Tax Changes Update

The Government’s release of draft legislation this week was disappointing on a number of fronts.

First, what was expected to be complex legislation has been successfully made nearly indecipherable. Second, it is of course disappointing that they are pressing ahead with the rules being effective from 1 October despite only this draft version being available to taxpayers at this time. Third, there is no detailed commentary to accompany the draft.  

In working through this, it is important to bear in mind that this draft legislation is yet to go through the select committee process, so there is a chance of details changing between now and when it finally becomes law.

Bits that were as we expected

Five-year bright-line

  • A five-year bright-line period has been brought in for new builds.
  • New builds have been defined as property purchased within 12 months of their code compliance certificate (CCC) being issued, with that CCC being issued on or after 27 March 2020. (Note this is not a typo – the date for the issue of CCC is on or after 27 March 2020, being one year before the 10-year bright-line period applies.)

Interest deductibility

The interest deductibility rules kick in from 1 October 2021 as expected, and there are exemptions for:

  • Renting out part of the main home.
  • Business premises – this excludes a business that involves the provision of accommodation, unless it is a hotel, motel, inn, hospital etc. Boarding houses are notably not included in this list of business premises, which suggests an intention for them to be caught by the new rules. I suspect there will be more to come on this.
  • Property bought as part of the business of dealing in or developing land or erecting buildings.
  • New builds – more information on this below.

Rollover relief

The government has followed through on extending the “rollover relief” rules. Rollover relief means you can transfer property within your structure without triggering adverse tax consequences (like resetting the bright-line period for 10 years). Under this draft legislation, rollover relief will apply to the transfer of residential land or a property that is subject to the interest deduction limitations by an individual(s) to a trust, provided that the individual(s) transferring the property are beneficiaries of the trust and the principal settlors; and every beneficiary of the trust is associated to that individual(s). 

It appears this will apply to transfers on or after 1 April 2022. This is excellent news and will open up scope for transferring property into trust ownership. 

There is also rollover relief when transferring residential land or property subject to the interest deduction limitations to an LTC where the shareholding in the LTC mirrors the ownership of the land pre-transfer. I see this as being of less significance, as there is typically unlikely to be much advantage gained by transferring a property held personally into an LTC where you own the shares personally.

It is also confirmed that the existing rollover relief that applies to transfer of assets under a relationship property agreement also applies for the purposes of the interest deduction limitation rules.

Unexpected developments

Main home exemption

The main home exemption has now undergone a further change for bright-line purposes. This exemption currently applies as long as most (i.e. more than 50%) of the property in question is used as a home. This has meant that if you rented out 50% or more of a property, so that you cannot say it was mostly used as your home, then you got no relief under the main home exemption. In other words, you would have had to pay tax on the full gain if the property was sold within 10 years of acquisition.

A new proportionate approach is now able to be applied where less than 50% of the property is used as the main home. By way of simple example, if you applied 25% of a property acquired on or after 27 March 2021 to your own private residential use, and then you sell it within the bright-line period, 25% of the gain realised on sale will be exempt.

New build exemption

The new build exemption for the interest deduction limitation rules applies for a fixed 20-year period. This means that if you have a property that qualifies as a new build, then interest can be claimed for a period of 20 years from the issue of CCC by all owners during that period who rent it out residentially.

As noted above, a new build is a property where CCC has been issued on or after 27 March 2020. This opens up scope for interest incurred on properties bought prior to the announcement in March 2021 continuing to be deductible under the new build exemption – subject to the 20-year time period. 

Interest can be offset upon sale

Denied interest deductions can be offset against taxable gains realised on sale of the property if that sale is taxable either due to the application of the bright-line rule or other provisions (for example the tainting provisions). While this is what we perhaps should have expected, as it is only fair for the interest costs incurred by an investor to be allowed as a deduction if taxable income arises on sale, this was not guaranteed so it comes as a pleasing inclusion.

Social housing exemption

Also exempt from the interest deduction limitations are properties that are applied towards provision of social housing. This means if you rent your property to Kainga Ora or a registered community housing provider, who in turn uses the property to provide social housing or temporary accommodation for people in need, then you can continue to claim interest deductions. This exemption is better than the new build exemption because there is no time limit attached. You get ongoing interest deductibility for as long as the property is applied towards this purpose. 

Fixing Our Housing Problem

The government need to treat investors and developers as the solution, not the problem. Supply is the long-term solution – and it comes from developers and investors. You need both.

The investors buy the assets from the developers. If the government continue to make it too hard and annoy property owners (the “landed gentry”) with uncommercial tenancy laws and rifle taxes on property (e.g. interest non-deduction, which is manifestly unfair), then the housing crisis gets worse, not better, because as an industry we will increasingly sit on our hands and wait for a more commercial government. 

Instead of vilifying and blaming property investors to deflect the issue away from government, I suggest Labour, academics, and the like do the following:

1. Stop worrying about what investors get, and look at what they actually do for NZ. They supply and manage housing, an essential service. They are one of your most important suppliers. Look after and help them, and you will get more supply. If you really encourage supply with good zoning and infrastructure on tap, you will see developers build too much stock and oversupply the market. (Arguably this is happening in Auckland at present.) Oversupply is the answer to the government’s problems: rents drop and so do house prices. Everyone gets a house.

