Accountants and tax experts warn investors forced to sell early will be 'collateral' damage in new two year 'bright line' test aimed at speculators; Parents buying homes for kids via trusts will get caught too

Accountants and tax experts warn investors forced to sell early will be 'collateral' damage in new two year 'bright line' test aimed at speculators; Parents buying homes for kids via trusts will get caught too
BDO Partner Alan Scott (left) and CAANZ Tax leader Peter Vial appear before the Finance and Expenditure Select Committee on Sept 23. Photo by Lynn Grieveson for Hive News.

By Lynn Grieveson

Property investors who suffer a change in circumstances forcing them to sell a property will be the “collateral damage” of the proposed bright line test, said tax lawyers and accountants at a parliamentary select committee hearing on Wednesday.

The bright line test, which comes into effect on 1 October, is designed to crack down on property speculation by automatically taxing the profit made on residential property (other than the main home) that is sold within two years of purchase.

Submitters from Chartered Accountants - Australia and New Zealand (CAANZ), EY, KPMG, Chapman Tripp and the Law Society were unanimous in telling the Finance and Expenditure Committee that the test would see rental property investors who sold due to illness, job loss or relationship breakdown hit with tax charges, while true traders and speculators would change their behaviour to avoid being taxed on their capital gains.

“This bright line test is a bad idea and shouldn't be enacted as in our view it will be ineffective in meeting the stated policy objective,” said Stephen Tomlinson of the Law Society Taxation Committee.

He described the proposed legislation as “incoherent, and just makes the current rules which are already fraught with difficulty even more difficult to apply.”

Tomlinson said the Taxation (Land Information and Offshore Persons Information) Bill passed earlier this month, which amended the Land Transfer Act to require buyers and sellers to provide IRD numbers, would be more effective than the bright line test at deterring property speculators by providing Inland Revenue “with effectively an audit list to basically go and check these property transactions, go and ask questions where they think questions should be asked and enforce the current taxation regime.”

The submitters were also unanimous in criticising the bright line test as inconsistent with already existing land taxation regulations.

BDO Tax Partner Alan Scott warned that people living in a property bought through a trust using money provided by parents might not be able to use the main home exemption to escape being taxed, even though they are a beneficiary of the trust.

Unlike under existing legislation, the parents, as “principal settlor,” would be the only ones able to claim the main home exemption.

'Change the start time'

The submitters also all called for a change in the time that the bright line clock started ticking, to bring it into line with current regulations setting the date of acquisition of a property as the day the contract becomes unconditional, rather than when the title is registered.

They said this would effectively make the bright line period longer than two years in nearly all cases.

“Using the date that title is registered also has an aspect of unfairness about it, because it effectively defers the start of the bright line period and that's contrary to the principle that was put in the regulatory impact statement to minimise the number of sales that are made taxable without an intention of sale,” said Peter Vial of Chartered Accountants Australia and New Zealand.

“We think that deferring the start of the bright line period by that acquisition date definition will mean that more properites are caught where there is no intention of disposal, more sales are caught, so there will be more collatoral damage.”

Ringfencing also criticised

The proposed bright line law also differs from existing land taxation law by ring-fencing losses made by property investors, which Tomlinson called “quite an abhorrent aspect” of the rules.

“The stated purpose of these rules is just to buttress the [intention] test. There is no such ring-fencing of losses under the existing test so we query why there should be a ring-fencing of losses under this proposed bright line test. It does create an economic distortion and we consider that is unnecessary and it is a bit of a design flaw of the Tax Act. We don't have those type of restrictions in relation to other types of losses. I thought we had got rid of that in the late 1980s ... and we find this now creeping back into the Tax Act,“ Tomlinson said.

The bright line test would also capture as “collatoral damage” people who sold within two years because they were forced into a mortgagee sale or were subject to a compulsory acquisition.

After hearing submissions calling for exemptions for such vendors, Jamie-Lee Ross asked why shouldn’t people forced into a mortgagee sale pay tax on any capital gain.

EY Executive Director David Snell said that depended on what the government’s true aim in bringing in the bright line test was.

“If you are bringing in this rule because you feel the current intention test needs some support it shouldn't be taxable because that is not what you are trying to design. If you are trying to tax as wide a range of gains as possible, then yes, it should be taxed. However, that latter point was not how the policy was explained on introduction,” Snell said.

He agreed with previous submissions arguing that, rather than introducing the bright line legislation, the government should instead amend the existing tax legislation to include an assumption that property sold within two years was being traded and therefore subject to tax – but allowing vendors the right to argue against the assumption.

'Cut it to one year'

Also presenting a submission was Andrew King of the Property Investors’ Federation. He called for the bright line test to be cut so it applied only to properties sold within one year.

“Rental property is a long term thing. Most of our members will not be affected unless something that happens out of their control such as a terminal illness or losing their job,” King said.

“A trader or speculator makes their money through trading and speculating,” he said.

“They buy and sell fast because holding the property incurs costs and reduces their potential gain. If the bright line test was one year it would catch 95% of the traders and speculators but it wouldn't have the affect on rental property investors who intended to hold for the long term but were forced by circumstances to sell.”

