Hon Peter Dunne
Minister of Revenue
18 August 2011
Feedback sought on options for tax fairness
Two issues papers released today for public consultation continue the Government's focus on ensuring fairness in the tax system, Finance Minister Bill English and Revenue Minister Peter Dunne say.
The issues papers, which were announced in Budget 2011, provide options for making the tax system fairer in two areas:
Livestock valuation - this paper presents options for fairer rules covering livestock valuation elections. Mr Dunne says the current rules appear to be too loose, allowing farmers to switch between valuation methods providing an unfair tax advantage.
Mixed use assets - this paper provides options to address unfairness in the tax treatment of assets such as holiday houses used for both private and income-earning purposes.
Mr Dunne says unfairness arises when some owners claim their house is available for rent during the significant periods of the year the house is empty.
"This provides them with a basis for claiming tax deductions for expenses relating to the period the property is empty. Claiming these deductions could be regarded as unfair, particularly if the owner holds the asset primarily for private enjoyment," Mr Dunne says.
Officials are also working on a third issues paper focusing on the tax and social assistance treatment of salary traded off for other benefits. This will be released separately once policy analysis is complete.
"Tax dollars are needed for a wide range of government services such as health, education, justice, lowering the road toll, reducing family violence, immunisation programmes and conservation," Mr Dunne says. "Taxes also pay for work in Christchurch on roads, hospitals, schools and emergency recovery.
Mr English says it's important that everyone pays their fair share of tax.
"By tightening the rules around property investment, aligning the top personal and the trustee tax rates and by ensuring greater fairness in social assistance programmes, Budget 2010 had a strong focus on fairness and integrity of the tax system.
"Today's announcement continues that focus," Mr English says.
The closing date for submissions is 30 September 2011. The two issues papers and fact sheet are available on the Inland Revenue policy website at: http://taxpolicy.ird.govt.nz/publications/year/2011
The officials’ issues paper – Mixed-use assets – suggests new tax rules for determining the deductibility of expenditure relating to assets used both privately and for income earning (mixed-use assets).
A review of the deductions available for mixed-use assets was announced as part of Budget 2011.
The suggested new rules categorise mixed-use assets into different groups based on the underlying use of the asset, and prescribe the level of deductions that owners in each group can claim.
The suggested new rules apply to assets:
- used for both private and income earning purposes;
- that have a cost of $50,000 or more (except land where the rules apply no matter the cost);
- that are unused for at least two months of the year; and
- rented on a short-term basis.
The suggested new rules apply to assets held by partnerships, by trusts, and by companies that are close companies, qualifying companies and look-through companies.
When assets (for instance, holiday homes, planes and yachts) are used partly for private purposes and partly to derive assessable income, it is necessary to determine what proportion of expenses can be deducted in deriving that income.
However, deciding whether expenditure is attributable to income earning use (deductible expenditure), or to the private use of the asset (non deductible expenditure), can be difficult. The problem is particularly evident if expenditure relates to periods where the asset is not being used.
A family holiday house is used by the owner and the owner’s family for 5 weeks of the year and rented out for 5 weeks of the year.
There is no concern about the family claiming deductions which relate to the 5 weeks the holiday house is rented. It is equally clear that no deductions can be claimed for the 5 weeks when the holiday house is used by the owner and the owner’s family.
The issue is to what extent the family should be able to claim deductions which relate to the 42 weeks of the year the holiday house was empty?
Currently, some owners are claiming that their property is available for use for the time when the property is not in use. This provides them with a basis for claiming tax deductions for expenses relating to the period the property is empty.
This amount of deductions could be regarded as overly generous. In reference to the example, it doesn’t seem fair or appropriate for the owner to claim expenses for the full 42 weeks when the holiday house was not in use, given the personal and rental use was equal and if the main reason why the family acquired the holiday house was for their private enjoyment.
The issues paper suggests two options that prescribe the level of deductions owners of mixed use assets can claim.