2. Stop disrespecting investors. You get no respect or buy-in from our industry by pelting us with insults and labels; you just look like envious socialists playing the blame game. And the attitude pervades through public policy. Creating scapegoats (investors) for what is a problem caused by successive governments’ under-investment in housing, is nasty.  Calling us tax cheats, alleging our “real motivation” is untaxed capital gains, demonstrates the government does not understand investors’ business model and intentions at all. (We can’t retire on capital gains; we retire on cashflow, which is taxed.) If you really can’t live with the gains being untaxed, then damn well step up and go to the election on a CGT platform; get permission to do it.

3. Instead, make it easier for developers and investors to succeed, and you will get more supply.

a. Immediately seek consultation with our community on how you can assist us to solve the housing supply problem.

b. Immediately look at how successful the Auckland Unitary Plan has been at reducing land costs in Auckland, by allowing multi-unit sites and high density housing. (Splice a million dollar section into 10 units, replacing one McMansion. Land cost dilutes 90%, houses get cheaper.) All cities and towns across NZ need this zoning change now. I know developers building to rent, and the zoning rules in small towns and most cities come from the 1960s, where everyone gets a quarter acre section. Times have changed; zoning needs to keep up.

c. Immediately assist landlords with rolling back the no-cause 90 day termination notices you abolished. This makes it nearly impossible to manage anti-social tenants, and makes me (and others) very, very picky with tenants, amplifying your emergency housing problems. Do they not see the link? 

d. Continue to ramp up and forward-fund infrastructure. (Brief accolade here to Labour. They inherited a hopelessly rundown national infrastructure from successive National and Labour governments’ under-investment in housing infrastructure. They have pledged $3.8b to infrastructure, and more, and it’s already helping small towns and cities. I’ve seen it first-hand.) Keep doing this and spend more building sewers, stormwater, telecommunications, and all infrastructure. Upgrade roads and public transport. This is the best investment in the future of NZ housing supply.

e. Don’t charge developers a development contribution that exceeds the cost of their actual pro rata share. All this does is encourage developers to land bank and sit on the land undeveloped because they feel like they are being taxed through the back door with exorbitant development levies. If you want supply, do what they did in Australia and forward-fund the 20 years of future development infrastructure. Charge developers a pro rata and fair connection fee as they connect to the infrastructure. There is talk at the moment of doubling development levies and there’s consultation going on about it. Quite simply, if this happens, many developers will just sit on their hands, and this will undermine supply. Moreover, developments that do proceed will simply pass the cost on to the buyers. Government needs to socialise the cost of forward funding, with a long-term scheme socialising the cost over the total potential number of connections. Not slam the current developers in a tax grab.

f. Stop with infusing ideology into Resource Management Act reform. It seems the government’s main agenda coming out of their initial work in this area is implementing He Puapua and Iwi rights into land development and the environment concerns. I thought this reform was about cutting red tape? They have lost perspective here.

g. Repeal interest non-deductions. Otherwise, when interest rates go up, you will send cashflow poor investors broke. This is because a rise in interest rates will no longer trigger tax relief, smashing the cashflow of fixed income households. The damage that will be done to supply by taxing the net yield (i.e. income before interest costs), rather than the net cashflow, won’t be seen until the phased in non-deduction rules bite in the 2025 and 2026 financial years, 3-4 years away. A downturn like this will inevitably stall investment in housing and reduce supply.  

h. Understand that the rough end of the tenant pool is now toxic to private investors, due the removal of the no cause tenancy termination. Labour made this rod for the government’s back because they don’t understand the housing market. Their emergency housing demand is blowing out. One of the reasons is because landlords are under-supported in the tenancy tribunal, and now without the ability to remove a tenant with ‘no cause’, most landlords won’t touch tenants with social problems. It’s just too hard. So it rebounds on to the government and will continue to do so, until tenancy laws are made more commercial. This is directly caused by these tenancy rules. I speak from listening to clients.

There is no one simple or specific cause to problems of housing affordability, lack of supply, and wealth inequity.  But it’s obviously not tax that causes all these problems. It’s cheap money, loose lending practice, and a desire to benefit from leveraged gains, which unleveraged investments (like stocks)

What can I claim as a tax deductible when I am in business?

Apart from a few special rules, any cost necessary to run your business will probably be tax deductible. 

However, there are a few things to be aware of – some items that you might assume could be claimed can’t be, and conversely, there may be others you didn’t realise are legitimate expenses.

General

If you have “incurred” an expense, you can claim it, even though you might not yet have paid it. Note that some costs that provide future benefits, like insurance, may not be fully claimable in the year incurred. 

Inland Revenue may not tell you how to run your business. If you want to run a Mercedes car, it is your choice. You cannot be told a cheaper car will do the same job. However, if the expense has a personal flavour about it, such as a couple going out to dinner and calling it a directors’ meeting, you will not be allowed to claim the cost. 

Business versus private expenses

Some payments appear to be necessary for business but are deemed private. Here are a few examples:

•  Travel from home to work and back

•  The clothes you wear to work unless they are protective clothing like overalls for a painter and sneakers for a roofer. To qualify, the clothes have to be subject to undue wear and tear or of a specialised type – not normal apparel. For example work-boots, overalls.

