The New Zealand Tax Podcast: Clarity about the the 39% trustee rate, and the timeline restoring interest deductibility for residential investment. But Inland Revenue doesn’t consider the removal of building depreciation “fair and efficient”

It's been a busy week in tax, beginning on Sunday when the Associate Minister of Finance, David Seymour, announced that interest deductions for residential properties would be restored to 80% deductibility from 1st April.

There had been a proposal under the Coalition Agreement for the present 50% deductibility in in the current tax year to increase to 60% with backdated effect, but that has now been dropped. The Minister also confirmed interest on residential investment property will become fully deductible with effect from 1st April 2025, in line with the Coalition Agreement.

Interest deductibility “Yeah, Nah”

The announcement reignited a long running debate over the fairness of the measure restricting interest deductibility. The crux of the argument against it being that businesses are allowed to deduct their costs when deriving income, and the change made to restrict interest deductibility by the last government was contrary to standard business and tax practice.

But when you consider this point keep in mind that under the Income Tax Act, expenses are deductible to the extent to which they are incurred in deriving gross income or to the extent they're incurred in the course of carrying on a business deriving accessible income.

“The extent to which” is the key phrase and the argument around non deductibility revolves around the fact that the economic return for landlords comprises of fully taxable rental income, and a capital gain which is largely tax free. But legislation generally has ignored this point of possible apportionment between what is taxable income and non-taxable capital income. This leads on to the never-ending debate as to whether we should tax capital gains. And so the argument of deductibility is just another continuation of this question.

It's also worth noting that businesses with overseas owners are subject to the thin capitalisation regime. This also restricts interest deductions where the New Zealand company’s debt to asset ratio exceeds 60%. Now this measure also contradicts standard tax and business practice, but it’s part of many jurisdictions around the world as a means of countering the risk of excessive interest charges transfer pricing money out of the country. In other words, there are arguments for and against restricting interest deductibility.

Improving the position of renters

On Thursday, the Minister of Revenue released an Amendment Paper for the current tax bill along with five Regulatory Impact Statements two of which covered the restoration of interest deductibility and the reduction of the bright-line test period to two years. There was some interesting commentary by Treasury in both impact statements noting:

“Rental affordability is a significant issue in New Zealand. Based on Household Economic Survey data for the year ended June 2022, a quarter of renting households were spending over 40% of their disposable income on rent housing, and rents have risen faster than mortgage payments. Renters also have higher rates of reporting housing issues like dampness, mould and heating.”

Treasury, Inland Revenue and the Ministry of Housing and Urban Development all agreed that restoring interest deductibility should have a long-term effect of putting downward pressure on rents, but ‘should’ is doing a lot of work in this space. Other measures are going to be needed to improve rental affordability.

But restoring interest deductibility has the benefits of simplifying matters. Restricting deductibility was an imperfect measure, with a great deal of complexity and arguably went too far in the other direction of apportioning expenses relating to the split between taxable and non-taxable income.

Trustee tax rate increase to 39% confirmed subject to $10,000 exemption

The announcement on interest deductibility was followed on Monday by the Finance and Expenditure Committee (the FEC) reporting back on the Taxation (Annual Rates for 2023-24, Multinational Tax and Remedial Matters) Bill. There's a great deal of interest around this Bill as it included the proposed increase in the trustee tax rate to 39%.

As had been hinted by Finance Minister Nicola Willis a couple of weeks back, there is going to be a de-minimis introduced for trusts with trustee income (undistributed income) of $10,000 or less. Such trusts will continue to have the 33% trustee rate apply to trustee income. However, for all trusts where the trustee income exceeds $10,000, a flat rate of 39% will apply.  Therefore, if there’s $10,000 of trustee income the 33% rate applies but if it's $10,001 the new 39% rate will apply on everything. It's not the first $10,000 is taxed at 33% and the excess at 39%. It's an all or nothing.

The FEC justified introducing the de-minimis exemption on the basis that the information it had received was that the compliance costs for many trusts were in the region of between $750 and $1,000 per annum. Therefore, the potential $600 benefit of a $10,000 threshold would be swallowed up by compliance costs, which is a fair point. But the reaction among my colleagues and myself is that the $10,000 threshold, although welcome is too low because, by the FEC's own logic, something closer to $25,000 could easily have been justified.

It's worth noting that the compliance costs for trusts have increased substantially in the last couple of years. Firstly, following the Trusts Act 2019 coming into force. And then secondly, Inland Revenue’s greater disclosure requirement for the March 2022 year onwards. By the way, we have seen nothing about those greater disclosure requirements being dialled back by Inland Revenue now there is the 39% tax rate in place. Back in 2021 part of the argument for not increasing the trustee rate to 39% at the same time as the individual tax rate went to 39% was to allow Inland Revenue to gather data on whether there was substantial amount of potential income sheltering through trusts. That theory seems to have been ditched for the moment.

