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.


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 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.

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

Tesla Jumps on Break-Up

Telstra (TLS:NZX / TLS:ASX)
Shares in Tesltra jumped yesterday after the company announced a major restructure that would split its business into three separate legal entities.
It comes amid speculation the telco is preparing for a bid to take over the National Broadband Network, and pre-empting any concerns that will be raised by the Australian Competition and Consumer Commission (ACCC).

The company plans to split itself into these divisions by December 2021:
InfraCo Fixed: which will look after fixed line assets like ducts, fibre, data centres, subsea cables and exchanges,
InfraCo Towers: mobile towers, which it plans to “monetise over time”,
ServeCo: the radio access network and spectrum assets.

“The proposed restructure is one of the most significant in Telstra’s history and the largest corporate change since privatisation,” said Telstra chief executive Andy Penn. “It will unlock value in the company, improve the returns from the company’s assets and create further optionality for the future.”

Telstra said, with “the NBN rollout effectively complete”, that it expects to earn (before interest, tax and depreciation) $7.5 million to $8.5 billion by the end of the 2022-23 financial year. While Telstra dominates Australia’s mobile and broadband markets, its mainstay fixed-line business has also been under pressure from the rollout of a state-owned NBN.

By Chas Gunaratne