LTCS, RENTAL PROPERTIES, AND AVOIDANCE
In the wake of the 2011 Loss Attributing Qualifying Company (LAQC) and Qualifying Company (QC) changes, and following the introduction of the Look-Through Company (LTC) regime, the inevitable question has been asked, "If I sell my home to an LTC that then rents it out to third parties, will this be treated as tax avoidance?".
This question is asked of course because of the concerns the Inland Revenue Department (IRD) had regarding what was considered "inappropriate use of LAQCs" for owning homes. The concern was that tax advantages were being obtained through the use of LAQCs that could not be achieved under any other structure. Now, with the introduction of the LTC regime, taxpayers are being, not surprisingly, cautious.
The IRD has released a "Questions We've Been Asked Statement QB 12/11" confirming that s BG 1 of the Income Tax Act 2007 (which applies to void a tax avoidance arrangement) will not apply to circumstances involving LTC's and rental properties in circumstances where:
- Person A sells their family home to an LTC;
- The home is used by the LTC as a rental property and is rented to a third party on an arms-length basis;
- Person A owns 100% of the LTC shares;
- The sale of the home is at market value;
- The LTC borrows from a bank to fund the purchase;
- The person then uses the funds raised from the sale to purchase a new family home; and
- The person, in their capacity as holder of an effective look-through interest in the LTC, is able to deduct the interest incurred by the LTC on the loan.
This approach is not set in stone. The IRD has stated that if an arrangement varies materially from those listed above, or other relevant facts apply, a different outcome may be reached.
How it affects you
If you had an LAQC that has transitioned into an LTC that owns a rental property that you had previously lived in, as long as you have met all the components identified in QB 12/11, the structure should not be challenged as tax avoidance. If the sale of the home was not at market value, or the home owned by the LTC is one in which you reside, or the home is leased to your associates, this may still be considered tax avoidance.
If you cannot tick all of the boxes, we recommend you speak to your advisor.
REPAIRS AND MAINTENANCE – DEDUCTIBLE?
All previous statements made by the IRD relating to repairs and maintenance expenditure have been updated by the recent release of Interpretation Statement IS 12/03, "Income tax – deductibility of repairs and maintenance expenditure – general principles". The Interpretation Statement effectively serves to add a two-stage approach for determining whether repairs and maintenance expenditure is of a capital or revenue nature.
The new two stage test requires that:
- In the first stage, we identify the relevant asset that is being repaired or worked on;
- In the second stage, we consider the nature and extent of the work done to that asset (Auckland Gas Co Ltd v C or IR (2000) 19 NZTC 15, 702 (PC)).
The IRD has noted that in adopting this approach, the Courts maintain the ability to distinguish repairs and maintenance expenditure on the specific facts of each case.
On its own and in isolation, there is no surprise in the outcome of the analysis. When however we consider the changes to the depreciation rules regarding buildings and commercial fit-out, and the IRD's three step process for identifying residential fit-out , the application of this two stage test becomes a little more complicated for commercial and residential property owners.
The first stage is to identify the relevant asset. When you have a commercial building, it is necessary to decide whether the work is being done in relation to the building, an item of fit-out, or something else that stands alone (appliances etc). If you have an item that is plant that is attached to the building, this is defined as fit-out and is not part of the building.
Similarly if you have an item that is attached to the building that is non-structural and not used for weatherproofing the building, this too is fit-out. If the item worked on is "fit-out" then that is the "asset" that needs to be taken into account when assessing stage two of the repairs and maintenance test. If the item is not "fit-out", by definition it is the building, and therefore that is the "asset" that needs to be taken into account when assessing stage two of the repairs and maintenance test. A similar approach will be adopted for residential rental properties.
How it affects you
If you own a commercial and/or residential rental property, care will need to be taken, particularly in the 2012 and 2013 income years, to ensure that depreciation and repairs and maintenance are treated correctly.
POINTS OF INTEREST…
The deemed rate of return on FIF attributing interest has been set for the 2011/2012 income year at 7.58%.
The NZ-Japan Double Tax Agreement is under review, with officials hoping to facilitate bi-lateral investment. Potential changes include lower withholding tax rates on dividends, interest and royalties, and an arbitration provision to deal with taxpayer disputes.
A Bill enabling the Government to offer New Zealanders minority shares in four energy SOEs has passed its third and final reading in Parliament.