•  Socialising with mates in a pub

•  Spectacles

•  Costs of getting into business, such as a lawyer’s bill and the cost of creating a limited liability company

•  Usually, the cost of taking your non-working partner on an overseas business trip

•  The costs relating to installing new machinery, including travel to go and evaluate it

•  The debt repayment portion of hire purchase, finance lease or other loans

The above costs are either considered to be personal or costs to put you in a position to do business, as opposed to actually doing it. 

Expenses which have an ongoing benefit to the business over a period of years are “fixed (or non-current) assets.” You can only claim a proportion of their cost each year, known as depreciation.

Use of home

If you use part of your home for business, IRD will accept a claim for a portion of the costs. The portion is work out as a percentage of the total home. For example, if the home office is 9m2, and total home is 100m2, then the portion of costs will be 9%. The standard costs would be:

•  Rates

•  Insurance

•  Interest on mortgage

•  Repairs and maintenance

•  Power

A few things to note:

  • If the business uses the garage, include this as part of the area used for business
  • Substitute rent for interest on mortgage etc, if you do not own the house
  • Keep supplier tax invoices
  • You can also claim GST on the business share of these costs
  • If your business is a company, the home office-related bills will not be made out to it. In this case, claim reimbursement from the company because you are one of its employees.
  • Generally, where income is only interest and dividends, there is no claim for use of home to run your investments.

Motor Vehicle expenses

Sole Traders and Partnerships

In order to clearly establish the apportionment between business use and private use, you need to run a logbook. Based on the logbook, there are two options that can be used for the calculation: the cost method based on actual costs, or the kilometre rate method.    

Cost method

Under the cost method, you claim a deduction based on the business proportion of your actual motor vehicle costs. 

For example, a business owner collects all the receipts and invoices related to motor vehicles expenses (including registration and insurance etc), which total to $12,500. Based on the logbook, 60% of the vehicle’s use is for business. So, the calculation will be:

$12,500 x 60% = $7,500  

Therefore, the total to claim is $7,500. 

Kilometre rate method

Under the kilometre rate method (also often referred to as “mileage”), you are required to keep a logbook for at least 90 consecutive days to determine the proportion of business use versus personal use. This is then applied for a term of up to three years.  

You must make an election to use the kilometre rate method. Once the election is made, it is irrevocable, and the kilometre rate method must be used until the vehicle is disposed of. In other words, you cannot switch between the kilometre rate and cost methods. 

It is important to note that without the election, you are deemed to have chosen the cost method. 

Two tiers of rates for the kilometre method

There are two tiers of rates for the kilometre method.  

•  Tier 1: 82 cents per kilometre for the first 14,000 kilometres related to business use. 

•  Tier 2: Over 14,000km, the rate per kilometre drops significantly to 28 cents.

**Note the per kilometre rate changes regularly – check the IRD website for the latest rates. 

Example: A car is used for business and private use. The logbook shows the car is used 60% of the time for business purposes, and travelled 20,000 kilometres for the year. So the calculation will be: 

14,000km x 82 cents x 60% = $6,888 

Plus (20,000 – 14,000) x 28 cents x 60% = $1,008

Therefore, the total to claim is $7,896

What if I don’t keep a logbook?

If you don’t run a logbook, then deductions are limited to 25% of the use of the vehicle. So for the cost method, this means you can claim 25% of your actual costs. 

For the kilometre rate method, you can only apportion a maximum of 25% of the kilometres travelled to business use, with the same tier rates applying. This means that without a logbook, Tier 1 equates to the first 3,500 business kilometres (14,000 x 25%). 

Example: To illustrate, we’ll use the same circumstances as in the example as above, i.e. the car is used for business and private use and travelled 20,000 kilometres. At least 25% (or 5,000km) was for business, but this time, no logbook was maintained. Now the calculation looks like this: 

3,500km x 82 cents = $2,870

Plus (5,000km – 3,500km) x 28 cents = $420

Therefore, the total to claim is $3,290.

By not keeping a logbook, in this instance, you miss out on a claim of $4,606. 

In summary, if your business use is more than 3,500km per year, it is well worthwhile keeping a logbook for the first 90 days to be able to claim the full deduction you are entitled to.  

Companies
Ordinary companies with five or fewer shareholders have different rules that they are required to follow in relation to motor vehicle expenses. 

Fringe Benefit Tax

Fringe benefit tax (FBT) must be calculated and paid to the IRD if a company’s vehicle is available to employees and/or shareholder employees to use privately, even if they do not actually use it. The FBT regime is complicated to follow, especially in relation to the quarterly calculations and annual FBT reconciliations, so seek help from a qualified accountant. 

If the vehicle is temporarily unavailable for private use (for example, being repaired), or it was used for an emergency call, then it is exempt from FBT during that period. 

Exemptions from FBT

Fringe benefit tax does not apply if you notify your employees in writing that the vehicle is not available for private use, except for travelling between home and work and travel related to the business (e.g. detouring to the post office for business related matters on the way to work).

To be exempt from FBT, there should be a separate document outlining the conditions, which is called a restrictive use agreement. Please get in touch with us if you need one.  

