Home > Publications > 2021 > Supplementary Order Paper No 23 to the Taxation (Annual Rates 2020–21, Feasibility Expenditure, and Remedial Matters) Bill > Extending the bright-line test

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Supplementary Order Paper No 23 to the Taxation (Annual Rates 2020–21, Feasibility Expenditure, and Remedial Matters) Bill

Commentary on the proposed amendments

Hon David Parker
Minister of Revenue

March 2021

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Extending the bright-line test

• Extending the bright-line test
• Amendments to the main home exclusion
• Treatment of short-stay accommodation

Extending the bright-line test

(Clauses 5A, 13F, 25C, 33F, 37E, 37EB, 37F, 37FB, 38BA, 38BAB, 57B, 58(3B), 58(3C), 73B, 73C and 73D)

Summary of proposed amendment

The Supplementary Order Paper extends the bright-line test from 5 years to 10 years.

Application date

The extended bright-line test would apply to residential land acquired on or after 27 March 2021. However, it would not apply to property acquired on or after 27 March as a result of an offer made by the purchaser on or before 23 March 2021 (the date the measures were announced), provided that that offer was not able to be revoked before 27 March 2021 – in this case, the existing bright-line period of five years would continue to apply.

Key features

Extended bright-line test (new section CB 6A)

The Supplementary Order Paper proposes to extend the bright-line test, which taxes gains from residential property acquired and sold within a specified timeframe, from 5 years to 10 years. Income arising under the bright-line test is taxed at a person’s marginal income tax rate.

The other policy settings for the bright-line test remain the same, except for the changes to the main home exclusion in section CB 16A and the business premises exclusion in the definition of “residential land”, as outlined further in this commentary.

Therefore, the following features of the 5-year bright-line test will continue:

• The rules that determine when the property is acquired and disposed of, and when the bright-line period is counted from.
• The definition of “residential land” covered by the bright-line test includes land that has a dwelling on it, land where the owner has an arrangement to build a dwelling on it, and bare land that may be used for erecting a dwelling under the relevant operative district plan. “Residential land” does not include farmland or land used predominantly as business premises (subject to changes to ensure property used to provide short-stay accommodation is treated as residential land and not excluded as business premises – see below).
• The current exclusions and other forms of relief will continue to apply – that is:
  • the main home will continue to be excluded (subject to changes to ensure the exclusion only applies for the periods the property was used as a main home – see below)
  • transfers upon death, and any subsequent disposal by the beneficiary will continue to be exempt, and
  • those who receive land under a relationship property agreement will continue to take on the bright-line start date (the date from which the bright-line period is counted) of the transferor.
• The main home exclusion is available to properties held in trust. However, people cannot use the main home exclusion for multiple properties held through trusts.
• The main home exclusion cannot be used if it has already been used twice in the two year period preceding the date of sale, and also cannot be used by a person, or group of persons, who has a regular pattern of buying and selling their main home.
• Residential land withholding tax will apply to taxable bright-line sales by anyone who is an “offshore RLWT person” (defined in section YA 1 of the Income Tax Act 2007) – in short, a vendor who is living or established outside New Zealand.
• Specific anti-avoidance rules remain, to counter companies and trusts being used to circumvent the bright-line test.
• Vendors will continue to be allowed deductions for property subject to the bright-line test according to ordinary tax rules (subject to amended deductions as a result of changes to the main home exclusion – see below).
• Losses arising from a sale under the bright-line test will remain ring-fenced so they may only be used to offset taxable gains from other land sales.

Application date (clause 5A(2))

The extended bright-line test would apply to property acquired on or after 27 March 2021. However, it would not apply to property acquired on or after 27 March as a result of an offer made by the purchaser on or before 23 March 2021, provided the offer could not be revoked before 27 March 2021.

An irrevocable offer is one that cannot be withdrawn before a certain time. For example, it is common as part of the tender process to sign a tender document that states the person cannot withdraw their offer until 5 working days after the tender has closed.