King also called for a hardship clause to exempt property investors forced to sell because of illness or job loss.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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14
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What is the difference between a property speculator and a property investor? Both need to be caught and taxed.

11
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The Nat's argument for not being willing to take tax off healthy foods is all about the economic efficiency and simplicity of the present tax on all goods and services. Yet, when it comes to tax on all forms of income - its an entirely different argument.

And that's because all CG taxation rests on the valuation involved. About which experts have been known to disagree. Unrealised gains have zero inherent value without a supporting valuation.

Quite different to yer average can of beans....

Unrealised gains aren't income.

Ha! You're clearly not familiar with the FIF regulations...

It is businesses who are selling foods that will be bearing the costs if GST were to be taken off healthy foods......and businesses do not get paid for collecting GST on behalf of the Government.....neither do they get paid for their supplying annual returns or workers wages......

It is an overhead, get over it.

Overheads still have to be paid for....so it has nothing to do with getting over it !!! You might be getting freebies out of the Government but anyone in business is sure as hell is not !! Instead of thinking that it is your right to put up other people's costs how about wearing the costs of that yourself......the Government should be paying businesses for collecting taxes on their behalf!!! Perhaps putting up ordinary wage earners taxes to cover the costs of tax collection is in order!!

13
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Crying over unspilt milk here.
This legislation should by for five years not a measly two.
It just shows how incompetent our law makers are.

11
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It's not incompetence, its by design. A well designed wet lettuce leaf.

I think 2 is enough to stop most of the crazy buying and selling. Besides which I think they can do an enabling legislation with a timespan they can then vary if its seems its needed?

13
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"Cut it to one year" submission by Andrew King of the Property Investors’ Federation?
Really - Lets make it 2 weeks shall we?
A question that should have been asked of all these "pros" was how much skin they had in the game then we could judge whether we were getting an unbiased view or it was more of what we get from our MPs who are well documented as real estate specvestors. Foxes / hen house

14
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The pigs are at the trough and don't like what's being served up.

I agree. How sad if someone's circumstances lead them to sell an investment property for a gain. It's terrible that they should have to pay tax on a profit from trading or speculating on a property.

These "experts" are spouting self-interest. It's not like someone selling a property for no profit or a loss is going to have to pay tax. That and they only have to wait 2 years to lock in a tax free capital gain.

17
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Tough. If you happen to make a gain its taxable. Get over it.

12
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There should be a comprehensive capital tax as Gareth Morgan argues. Anything else simply creates economic distortions and means the over taxation of labour.

And Gareth Morgan is wrong!!!
Taxation was not meant to be a tool to be used at whim by those in power...its purpose is to cover Government social spending only !!! Taxation was never meant to breach ancient human rights......people who earned the money have a right to keep their money......and not to be arbitrarily interred with at every corner by some zealous idiots who have personal agendas.

10
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Indeed. It is the god given right of the rentier speculator to harvest untaxed risk free capital gains from now into perpetuity! How dare they meddle with that!

11
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I don't think they will find many sympathetic ears...a gain is a gain, regardless of the circumstances that have lead to the sale. You have to pay tax on that gain, why should you be exempt because you lost your job or your marriage fell over? You have still made a gain...

agree

Exactly. I love the emotive "collateral damage", what a travesty having to pay tax on a capital gain

You are only going to drive people into creative ways of avoiding as much tax as they can!!

And reducing that gain you speak of will be the target of the wise and informed!!!

Does this tax still apply if the property was never actually sold?
For example Bob sets up a company called "Transfer" and gifts/allocates the house to Transfer. He then sells Transfer to Jane for the value of the house owned by transfer so that to all intents and purposes Jane now controls the house even though the house was never sold. Jane could then sell Transfer to Jimmy for the price of the house, etc, etc...

The accountants and financial advisers have to earn their crust some how...just because people will find a way around a tax does not mean that tax should not be applied - it just means it'll need to be tightened in the future. Entire industries are built on tax avoidance.

11
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Judging by this lot's response the tax will be more effective than first thought. The comments sound like various forms of "but...but....we can't drive a bulldozer through it! Where are the loopholes!?!?..."

Sure they can. Even a layman like me can see issues with houses being bought by companies and then those companies being sold as proxy for the houses.

So you admit to trying to avoid paying tax?
Would you with your layman knowledge be willing to help the IRD so that it is fair for all?

Can you inform as to why you think it is wrong to not pay more tax than what one should?.......would you pay more taxes than what you need to in a given year??

I'm more than willing to help the IRD come up with a rule that is fair for all. Try "Universal Basic Tax" this would ideally be a flat $ rate that everyone pays regardless of their income level, given the simplicity of the system it would be more difficult to avoid.
An alternative would be a 20% or 25% flat income tax. If the IRD feels the need to penalize those who contribute more to the economy, then you could just raise the GST in addition to one of the above 2 taxation methods.

Sitting here having a coffee in Vancouver and so glad all you greedy enzud self entitled, trust funded "baby boomers" are all so far south !!! Grow up !!! Taxes are a world wide and why should NZ be exempt .....that is why there are so many foreign buyers laundering " funny munny" on the Auckland market !!!

