Last week’s report from the Tax Working Group makes some comments that are sure to be contentious. The Tax Working Group was established back in May to assist the Government in considering the key tax policy challenges facing New Zealand. Their latest report targets the $200 billion rental property industry, stating that it not only pays no tax, but is actually getting refunds when it might be contributing tax of more than $500 million a year.
The Tax Working Group calls the widespread tax minimisation using rental property investments “the glaring hole in the current tax system”.
Here are some of the key points from that report:
The report all but rejects a capital gains tax on property as an option for New Zealand.
Instead, it proposes a so-called risk free rate of return method to tax assumed income from rental property, which it estimates would collect more than $500 million additional tax revenue every year.
Under this method, “rents from land would not be taxed, and other expenses relating to the investment would not be deductible, but a risk-free rate of return would be applied to the net equity in the property and included in taxable income”.
This approach would not work if a capital gains tax were introduced, but in the absence of a capital gains tax, the Tax Working Group considers that it is an option worth considering for taxing residential rental properties.
I am in full support of encouraging investment in New Zealand in productive enterprise rather than non-productive “investment”. This seems to be a no brainer as part of a strategy to bring this country into line with the economic performance of our trading partners, who actively encourage entrepreneurship rather than tax driven non-productive investment.
The current regime encourages Kiwis to “spend a dollar in order to save 33 cents in tax” rather than “invest a dollar to earn 33 cents a year in income”. This has been a major driver in the country investing en masse in rental properties over the past decade or so.
But in my opinion the policy advisors also need to be mindful that residential property investors provide a valuable social function in this country – and disincenting residential property investors may well have some consequences that are not ideal. Here are some of these:
There is a potential for rents to rise and hurt low income renters to meet new tax obligations;
The risk free rate of return method of taxing property investment would surely make highly geared property investment more attractive, as tax would only apply to the equity in the property rather than its total value or the actual rent received;
This method would result in tax being payable on many thousands of genuinely loss-making properties, surely making these uneconomic to be kept long term in the country’s stock of available rental properties;
The government and local authorities have been backing out of the provision of accomodation as fast as the private sector has been piling into it. If the private sector is disincented from continuing to hold these properties, is the government willing and able to increase its presence in this sector to fill the gap? I suspect not.
The Tax Working Group’s final report is expected to have influence on government decisions on tax reform, which John Key has signalled is one of his government’s top six economic policy priorities. It will be interesting to see what comes out of this, and I hope the government carefully considers the causes and effects right down the chain before acting.
Fraser Hurrell is one of three directors of Elevate CA Limited, Chartered Accountants & Business Advisors in Whangarei, New Zealand.
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