Table 1 outlines some scenarios and whether the 5-year or 10-year bright-line would apply.

Table 1: Extended bright-line test application date examples

Example	What bright-line test applies?
The following scenarios deal with revocable offers
Purchaser offers on 21 March 2021, seller accepts on 24 March. Sale and purchase agreement (ASAP) signed 24 March.	5-year test applies.
As above, but the seller accepts the offer and signs the ASAP on 27 March.	Extended 10-year test applies.
Purchaser offers on 18 March 2021, seller verbally accepts on 24 March, but does not sign ASAP until 27 March.	Extended 10-year test applies (for property transactions a verbal contract is not binding, and the purchaser does not have an equitable interest in the property at that point).
Purchaser offers on 19 March 2021, seller counter-offers on 24 March, purchaser accepts on 25 March.	5-year test applies.
As above, but the purchaser accepts the counter-offer on 27 March.	Extended 10-year test applies.
The following scenarios deal with irrevocable offers
Purchaser submits offer as part of tender process that closes on 22 March 2021. The tender document states that the offer cannot be withdrawn until 28 March. Seller accepts offer on 27 March and ASAP is signed.	5-year test applies. Although the purchaser acquires the land on 27 March and therefore is prima facie subject to the extended test, the carve-out for offers made on or before 23 March applies.
Purchaser submits an offer as part of a tender process that closes on 16 March 2021. The offer cannot be withdrawn until 22 March. Purchaser does not withdraw the offer, seller accepts on 27 March and ASAP is signed.	Extended test applies. The carve-out does not apply because the purchaser was able to revoke their offer before 27 March.
The following scenarios deal with conditional offers[1]
Purchaser submits an offer subject to a building report on 18 March 2021. The vendor accepts the offer and the ASAP is signed on 24 March. On 2 April, the purchaser informs the vendor that the condition is satisfied and the agreement goes unconditional.	5-year test applies. The purchaser acquired the land when the binding agreement (subject to conditions) was entered into on 24 March, not on 2 April when the conditions were satisfied.
As above, except the purchaser and seller agree on a reduced price on 2 April, each signing the change in the agreement.	5-year test applies. The binding agreement was entered into on 24 March, which is before 27 March.

The 5-year bright-line test (section CZ 39)

The 5-year bright-line test continues to apply in limited circumstances:

• to residential land acquired on or after 29 March 2018 but before 27 March 2021
• to residential land acquired on or after 27 March 2021 as a result of an offer made by the purchaser on or before 23 March 2021, if the offer could not be revoked before 27 March 2021.

The income charging provision for the 5-year bright-line test has been shifted from section CB 6A to section CZ 39.

The current main home exclusion that applies for the purposes of the 5-year test has been shifted from section CB 16A to section CZ 40.

Residential land withholding tax (section RL 1 of the Income Tax Act 2007 (ITA) and sections 54C–54E of the Tax Administration Act 1994 (TAA))

Residential land withholding tax (RLWT) applies to sales of residential land made by an “offshore RLWT person” if the sale occurs within five years. This is provided for in section RL 1 of the ITA and section 54C of the TAA.

With the extension of the bright-line test from five years to ten years, sections RL 1 and 54C will be updated so that RLWT will apply to sales of residential land made within ten years of acquisition (where the acquisition occurs on or after 27 March 2021 and the irrevocable offer carve-out does not apply).

Section RL 1(2)(a) is being updated to include references to new sections CZ 39 and CZ 40, so that a five-year test will still be relevant for properties acquired before the application date of the 10-year test.

Section 54E of the TAA provides that the Commissioner is able to issue an RLWT exemption certificate in limited circumstances – including where a seller is in the business of developing land, dividing land into lots, or erecting buildings; and where the property was the seller’s main home.