Cost or kilometre methods for companies

Close companies are also allowed to use the cost or kilometre rate methods as an alternative to paying FBT, provided that the vehicle is the employee’s only non-cash benefit. The election should be made via the company’s tax return and once it is done it cannot be revoked.

Telephone/ Internet

Unless you keep records to show the contrary, IRD allows you to claim half domestic telephone rental/internet for business if the phone/internet is used for both private and business, so long as the business element is reasonably significant.

Entertainment

This is complicated. If you want full details on claiming entertainment, you can get a booklet from IRD

Interest

Interest is generally tax deductible. However, borrowing to buy real estate can be tricky, as there are new rules surrounding interest deductions for residential investment properties.

Business Expenses

Don’t be tempted to pay yourself an expense allowance. IRD gets concerned that not all of it will be spent on business costs – they prefer actual expenditure.

If your business is a limited liability company, an expense allowance may be permissible on the basis you are an employee of the company. You need to discuss this with your accountant before you determine the amount of the allowance.

If you need cash for parking meters, keep a float in the car and draw cash to top it up from time to time as needed. Try to keep some evidence to show the money was really spent on parking. (You can only do your best.)

Pay as much as you can through your business bank account. For other small petty cash items, keep a notebook. Record the date, nature of cost and amount. Keep supporting receipts where you can. When the business owes you a reasonable amount, get reimbursed from the business bank account and record this in your notebook.

Interest Deductibility — NZ Government — Update

On 10 June 2021, the Labour Government opened up a five-week consultation period on the new interest deductibility rules.

They have released a Design of the interest limitation rule and additional bright-line rules discussion document which is lengthy and quite detailed, and reveals some interesting thinking, some of which I think is surprisingly taxpayer friendly.

On first look through the document, the following points are worthy of mentioning. Before going on, I stress that these are all proposals subject to feedback and finalisation (i.e. things could yet — and probably will — change).

Interest limitations will not apply to property outside of New Zealand.

Interest limitations will not apply to the home. For example, if you rent out three bedrooms of your home, interest expenses will be deductible as usual.

They are giving consideration as to whether serviced apartments and short-term stay accommodation type properties that are not “suitable substitutes for a home” should also be carved out from the interest limitation rules.

There is a fair bit of detail on what they anticipate a new build to be. The underlying philosophy is that the concession is available where there is an increase in housing supply. The following examples are given of newbuilds:

  • Adding a dwelling to land where there is no existing dwelling. Note that this does not have to be a new build constructed on site; it includes relocatable houses.
  • Replacing an existing dwelling with one or more dwellings. Therefore even a one for one replacement is proposed to qualify.
  • Adding a second or further dwelling to land that already has a dwelling on it.
  • Attaching a new dwelling to an existing dwelling; for example, building on top or developing underneath.
  • Splitting an existing dwelling into multiple dwellings. They give an example of a six-bedroom house converted into 2 x 3 bedroom units.
  • Converting a commercial building into residential.

The exemption means that interest will be deductible from the point of acquisition if you buy one of these properties within 12 months of the Code Compliance Certificate (CCC) being issued or from the point of CCC being issued if you develop it yourself.

The concession will only apply to new builds where CCC is issued on or after 27 March 2021. There is a limited exception to this rule for a new build where CCC was issued before 27 March, but the property is sold to a new owner within 12 months of the issue of that CCC.

They are considering whether the concession on interest deductions should apply only to the first owner of the building or whether it can pass on to subsequent owners. They are also considering whether there should be a time limit on the ability to claim interest deductions on new builds.

Additionally, there is a concession for developers, which is to say if you incur interest costs developing a new build then you can claim those costs as you go through the development process until the point of sale or issue of CCC. If you retain it as a rental once you have CCC, you then qualify for the new build exemption.

The government is considering allowing denied interest deductions to be claimed on sale, but I am not optimistic about this. They have set out several options here, but have not tipped their hand as to what they prefer.

The options range from extraordinarily taxpayer friendly, which would include claiming interest deductions not only if they exceed any taxable gain but also claiming them when a property is sold for a capital gain, through to taxpayer unfriendly options where there is no offset against future gains even if they are taxable.

My pick is they won’t land on the taxpayer friendly option, but there might be a middle ground, e.g. allowing deductions to be claimed as long as don’t exceed the gain.

The most surprising inclusion in the discussion document is that they are considering rollover relief both in respect of bright-line rule and interest deductibility on transferring properties into a trust or transferring rentals into an LTC where the owner(s) hold the shares in the LTC.

If this were to come in, it could allow transfer of residential property into a trust without resetting the bright-line clock, for example.

New Tax Changes

I’m seething about these tax changes and it’s not just the fact that Labour lied to us; it’s the whole bigger picture and the implications for ordinary New Zealanders. 

This Government is attacking middle New Zealand with all these housing initiatives and tax reforms – it’s mums and dads being hit, not property oligarchs. According to February 2021 stats from MBIE, 80% of landlords in New Zealand own just one rental property. And 96% own four or less. 

In other words, six out of seven properties are provided by private landlords and NGOs. This begs the question: who is going to provide the houses if landlords give up?

The 96% of the landlords that own four or less properties are hardly rich listers, but they are being treated like economic terrorists and scapegoated for successive governments not solving supply.