Vancouver too.

yep

Their very whinning says it all for me. There is always a risk to gambling, this is one to take into account when laying your bets. Long term genuine landlords aiming for positive cashflow long term I cant see as having any issues with this.

Bring it on.

Surely they could have chosen more sympathetic examples of affected persons than investors or trust fund babies.

If they want their argument to have any traction with the rest of NZ...

Because all I am thinking, is that these are exactly the kinds of people we want the legislation to hammer hard.

The Left Wingers are in full cry again.
Everyone is a Socialist until it's their money that's at risk
People who buy and resell investment houses within two years are to be taxed.
How do you work out what the tax should be if the investor, plus his wife and kids, are forced to sell under two years for health reasons, but have spent hundreds of hours of their own time doing up the property. Do they have to keep a log book? Does the man charge his time at higher rate than his wife? What hourly rate are the kids on? Can they charge overtime? Time and a half? Travelling time? What if they use materials on the investment property that were lying about at home? How do they cost that? What happens if they bought the house for an elderly relative who dies after only 6 months so they don't need it any more? Should they be forced to sell at market and incur tax, or sell at cost and get done over by the IRD. Answer these just for starters .

I'm not saying I necessarily disagree as I haven't had time to thoroughly think this through, but they could keep it simple - i.e. if there is a profit they pay tax (and forget the sob stories).

Now tell me BigDaddy, you've been a bit quiet on the numbers out recently. Are property owners in Auckland in your opinion going to see their property values fall over the next 12 months?

......no reply BigDaddy? That means you also think prices are going to fall.

Overleveraged should panic!!!!!!!!

..dead right Big Daddy, you ar so right...this is exemption is so complex we just need to tax all cap gains on all property. Excellent stuff.

Crocodile tears. An imaginative "what if", but not impossible, scenario likely to represent a scant minority of situations dwarfed by those who will misrepresent their circumstances to avoid taxation of deliberately accumulated capital gain. Just another trapped exploitative rat squealing. Cue the saving the world landlord diatribe.......

Start a renovation company structure for your property......the house has to pay the renovation company.......which in turn pays you for doing the work........maybe keep the leverage on the investment house maxed up at the bank as the property increases in value......they can only tax the difference between the sale price and the mortgage repayment.......it needs a bit of closer look than what I have had time to give it!

I foresee each investment house having an entity setup to hold it which is then traded instead of the house. Selling without actually selling. Such proxy selling will distort real estate sales statistics and create a complex sale and purchase environment where the losers will be the uninformed who believe that market value for their property is reflected by it's "valuation". Investors would quickly buy up these and put them into companies which get traded between investors at the true value of the houses.

....no doubt the IRD will counter this with a change of shareholding type rule (much like losses carried). And without a commercial reason for the structure, also argue tax avoidance.

This legislation will be welcome with open arms by the tax accountants (as xero erodes their other work). So while you might engineer an apparent out, it will be expensive and high risk - fancy an IRD door knock 7 years down the track carrying their bag of penalty taxes, late payment provisons and so on?

I think you're more than likely very correct on how this will work sadr001 !!

Sell a house, sell a company - make a profit, pay your tax. If your company is started as value of $0 then you probably pay more gain than what you would if you just had the house.

Easy legislative change if company has over 80% of it's fixed assets in residential property then capital gains due on sale of company or shares in said company. Also likely IRD could push for tax evasion rather than avoidance via ruling and come after back tax with penalties, punitive interest etc. Structuring affairs this way would be a like buying an option that gives the IRD, the opportunity to bankrupt you at some future date.

Have purpose built trusts (whose trustees are more diverse than their beneficiaries obviously) transfer the companies between them. Also your rule would catch numerous motel / hotel / hostel operators as well as numerous boutique legal / accounting / dental firms that operate out of houses.

We can only hope that the IRD has its eyes open to the mainly Asian sellers who after only a very short ownership have featured in recent sales with conditions specifying settlement prior to 1st October.
I would have a bet that the IRD will do nothing to constrain the funds to guarantee their fair share of tax under existing rules.

Tax should be designed to be simple and to minimise opportunities for fraud and be fair for all. The intention rule for capital gains tax on residential rental property should be completely replaced with a series of graduated bright line steps - perhaps from 2 to 5 years. Then there would be clarity and certainty for all. There would be no opportunity for abuse and the simplicity of the rule would save on costs for both IRD, for traders and for investors.

You have to love it. Shouldnt have to pay tax because you are sick, or might get sick, or divorced

Watching court cases and various convictions meted out it is remarkable how many of the perpetrators suddenly develop a serious case of schizophrenia, or autism or some form of depressive illness, or they were on some powerful psychedelic medication at the time - hoping to be excused

Now the bean-counters and tax-spivs reckon everybody should be exempt all because their pet client-spiv might have an accident, or get a case of the jitters and their relationship or marriage might break down

Well that might work only if the spivs can demonstrate they have donated to charitable causes at least $50,000 per year for the past 5 years to help out the lower-caste peons who can equally suffer from the same afflictions - otherwise TAX THEM