RLWT exemption certificates will continue to be available where a property is used as a main home:

• For properties acquired before 27 March 2021 (or subject to the irrevocable offer carve-out), this will be where it was the owner’s main home for more than 50 percent of the bright-line period (in current CB 16A which will become new section CZ 40).
• For properties acquired on or after 27 March 2021 (excluding where the irrevocable offer carve-out applies), this will only be where it is used as the owner’s main home for the whole bright-line period, including days within the 12-month buffer that are counted as main home days (provided for in proposed new section CB 16A).

The Supplementary Order Paper proposes to amend section 54E of the TAA to refer to both section CB 16A and proposed new section CZ 40 of the ITA (that is, both versions of the main home exclusion).

Where RLWT has been withheld, section 54D of the TAA and section RL 6 of the ITA permit a taxpayer to file a form for their land transactions to obtain a refund if too much RLWT has been paid relative to their overall income tax liability for their land transactions. The Supplementary Order Paper proposes to update section 54D to refer to both CB 16A and proposed new CZ 40.

Questions on the appropriateness of the RLWT settings more generally were not considered as part of this exercise. These may be considered as part of future work in the area.

Amendments to the main home exclusion

(Clauses 5A, 5, 13F, 14B, 58(10ABA), 58(12BAB), 58(3B), 58(3C) and 58(3D))

Summary of proposed amendment

The Supplementary Order Paper amends the “main home exclusion” from the bright-line test so that it no longer applies on an all or nothing basis, but rather applies only for the period the property is actually used as the owner’s main home. A 12-month buffer is proposed to allow the property to not be used as a main home without tax implications.

Application date

The amended main home exclusion applies to property subject to the 10-year bright-line test. That is, property acquired on or after 27 March 2021. However, it does not apply to property acquired on or after 27 March 2021 as a result of an offer made by the purchaser on or before 23 March 2021, provided the offer could not be revoked before 27 March 2021. The existing main home exclusion will continue to apply for such properties, as well as properties acquired before 27 March 2021.

Key features

• The main home exclusion is being amended so that it no longer applies on an all or nothing basis. Instead, it will only apply for the period(s) the property is actually used as the taxpayer’s main home. To be within the exclusion, there is still a requirement that the property has been used predominantly (on a floor area basis) as the taxpayer’s main home.
• The proposed legislation provides that a property is excluded from the bright-line test if it is the owner’s main home for the full bright-line period. Days when the property is not used as the main home will be treated as main home days if:
  • the non-main home days are in a period of non-main home days of 365 days or less (the counted period), and
  • the counted period is immediately before or after a period where the property is the person’s main home.

The effect of this is that there is a 12-month buffer, within which a change of use of a property to or from being the taxpayer’s main home would not need to be accounted for. In other words, the main home exclusion would still apply if the property was not used as a main home for periods of less than 12 months at a time. If the period that the property was not used as a main home exceeds 12-months, the main home exclusion will not apply.

• If the full main home exclusion in proposed new section CB 16A does not apply, the amount the person derives from selling the property is income under section CB 6A. However, if the property has been used as the main home for some of the time it was owned, the proposed legislation provides that the taxpayer is required to pay tax only for periods where the property was not used as their main home, or not counted as their main home. Periods of 12-months or less where the property is not used as a main home will be counted as main home days for the purposes of the calculation. The proposed legislation provides for this as follows:
  • New section CB 6A(6) provides that if the person has excluded days (that is, main home days) in the bright-line period, the amount of income the person derives from disposing of the land is reduced by reference to the formula in section CB 6A(7).
  • New section CB 6A(7) provides that the person’s income is reduced by the amount calculated by subtracting the value attributable to the period the property was used as a main home or counted as a main home (that is, the proportion of days the property was used/counted as a main home multiplied by sales price) from the sale price. This ensures that the taxpayer only has income attributable to the days the property was not their main home (provided the days are a period of more than 12 months).
  • New section DB 23C reduces the deduction the taxpayer can claim for the cost of the property (which includes the acquisition cost and any capital improvements), so that the deduction is only allowed for the period the property was not used as the main home (as this is the period in respect of which the gain is taxed).