The first is referred to as the two-outcome option. This option distinguishes between asset owners who can claim all expenditure for unused time and those who can claim none. For the owner to be able to claim all expenditure for unused time, the following criteria must be met:
- the asset must be used to earn income for 62 days or more in a year;
- the asset must be marketed as available for rental in a realistic way for the entire period in which it is reasonable to rent it out; and
- private use must be less than 15 percent of income earning use.
The second is referred to as the three-outcome option. This option distinguishes between owners who can claim all expenditure for unused time, those who can claim some, and those who can claim none. For the owner to be able to claim all expenditure, the following criteria must be met:
- the asset must be used to earn income for 62 days or more in a year;
- the asset must be marketed in a realistic way for the entire period in which it is reasonable to rent it out; and
- private use must be less than 10 percent of income earning use.
Under the three-outcome approach, if the first two criteria are met, but private use is more than 10 percent of income earning use, a proportion of expenditure attributable to the unused period will be deductible.
Both options attempt to draw objective boundaries between those asset owners that are likely to have mainly an income earning objective and those whose main objective is to use the asset privately
The options will apply to mixed-use assets held in partnerships, trusts, and companies that are close companies, qualifying companies and look-through companies (with private use being treated as use by a partner, a settlor, a beneficiary or an associate of any of them).
Q: Why is the Government looking to change the rules in this area?
A: The changes suggested are about fairness. For example, under the current rules, the owner of, say, a holiday house can rent the property out for a few days a year even though its main purpose is to provide holiday accommodation for the owner and the owner’s family. Unfairness arises because some owners claim that the house is available for rent during the significant periods of the year when the house is empty. This provides them with a basis, under current law, for claiming tax deductions for expenses relating to the period the property is empty. The result is often inflated tax deductions used to offset not only the rental income, but also other income such as salary and wages.
Q: What assets will be covered by any new rules?
A: The suggested new rules would apply to assets that:
- are used for both private and income earning purposes;
- have a cost of $50,000 or more (except land where the rules would apply irrespective of cost);
- are unused for at least two months of the year; and
- are rented out on a short-term basis.
However, these are only suggestions and submissions are sought on what assets should be subject to the suggested new rules.
Q: When will these proposals become law?
A: Officials are seeking submissions on the options outlined in the issues paper. Only after officials have considered the feedback will final proposals be developed. It is likely that proposals will be submitted to Government for decisions sometime next year.
Q: How many people could be affected if the rules are changed?
A: Officials expect that around 15,000 mixed-use residential properties may be affected. Other assets that may be affected include assets such as yachts and aircraft which are both rented out and used privately.
Q: How much revenue will this raise?
A: The suggested changes would be revenue positive. Exactly how much additional revenue would be collected depends on the shape of the final proposals.
Q: Will new rules in this area increase complexity?
A: The approaches outlined in the issues paper attempt to strike a balance between fairness, certainty and complexity. Two approaches are suggested - one approach presents a relatively simple method of prescribing allowable deductions, while the other provides a slightly more complex solution – but arguably with fairer results. Whether and by how much complexity increases will depend on which approach is adopted.
While the new rules may be more complex to apply, they would provide additional certainty to taxpayers as they clearly prescribe the amount of deductions that may be claimed.
Q: How do other countries deal with this issue?
A: This concern is not unique to New Zealand. A number of other countries, including the United States and the United Kingdom, have developed rules along similar lines to determine the deductions that mixed-use asset owners can claim.
Q: What will this do to values of holiday homes?
A: It is difficult to predict the effect on property values, as no firm proposals have been developed. In addition, property values are influenced by numerous factors, the tax rules being just one. It is very difficult to isolate the effect that changes to tax rules may have on this process. However, officials expect that any changes made will have limited effects.
Q: Will this increase the costs of renting a holiday home?
A: Again, various factors influence the cost of renting a holiday home, the tax rules being just one.