TO THE POINT…
"Abscond - to move in a mysterious way, commonly with the property of another. "
SHARE SALES AND TAX EXEMPTIONS
In New Zealand it is often difficult to distinguish taxable from non-taxable gains made on the sale of shares. As a general rule, if the shares were acquired with an intention to sell them, the gains will most likely be taxable. If a taxpayer is a share trader, the gains are also most likely taxable. If shares are acquired for long-term hold with a view to earning dividends in the medium to long-term, any gain on sale is likely to be a capital gain and generally non taxable. This follows the standard accessibility of income rules.
New Zealand is one of the few countries in the world that does not (yet) have a capital gains tax, per se.
In an article published by Chapman Tripp, a suggestion was made that given the similarities between New Zealand and Singapore's respective tax regimes, adopting Singapore's recent reforms would be both consistent with measures already taken here, and may reduce uncertainty and promote an attractive image for New Zealand investment. This is an interesting proposition, and one that warrants discussion.
In both New Zealand and Singapore, the tests for distinguishing capital and revenue are quite similar.
In Singapore, a decision has been made to apply an exemption to gains made by a company from the sale of voting shares where, at the time of sale, the seller has held at least 20% of ordinary voting shares in the relevant company for a continuous period of at least 24 months. This is to be applied to shares in both domestic and foreign companies, but excludes gains made by insurance companies, or to sales of shares in unlisted companies which are in the business of trading or holding land in Singapore. Deductibility of losses from sales is unaffected, and there is no negative implication that a gain which is outside the terms of the exemption is necessarily on revenue account.
New Zealand already taxes gains under the Foreign Investment Fund regime through the Fair Dividend Rate method which taxes a "deemed dividend return" of 5% of the opening market value of the investments each year, but not the capital gain, and exempts tax gains made by Portfolio Listed Entities from the sale of New Zealand and listed Australian share investments.
How it affects you
Although New Zealand may wish to consider different thresholds for an exemption on gains made on the disposal of shares, a simplification of the rules and certainty around the taxation of those gains would be welcomed.
SALE AGREEMENTS IN FOREIGN CURRENCY
Tax officials are looking at options to simplify the tax rules relating to the sale and purchase of property or services, particularly where the consideration in the agreements is designated in foreign currency. These essentially fall into the Financial Arrangement rules from a taxation perspective.
This has been prompted by concern over the complexity of the rules currently governing these types of arrangements. Officials have also expressed concern at the volatility caused by some of the methods mandated for these agreements in Determination G29, as this is contrary to good tax policy and the intention of the Government to create certainty of tax treatment and fairness of tax outcome so that those taxpayers in the same position are taxed the same way. Determination G29 has four methods available to determining the income calculated in relation to the arrangement.
At the present time, arrangements in foreign currency must be accounted for in two separate components.
The first is taxed as a forward contract for foreign exchange from the date of entering agreement until the date the service is performed or the property is made available. It is this component that has been particularly problematic.
The second is to treat the agreement as including an interest-bearing loan. These can result from both prepayments and deferred payments made under such agreements.
The preferred solutions are:
- to require taxpayers using IFRS to apply IFRS GAPP treatment to the taxation of the agreements.
- to allow non-IFRS taxpayers to use the aggregate NZ$ value of the property or services using the actual spot rate, subject to three exceptions.
It is important to note that the current proposals relate to agreements made in either New Zealand or foreign currencies.
Any new rules would be made effective for the 2012/13 year, however taxpayers would have an option to elect into the new rules from the 2011/2012 year. Once elected, the rules apply to all new agreements going forward.
How it affects you
If you enter into agreements for the sale and purchase of property or services that are currently caught by the Financial Arrangement rules, the taxation rules may soon be simplified. We will follow progress of this discussion document in future issues.
POINTS OF INTEREST…
The Inland Revenue Department has recently released an industry guideline for winemakers, detailing how to claim the wine equalisation tax (WET) rebate.
The Public Trust free will service has ceased from 1 July 2012, although it has been noted that some low income clients may still qualify.
The Financial Markets Authority will continue its engagement with Perpetual Trust Ltd to recover $25m in related party loans made by Perpetual as trustee of the Perpetual Cash Management Fund.
TO THE POINT…
"Apple's market share is bigger than BMW's or Mercedes's or Porsche's in the automotive market. What's wrong with being BMW or Mercedes?"