Background

A person’s main home is not taxed under the bright-line test. Under current law the property is either fully in or fully out of the main home exclusion. For example, a person can currently qualify for the main home exclusion where the property is rented out for some of the time it is owned, provided it is used as the owner’s main home for more than 50 percent of the bright-line period. This all-or-nothing approach is simple and easy to apply, and made sense in the context of a shorter bright-line period. However, it would not be appropriate with a longer bright-line test as much more income could be involved. For example, without any changes to the way the main home exclusion works, a person would not have to pay tax under the bright-line test for a property that was rented out for four years if it was used as the taxpayer’s main home for five years.

Detailed analysis

Main home exclusion (new section CB 16A)

The Supplementary Order Paper proposes to amend the main home exclusion so that it no longer applies on an all-or-nothing basis in relation to residential land acquired on or after 27 March 2021 (subject to the carve-out for irrevocable offers). The existing main home exclusion would continue to apply to properties acquired before the application date (or after but subject to the irrevocable offer carve-out). This has been shifted to proposed new section CZ 40. Table 2 outlines the existing section and the proposed change.

Table 2: Existing sections and proposed changes

Current law	Proposed change
CB 16A: Section CB 6A does not apply to a person who disposes of residential land if, for most of the period [the bright-line period],[2] the land has been used predominantly for a dwelling that was the main home for the person…	Proposed new section CB 16A: Section CB 6A does not apply to a person who disposes of residential land if, for all of the days [in the bright-line period], the land has been used predominantly for a dwelling that was the main home for the person…
Section YA 1 definition of main home: means, for a person, the 1 dwelling – (a) That is mainly used as a residence by the person….	Section YA 1 definition of main home: means, for a person, the 1 dwelling – (a)That is used as a residence by the person…

 

12-month buffer (new section CB 16A(6)

Despite the requirement that the property must be used as the person’s main home for “all of the days” in the bright-line period, a 12-month buffer is proposed under which any period of up to 12 months that the property is not used as the person’s main home is counted as a main home period, provided the period is immediately before or after a period during which the property was used as their main home. Therefore, the property would still qualify as the person’s main home if it was vacant or rented out for a period of less than 12 months before or after main home use.

This is intended to provide leeway for moving in or out of a property (for example, there may be vacant periods between settlement and moving in, or between moving out and sale). It would also cover periods of up to 12 months where the taxpayer is not using the property as their main home (for example, if they rented the property out while overseas and it was no longer their main home for that period).

If a period of non-main home use exceeds 12 months, the entire period for which the property was not used as a main home would be subject to tax.

If the main home exclusion does not apply to take the property completely outside the bright-line test (that is, because there was a non-main home period that exceeded 12 months), any non-main home period exceeding 12 months will need to be taken into account in working out a taxpayer’s income. See quantification section below.

 

Quantification (new section CB 6A(6))

Proposed new section CB 6A(6) would apply if a person has used their property as their main home for some but not all of the time it is held. Under section CB 6A(6), the person’s income from the disposal of the property is reduced by the excluded adjustment amount that is the amount calculated under subsection (7):

Income from disposal − excluded adjustment amount

This formula only needs to be used if the property is used as the person’s main home for some of the time it was owned. If the property is never used as the person’s main home, the person’s income is simply the amount they derive from disposing of the property. These persons are not required to apply the formula as it does not impact them.

Quantification formula (CB 6A(7) to (11))

The formula for the excluded adjustment amount in proposed section CB 6A(7) is:

(Adjustment days / Total days) × Unadjusted amount

Adjustment days is the total number of days during the bright-line period where the property was used as a main home. It also includes days that are counted as main home days because the 12-month buffer applies.

Total days is the total number of days in the bright-line period.

Unadjusted amount is the amount of income the person derived from disposing of the property.

The effect of this formula is to evenly apportion the sale proceeds from the property over the period it is held. The amount attributable to the period the property was not used as the taxpayer’s main home then becomes income for tax purposes. There is no option to pay tax based on the actual valuations of the property at the start and end of the period the property was not the taxpayer’s main home. The following examples illustrate how the formula works:

 

Cost of some residential land reduced (DB 23C)

A person can claim a deduction for the cost of property subject to the bright-line test under section DB 23.