Investors are being labelled ‘speculators’, ‘tax cheats’, and are now accused of running potential rent cartels, to name a few recent characterisations in the press and from Labour. Property investors are suffering the most sustained attack by this Government: loss ring-fencing, the cost of Healthy Homes, ridiculous tenancy rules, 60% LVRs, and now interest non-deduction rules and 10-year bright-line rules. Soon to be added, if we read between the lines, are rent controls and removal of interest-only loans. The latter is very serious.

And when investors start to exit the market, which they will, who will provide the housing? The state?  That’s called socialism. That’s what that is – the government seeking to centralise and control, and stifle private initiative, stop a middle class trying too hard, and especially stop any one group getting too far ahead. The reward for trying hard, being smart, sacrifice and investment is wealth. This Government calls it a wealth gap, and sees this as a problem, not a means to greater productivity and self-determination. It’s socialism, and envy politics is part and parcel. Turn the poor against the rich, using labels like ‘speculator’ and ‘tax loophole exploiter’.

The solution is to vote against these socialist (but well-meaning) zealots; vote against these ideological academics, that went straight from school to university to politics, and apart from one of them working in a fish and chip shop, none of them have run large businesses and built productive business units in their lives. Yet they are running our country.  

Look at how they run the health system for example, and the gaping holes and problems there. 

They just want to take from the rich and give to the poor, seek out victims to virtue signal to, hug and apologise to the world. But they don’t know how to consult and facilitate the very clever and efficient private sectors. They are so arrogant, they think they know better; they shoot from the hip with poorly thought-through policy like these tax changes, rather than from informed discussion in select committees and taking advice through community and expert consultation.

Make sure you educate your peers and mates on the utopian problems that come out of Marxism and this socialist government.

Breaking News: Government introduces bright-line and interest deductibility changes

As part of the Government’s property policy announcements today (23 March 2021), there are two significant changes to tax rules that will impact residential property investors.

Extension of the bright-line period

Currently the bright-line period for residential property is five years. For residential properties acquired on or after 27 March 2021 that period will increase to 10 years. There is a a significant exception to this rule for ‘new builds’, which will continue to be subject to a 5-year period. There is not a lot of detail on what a ‘new build’ is, although the suggestion is that it will include properties that are acquired within a year of the Code Compliance Certificate being issued.

A key question here is what constitutes ‘acquisition’, which is critical for determining if the 5 or 10 year rule applies. Acquisition occurs when there is a binding sale and purchase agreement in place. Thus if your agreement is dated prior to 27 March 2021, then the 5-year rule applies. If the agreement is dated on or after 27 March 2021 then the 10-year rule will apply. 

An immediate point for readers to be aware of is that if you are considering restructuring the ownership of an existing property then you need to have a binding agreement in place to sell it into the new entity before 27 March 2021, if you want the new entity to be subject to the 5-year bright-line rule rather than 10-year rule.
There is also a change to the main home exemption. Previously you got this if you lived in the home for most (i.e. more than 50%) of the time that you owned property. Under the new 10-year rule, you only get to claim the main home exemption in full if you have lived in the property 100% of the time. If the property has been used as your home for part of the time and as a rental for part of the time, then the gain that arises on sale is apportioned across the relative uses and you pay tax based on the proportion of the time that it was not your home.

No interest deductions

This is a more significant change for investors and was not signalled by the Government.
From 1 October 2021 there are going to be restrictions on residential property investors’ ability to claim interest as a deductible expense. For properties that are not new builds and acquired on or after 27 March 2021, you will not be able to claim any interest deductions at all.
For second hand properties acquired prior to 27 March 2021 your ability to claim interest will be phased out over the next four income years, so that from 1 April 2025 there will be no ability to claim any interest as a deductible expense against residential rental income. The phase-in period over four years sees interest become progressively less deductible over each financial year as depicted in the following grid:
New build exemption on interest

Interest incurred on a ‘new build’ that is bought for investment purposes is exempt from this, i.e. interest deductions can still be claimed where you buy a new build as a rental. The question is though, what ‘new builds’ qualify for such exemption? This is yet to be clarified and the Government have given themselves up to 1 October 2021 to work out what this definition is. They have said they will consult as part of the process.
Interest incurred by property dealers and developers, is not impacted by this change, i.e. still deductible. Obviously, property dealers and developers pay income tax on profit realised when the property is sold.
Under current rules, which have been in place for decades, you get to deduct interest against rents – 1/3 of interest is therefore tax offset. With no tax offset between interest and rent, you now pay effectively 33%-39% of the interest not deducted. (Assuming you are paying tax at 33%-39%.)
For instance, if you previously received $32,000 in rent and paid $5,000 in rates, insurance and repairs, and $27,000 in interest, you had net cashflow of zero. Now you will have to pay tax on $27,000, due to interest not being deductible. So net cashflow will become negative $9,000 due to the new tax rules, when previously it would be zero. (At 33% tax).

Illustration of phasing in of interest deduction changes

Have a look at the table below which shows how these changes will affect an investor as they are phased in over four years. In this example, the investor has a $750k property, with $750k of debt at an interest rate of 3%. 
While $7,425 does not sound like a lot to many, it is to the household that is likely spending every dollar they earn maintaining their own home and the rental property they purchased as an investment. Typically, average Kiwis own these houses, not rich oligarchs.

