

The issues paper suggests the new rules will apply from April 1, and that they will either apply in full from that date, or be phased in over a two to three-year period. This is interesting in that it overrides Labour’s pre-election suggestion that any ring-fencing of losses will be phased in over a five-year period, to ensure investors have time to adjust. If the rules are phased in over a two to three-year period, the paper suggests that will be accomplished by progressively reducing the proportion of tax losses that can be offset against other income.

Avoidance Measures

There will be avoidance measures to prevent attempts to structure around the rules. The issues paper specifically contemplates a scenario where a taxpayer borrows money to buy shares in a company that owns a property, rather than borrowing money to buy the property itself. The objective in borrowing money to buy shares would be the hope that the loss produced by the interest deductions falls outside the ring-fencing rules. However, the paper makes it clear that the loss produced by the interest deductions would be considered ringfenced property losses.

Impact On Lower Income Voters

In my view, these rules will weigh a heavy tax toll on lower net worth, lower income families. Lower net worth investors getting on the property ladder tend to rely on tax credits more. If interest rates go up substantially, such lower income/ lower equity investors could be made insolvent (or more insolvent) by these rules, whereas affluent investors will be less affected. It does make me wonder if the Labour Government understands this point – such policy is contrary to much of their core voters’ interests.

Summary

The rules are intended to prevent the offset of tax losses produced by residential rental property against other forms of income. The commentary above is a reflection of proposals only – this is far from finalised law, but clearly there is an intention to put these rules in place. To have your say, you can send submissions to policy.webmaster@ird.govt.nz. If you have any queries regarding the above, please contact us at mg@gra.co.nz