Where proposed new section CB 6A(6) applies, proposed new section DB 23C reduces the deduction that can be claimed under section DB 23 as follows:

Excluded adjustment amount = (Adjustment days / total days) × cost

Adjustment days and total days have the same meaning as in CB 6A. Cost means the cost of the residential land.

Combined impact of proposed new CB 6A and DB 23C

The Income Tax Act 2007 operates on a gross basis and the structure of income charging and deduction provisions in different subparts does not allow for the provision of one single mathematical formula. However, it is possible to mathematically simplify the formula as follows:

(disposal price − cost of the property) × ((total days − adjustment days) / total days)

Treatment of short-stay accommodation

(Clauses 58(12BAC) and 58(16))

Summary of proposed amendment

The Supplementary Order Paper proposes to amend the “business premises exclusion” in the definition of “residential land” to ensure that residential property used to provide short-stay accommodation, where the accommodation is provided in a dwelling that is not the owner’s main home, is subject to the bright-line test. The amendment will also ensure short-stay accommodation is subject to the residential rental deduction ring-fencing rules in subpart EL of the Act.

Application date

Bright-line test

The amendment to the business premises exclusion from the bright-line test applies to property acquired on or after 27 March 2021. It does not apply to property acquired on or after 27 March 2021 as a result of an offer made by the purchaser on or before 23 March 2021, provided that offer could not be revoked before 27 March 2021. The existing business premises exclusion will continue to apply for such properties, as well as properties acquired before 27 March 2021.

Residential rental deduction ring-fencing rules

The amendment in respect of the residential rental deduction ring-fencing rules applies from the 2021–22 income year onwards, regardless of when the property was acquired.

Background

The bright-line test and residential rental deduction ring-fencing rules apply to “residential land” as defined in section YA 1. “Residential land” does not include land used predominately as business premises. It was not intended that a residential property used to provide short-stay accommodation via predominantly digital platforms as part of the sharing economy should be able to potentially qualify for the business premises exclusion and therefore be out of scope of the bright-line test and residential rental deduction ring-fencing rules.

However, due to interpretive uncertainty this is not currently clear and a difference in tax treatment could distort a person’s decision to rent a property out on a long-term basis or list the property using a digital short-stay accommodation platform.

Key features

Bright-line changes (paragraph (b) of the definition of “residential land”)

The Supplementary Order Paper proposes to amend the definition of “residential land” to include land with a dwelling on it, if it is used predominantly for a business of supplying accommodation and the dwelling is not the main home of the owner.

This is intended to ensure the bright-line test applies to short-stay accommodation properties (including a property that is rented out as part of the sharing economy on digital platforms, or a bach that is sometimes rented out when the owner does not use it) unless it is a bed and breakfast type facility where it is also the owner’s main home and they rent out rooms for short-stay accommodation. This ensures that the treatment is the same between a person who rents out a property on a long-term basis (that is, has tenants) and a person who rents out a property on a short-term basis – that is, both are subject to the bright-line test. There is a carve-out for bed and breakfast type properties (that is, where it is the owner’s main home) to ensure they are treated the same as a homeowner who rents spare rooms to flatmates – that is, neither are subject to the bright-line test. This is necessary because in a bed and breakfast situation the property may not be used predominantly as the owner’s main home.

Residential rental deduction ring-fencing (paragraph (b) of the definition of “residential land”)

The amendment to the definition of “residential land” discussed above also ensures that residential properties used to provide short-stay accommodation are subject to the residential rental deduction ring-fencing rules.

Hotels, motels and other commercial accommodation

Hotels, motels and other similar commercial accommodation are not “residential land” and are therefore not subject to the bright-line test or the residential rental deduction ring-fencing rules. This is because they are specifically excluded from the definition of “dwelling” in the Income Tax Act and the Supplementary Order Paper does not propose to change this treatment.

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