Restructuring?

When the 2022 income year commences on April 1 2021, the government’s new highest personal marginal tax rate of 39% will be in effect. This rate of income tax applies to individuals on income that they earn in excess of $180,000. It is likely that the implementation of this new tax bracket will lead to a flurry of taxpayers seeking advice around their structure. But before you jump into restructuring, it always pays to “look before you leap”.

The reason why there may well be a flurry of restructuring is because the government have decided not to increase the trust rate to match the new highest personal tax rate. This was a surprise to many, due to the incentive it then provides for redirecting income into trusts. However, the government are conscious of this and have given the IRD a new set of tools to monitor taxpayer behaviour. When you next file an income tax return for a trust you are going to have to disclose matters such as:

– The identity of the holders of the power to appoint and remove trustees
– The identity of any individuals who have made gifts or settlements upon the trust
– The identity of any beneficiaries who have received distributions
– Profit and loss statement and balance sheet

Doubtless the IRD will be trawling through this data looking for evidence of taxpayers restructuring their affairs driven by the new highest tax rate. That is not to say that all restructuring which sees income-producing assets transferred into trust ownership are going to fall foul of the IRD. In my experience there are usually other factors that drive clients to restructure to transfer assets into trust ownership. 

For example, those who are self-employed, or engaged in activities that require them to personally guarantee large amounts of borrowing, want asset protection. I often find that parents want to ensure that the asset base they build up during their lifetimes is protected from exposure to relationship property claims by ex-spouses of their children. I also often come across single clients or those in newly formed relationships who want to put in place structures that allow them to preserve their independence by separating out separate assets, while simultaneously having a structure that allows them to move forward together. All of these things could drive a restructure which sees assets moved into trust protection. In my opinion, when this happens any tax benefit that may arise in the long term is not the driver and therefore the arrangements should not be viewed as tax avoidance.

You also need to be careful when moving assets around that the movement itself does not trigger an adverse tax outcome. Moving shares in companies can see imputation credits and tax losses forfeited. Moving property around can generate taxable gains on internal transfers or reset the bright-line clock – increasing the chances of there being a taxable gain at a later point in time. 

Finally, there is the new trust law to take into account. While many commentators seem to be of the view that trusts are out of vogue due to these changes, I see that as being short-sighted. That said, you do need to be aware of the obligations that arise under this new legislative framework before proceeding to restructure your affairs in a manner which sees you moving assets into trust ownership.

In summary, there may well be temptation to restructure your affairs to move assets held personally into trust ownership, particularly in light of the new highest personal marginal tax rate. However, care needs to be taken when restructuring as there are many potential unintended consequences. At the same time, a carefully conceived and executed restructure can provide you with long-term asset protection, estate planning and tax benefits. As always, seek expert advice. 

Tesltra – Buy for Yield | Briscoes | James Hardie

TELSTRA (TLS:ASX / TLS:NZX) BUY: Yield Stable
Telstra shares have reacted favourably after reporting its 2021 half year result. The telco giant reported a -0.4% decline in total income to $12 billion and a 14.2% reduction in underlying operating earnings (EBITDA) to $3.3 billion. The latter was largely due to an estimated in-year NBN headwind of $370m and an estimated $170 million impact from COVID-19.

Positively, Telstra’s free cash flow was strong, allowing the board to maintain its 8 cents per share dividend, also confirming that it plans to maintain its fully franked full year dividend of 16 cents per share. Further, Telstra’s CEO was optimistic Telstra would return to growth in the 2022 financial year after years of profit decline. We also see a tailwind from the roll-out of 5G.

Telstra is undertaking a major restructure at the company level to position itself to buy the national broadband network (NBN) off the government. Telstra is in the process of splitting itself up as the NBN sale looms and in the process revealed to its investors its real value lies in its infrastructure assets. Telstra’s infrastructure business InfraCo will be divided into two separate units – InfraCo Fixed, which will own and run Telstra’s fixed line assets, and InfraCo Towers, which will own its mobile infrastructure. A third unit, ServeCo, will own Telstra’s retail mobile business, including the back-end technology and spectrum. This could provide a clearer view on the valuable assets that are already owned by the company, and a potential future avenue for sale or IPO which further strengthens our positive investment case.

Briscoes Group (BGP:NZ) HOLD: Great Result, But Reflected in Price
Briscoes (BGP) shares were higher after reporting another solid sales update for the final quarter of its 2021 financial year. Fourth quarter sales for the group came in at $248.1m, up +18.3% on the same corresponding period last year, benefiting from Black Friday and strong December trading period, as consumers continue to boost retail spending well after the initial lockdown restrictions were lifted. Full year sales were $701.8m, up +7.5%.

BGP is still our top retail pick given their strong performance in the past, no interest-bearing debt and the relatively defensive nature of their homeware businesses. With the lack of international travel, low interest rates and a booming housing market, local consumer spending is very strong. How this holds up when borders re-open remains to be seen. BGP’s Holdings of Kathmandu aren’t likely to pay any dividends anytime soon, and BGP’s dividend is no longer very attractive at current levels (3.2%).

Given BGP’s current valuation (19x earnings) with the shares trading at record highs, the market may be getting too optimistic that this recent surge in growth will continue at its current rate over the medium-term, in our view.