Energy Consumer and deceased estates remain at 33%

Separately the FEC confirmed that the trustee rate for energy consumer trusts would remain at 33%. It also made changes to the treatment of deceased estates following submissions. A flat rate of 33%, will apply to all deceased estates rather than the deceased persons personal tax rate as originally proposed. More importantly, the trustee rate of 33% will now apply for the year of the person's death and three subsequent income years. That was in the in the wake of many submissions pointing out that deceased estates typically don't get wound up inside 12 months. These changes are welcome.

The Bill also covered off a number of amendments to other key topics, including the introduction of the global anti base erosion rules, the taxation of backdated lump sum payments for ACC and social welfare, rollover relief in respect of bright-line property disposals and relief under the bright-line tests for people affected by the Nelson floods.

Those global anti avoidance rules will take effect in two parts, the so-called income inclusion rule with effect from 1st January 2025 and then the ‘domestic income inclusion rule from 1st January 2026. This is a little later than the rest of the OECD and the intention is to give the affected multinational enterprise entities (those with consolidated revenue above €750 million per annum) time to get ready.

Inland Revenue recommended against removing building depreciation

On Thursday the Minister of Revenue published an Amendment Paper containing details of the proposals regarding the restoration of interest deductibility for residential investment properties, replacing the current five and ten year bright-line tests with a two year bright-line test period, removing the ability to depreciate commercial buildings and introducing a new Casino Gaming Duty. The Amendment Paper was accompanied by a detailed commentary .  and, as I mentioned earlier, the relevant Regulatory Impact Statements. Now as usual, these Regulatory Impact Statements (RIS) contain some interesting reading.

The ability to depreciate commercial buildings is being removed in order to help pay for the Coalition Government’s tax package. However, in the relevant RIS Inland Revenue recommended recommends retaining the status quo and that “the Government reconsider introducing commercial and industrial building depreciation when fiscal conditions allow.”

Citing its last Long-Term Insights Briefing Inland Revenue noted that in paragraphs 19 and 20 of the RIS, that under some assumptions made by the OECD:

“…New Zealand was likely to have had the highest hurdle rate of return for investment in and industrial buildings for the 38 countries in the OECD. This was when New Zealand allowed 2% depreciation on these buildings. Denying depreciation deductions will drive up these hurdle rates of returns even higher and make New Zealand a less attractive location for investment.

This tax distortion does not only impact building owners. To the extent the additional cost is passed on and there is less investment, it also impacts any business that needs to use a building and the customers of such a business. It thereby negatively impacts productivity more generally.”

Inland Revenue conclude in paragraph 32 of the RIS:

“We do not consider the removal of building depreciation to be a fair and efficient way of raising revenue. We are particularly concerned about the efficiency impacts which will make New Zealand even more of an outlier in pushing up cost of capital for commercial and industrial buildings. We therefore recommend retention of the status quo. We note this RIS is not evaluating the merits of the Government's tax package as a whole.”

So, why is the Coalition Government withdrawing building depreciation? Because doing so is worth $2.31 billion over four years which was understood before the election. Even so it's fairly interesting and unusual to see such a blunt assessment.

A new Gaming Duty

National’s Election policy included a new online gaming duty which was expected to raise something like $700 million over a four-year period. I was one of the those who was a bit sceptical about the revenue forecast. And it transpires that the numbers were indeed a bit optimistic.

What is now being proposed is a new 12% gaming duty for online offshore casino websites and this is in addition to GST, which is already payable when gambling on offshore sites. This new duty would be in line with how some other countries tax offshore casino websites. It's estimated to collect $35 million of additional tax revenue in the forthcoming year ended 30th June 2025 and expected to grow by 5% each subsequent year. This still leaves a gap of about $500 million over four-years in the original revenue forecasts.

The Budget in May is becoming more and more interesting for finding out how the Government will follow through on its commitment to increase personal income tax thresholds. Even though they won’t compensate for the effect of inflation since 2010 those threshold adjustments come at a substantial cost. I could see that further cost reductions may be imposed further down the track. Those are political matters which we'll have to wait and see how they work out.

Foreshadowing a capital gains tax?

Some commentary in the bright-line RIS raised the prospect of a capital gains tax. Treasury, for example, proposed a 20-year bright-line test or longer as it

“…would capture more capital gains, thereby improving the fairness of the tax system and supporting more sustainable house prices.”

Inland Revenue meantime felt the 10-year bright-line test was not an efficient way of taxing capital income before adding “If the government wanted to tax the income, it would be preferable to have a tax on these gains, irrespective of when the assets were sold.”  It’s interesting to see Treasury and Inland Revenue raising the bogeyman of a capital gains tax to address funding and fairness issues within the tax system.

And on that note, that's all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts.  Thank you for listening and please send me your feedback and tell your friends and clients.  

“As-salamu alaykum. Peace be upon you and peace be upon all of us.”