JAMES HARDIE (JHX:AX) BUY (High-Risk): Surging to Records
James Hardie shares have been on a strong run reaching new all-time highs after reporting a +50% jump in profit for the 2020 December quarter, upgrading 2021 full year profit guidance again as JHX benefits from surging residential construction activity.

Looking at the numbers, 3rd quarter profit of $123m was higher than market consensus at $106m. Full year 2021 guidance was increased to US$440-$450m (above current consensus at US$431m). All regions reported solid increases, due to strong demand and cost savings. A special dividend of US$0.70 was declared, with the company expecting to resume paying dividends in the 2022 financial year. Despite impacts of covid-19, JHX appears to be performing strongly thanks to new construction activity globally rebounding quicker than expected, helped by low interest rates and a supportive housing market.

We believe JHX are able to deliver and outperform during normal conditions and history shows it has done well to recover after the GFC. Despite JHX’s current valuation pricing in high expectations, the outlook appears to remain supportive for its major markets, while JHX is maintaining healthy margins from their restructuring efforts. However, we do caution there may be some share price volatility if there were a sudden shock to the economy – particularly with residential housing. Another risk we are watching is the strong Aussie dollar, which is a headwind given a significant amount of JHX’s business is from the US.

By Chas Gunaratne

New Zealand’s Housing Markets

  • Strong demand for housing, extreme shortage of listings, strong interest from overseas buyers inc. expats, some buying sight unseen. Strong sales in the high-end bracket $3 to $6m.
  • Swamped with buyer enquiry. Everyone seems to be clambering to get a slice of the action. Bare land, sections, new builds existing houses. All attracting huge buyer interest.
  • Software improvements are making deals quicker & easier. More information available. Prices still rising. Plenty of FOMO.
  • Many townhouses being built with low maintenance in handy location.
  • Continuation of market from December. Listing numbers are very low with new property coming to market and being sought- after by multiple buyers. With the current fundamentals of low interest rates and people arriving back in NZ, along with the shortage of homes, we see plenty of legs in the market for the foreseeable future.
  • Christchurch market, hot with dramatic market conditions especially at the entry level 1st home buyers, there is some ‘trickle-up’ but properties in the $800,000 to $1,400,000 are slightly slow in comparison. Possibly more caution with this group being professionals and business owners?
  • I am in residential property in the lakes area around Rotorua. Demand has been stronger over this summer for lake properties than in the last 5 years I’ve been working in this area. Challenge is in getting listings to meet demand. Prices are up dramatically even for leasehold properties which have at times struggled to get any interest from the market.
  • There is vendor apathy…not signing Agency Agreement in a timely fashion…dragging out process & they lose their vigour/drive to go to market. (Then they were not real vendor’s in the first place). Potential vendors want to sell but need a property to buy before moving, not enough stock in desirable areas of Auckland. Anything from $1.2M to $1.3M; Vendor expectations – they’ve seen the house on their street sell before Christmas 2020 for a ridiculous amount & now want the same money. Competition is still fierce amongst some buyers in the market. Anecdote: a property in Remuera (Seascape Rd) I am told, had 100 groups through in the first week of open homes (at least 200 bodies – came through to view property).
  • Few people are listing, strong demand – these are second homes in the main. There is a lot of confidence and desire to invest in NZ real estate especially in the South Island from what I’m told by prospective buyers.
  • There is a shortage of stock/listings.
  • Crazy buying and limited stock.
  • Strong FOMO amongst buyers, demand is outstripping supply. There is real confidence in the marketplace. Some owners late last year expecting more than the market have are now easing to allow market to dictate.
  • There is a lack of properties for sale with a high level of unsatisfied buyer demand.
  • Properties are selling fast & for great prices – FOMO. Not enough stock.
  • There is a lack of listings.
  • Even more buyers, but even fewer sellers!
  • Simply lack of stock. There are no other significant frustrations.
  • Property valuation…The market is continuing to increase with demand continuing to outstrip supply. Will be interesting to see now that Auckland is on the move again if we continue to see out of town buyers looking to the regions.
  • High buyer demand low stock numbers.
  • Problems are the continuous trend of escalating price of property due to lack of choice for the consumer, and the continuous decline of new listings coming to the market – potential vendors are concerned about selling and then having nothing to buy due to lack of stock.
  • Lack of listings, loads of buyers, very frustrated first home buyers missing out, very high prices being paid.
  • Housing affordability and potential government meddling and legislation. Availability of buildable land and low property listings combined with low deposit buyers less than 20% deposit finding harder to secure properties.

By Chas Gunaratne

Growth Supporting Factors

Interest rates
We have probably seen the lows this “cycle” for wholesale borrowing costs a month or so ago. Rises from here are more likely than declines, but those rises will be capped by central banks around the world adopting a deliberate risk preference.
A number of central banks have stated that they prefer to take the risk of taking interest rates too low and leaving them low for too long – thus eventually over-stimulating growth, inflation, and asset prices – than not easing by enough. Risks are weighted in favour of low rates for the next couple of years, but then catch-up surprises on the upside from 2022-23.

Housing wealth & construction
The Reserve Bank wants house prices to rise because that will help reduce the risk of inflation consolidating too low in their target range of 1% – 3%. Rising house prices make people feel wealthier and they spend a bit more. The number of homeowners far outweighs the number of first home buyers who might have to cut spending to save more for a deposit.
Rising house prices also stimulate house construction and this sector accounts for around 6% of GDP and provides employment and business opportunities for thousands of people across a very wide range of activities.

Business capital expenditure
When recessions come along businesses pull back from spending plans and this aggravates the downturn. But when growth returns businesses re- engage with their expansion and modernisation plans and this catch-up period of capital expenditure boosts the pace of economic growth coming out of a recession.
Bank lending policies
Banks have tightened up policies for lending to business borrowers, in recognition of economic weakness and uncertainty associated with the Covid-19 shock. But as the shock dissipates and confidence about economic conditions improves, banks will become more willing to finance business growth. The chances are good that their improved willingness to lend will coincide with the increased willingness of businesses to borrow and restart their capex plans.

Migration anticipation
Most Kiwis expect that once the borders open many Kiwi expats will return to New Zealand. Maybe, probably not. There are very good reasons why the estimated one million people offshore with at least New Zealand residency are not in New Zealand right now.
Most will not return. But expectations that they will are likely to drive the decisions of Kiwis already here to buy assets before the hordes come back. This will accentuate upward pressure on house prices through 2021 and perhaps encourage greater purchasing of businesses in anticipation of greater population growth and possible business demand from returning Kiwis.

Tourism returning
When the borders are fully open it is likely that visitors will return to New Zealand in large numbers, just as we Kiwis will take trips overseas. International travel is a net positive for the New Zealand economy so this is a boost which will build over 2022. industries, and pushback against businesses which have adopted a model of operations dependent upon cheap, often desperate, foreign labour. Seeing more and more job opportunities, average employees will tend to be willing to spend more than would be the case if unemployment were to remain at high levels and stories abound of continuing job losses.

Export prices
The prices which our primary exporters are receiving for their goods sent overseas by and large are good. The rising NZ dollar will provide some restraint, and we cannot discount China treating New Zealand in some degree the same as they are treating Australia.
But the return of growth overseas, particularly in the food services sectors, will be beneficial for our exporters.
Mortgage repricing
Over the coming year some $176bn worth of fixed rate mortgages will come up for repricing. As perhaps half these people roll onto lower rates this lagged effect of earlier interest rate falls will support more consumer spending.

Term deposit rollovers
As each month goes by more and more savers will roll off their old, high, term deposit rate and be offered the lowest rates for reinvestment that they have ever seen – usually now below 1%. These investors are likely to shift some of their funds to other assets, including property.

Extra deposits
At the moment households have about $10bn extra on deposit with banks than would have been the case had Covid-19 not come along. This extra financial wealth will help support consumer spending.

Infrastructure
The government is determined to forge ahead with more spending on the country’s infrastructure, and local authorities are under pressure to catch-up on basic investments which should have occurred earlier. A lack of appropriate labour is likely to see the list of projects able to be completed scaled back over the next five years. Nonetheless, work done will rise and this will help drive some greater economic growth, job security, wages etc.

Underlying growth
There were many sectors experiencing firm underlying growth heading into Covid-19 and by and large they will continue to experience good growth going forward.
Examples include aged care, healthcare, games development, video production, medtech, horticulture, viticulture, space, etc.
But there will be some restraint on the pace of economic growth from a number of sources.

Consumer Durables
There is one traditional factor boosting growth coming out of a recession which will not be in play this time around – increased household spending on consumer durables.
Normally during a recession, you and I pull back on buying spas, gazebos, motorbikes, campervans, house extensions and renovations, new TVs and so on. Then, when the economy looks better and we feel more secure in our jobs, we catch-up on this delayed spending and this gives the pace of economic growth an extra kick upward.
But this time around we have greatly increased our spending on durable goods during the
recession through diverting $10bn which we had planned to spend overseas. At some stage we will not only revert to more normal levels of spending on spas, but we will spend less than average because those people who had been planning to buy such things over 2021-23 will have already bought them.
Retailers and manufacturers in such sectors should give the uniqueness of this cycle some deep thought before risking over-extending themselves heading into 2022 in particular.

Deficit repair
The government is under no international pressure to quickly reduce annual budget deficits. Nevertheless, New Zealand is a country which receives a number of economic, seismic, disease shocks as the decades proceed and the government will want to slowly restore the fiscal buffers able to be utilised when the next shocks come along.
This is unlikely to involve extra taxes beyond the ideologically driven imposition of a 39% top personal income tax rate. Instead, restraint on spending is likely to be emphasised, with assistance from a lot of money put aside for Covid-19 not being needed, and a lot of planned spending unable to be done because of staff shortages across the relevant sectors.

Business closures
History tells us that not all businesses which go under as a result of a recession do so when the economy is actually shrinking. For some the closure decision can take some time to be made and through 2021 some more businesses are likely to close down and lay off their staff.

Rising Kiwi dollar
In the absence of interest rates being pushed up the NZD is unlikely to rise tremendously over the coming 1-2 years. But there will be good support from the state of the domestic economy and recovery in trading partner growth rates. A rising NZ dollar will take some earnings away from exporters whilst making ability to compete on price more difficult for domestic manufacturers of imported products.

By Chas Gunaratne