Tax Changes and the Upcoming Election

Lots of our clients are asking GRA what is on offer from the various parties for the 2023 election, so I thought it would be useful to recap the tax changes made by Labour in their past two terms, and then canvas the different offerings from political parties to reverse their changes. As a disclaimer, I’m not a fan of this government’s tax policy on residential landlords (being a landlord myself), so if you are left-leaning investor, you might be better to move on to another article. 

When Labour astonished investors with bombshell tax changes in early 2021, I said that I would remind our clients and readers of the ‘about face’ the government did on tax policy in the run-up to the 2023 election. Let’s not forget Grant Robertson swore black and blue that the only tax change would be an increase in the top marginal tax rate to 39%. He said “no new taxes” but liberally interpreted that to meaning he could make huge changes to existing taxes, without campaigning on them transparently. He also very clearly said he would not extend the bright-line period, then he doubled it to 10 years.

Labour’s stated position on tax in 2020 election was not transparent

The most astonishing thing to me about the bright-line extension and interest non deduction rule changes, was the robust promise ‘set in stone’ from the Labour Finance Minister Grant Robertson in late 2020. You may recall the quite pointed Heather du Plessis-Allan interview, where she asked Robertson three times in a row to guarantee no tax changes other than increasing the marginal tax rate to 39%. Each time she asked him if he would change something, he said ‘no’; he was emphatic there would be no other tax changes and he certainly would not extend the bright-line period, he said. He made the same promise throughout the 2020 election as well.

I actually took him at his word; it never occurred to me he would back flip and make radical tax changes. More fool me (and others who take this politician at his word). Within 100 working days of taking office, Roberston implemented arguably the most far-reaching changes affecting residential property taxes in the history of New Zealand. In fact, Labour introduced the most radical new tax policy I’ve seen in my career as a chartered accountant.

Recap of the Labour tax changes

You will recall that in addition to Robertson demonising property investors with labels such as ‘tax evaders’, ‘speculators’, and the like, Labour set about changing tax policy to specifically target residential property investors, who are of course predominantly ordinary ‘mum and dad’ investors. These changes have included:

1. Loss ring-fencing rules introduced with effect from 1 April 2019 for the 2020 financial year (during Labour’s first term), preventing the offsetting of tax losses from residential property investment with other sources of income. Where previously (for over 100 years) a rental loss would be allowed offset with other business or PAYE income, and a tax refund from rental losses could occur, Labour caused such residential property losses to be quarantined and carried forward (i.e. no more tax refunds from property losses offset.) That was the end of negative gearing right there. 
   
   
2. Bright-line rules: Labour extended bright-line from two to five years during their first term, and later to 10 years in their second term. A 10-year bright-line period is best described as a ‘capital gains tax in drag’ or a rifle tax on residential property investors’ capital gains. Labour’s latest 10-year rules exempt new builds (which remain subject to a 5-year bright-line rule), and apply to properties acquired on or after March 27 2021.
   
   
3. Interest non deduction rules, denying the ability to deduct the largest cost of property ownership as an expense, being the cost of funding. These rules apply from October 2021 and are phased in over four years for property acquired before March 27 2021. They apply in full for property acquired after this date. The rules exempt new builds for a period of 20 years from such effect, as well as residential properties leased to social housing organisations. 
   
   

A few thoughts on these rules:

• Every other business of any nature in New Zealand (including commercial property investors) still get to claim interest as a tax deduction. However, residential property investors now pay tax on the net yield (rent less operating expenses) rather than the net cashflow (rent less operating expenses less interest). This effectively means residential property investors pay tax on the interest they would otherwise get to deduct. Consider this residential example:

Looking at this example (that is endemic of what is going on in a higher interest rate environment for investors), if a residential property investor has $50k of interest cost and has negative cashflow of ($15k), they now get a $11.5k tax bill to pay. How is hitting someone with $15,000 of negative cashflow with a tax bill of $11.5k fair and equitable? 

Remember, the investor also pays tax on the capital gain on the property if they sell within 10 years. And don’t forget new houses with Code Compliance Certificates issued on or after March 27 2021 don’t have to pay this tax (as new builds are exempt). This is distortionary, and crippling to smaller residential landlords who own second-hand houses, most of whom are small-scale landlords. 

• When I say small-scale landlords, 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, nearly 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? These small-scale landlords are the backbone of nearly 80% of the rental housing market in New Zealand, and they are terribly affected by the interest non deduction rules. They particularly suffer as interest rates rise, resulting in negative cashflow that is non-deductible. Then they get a massive tax bill; it doesn’t make sense. Nor does it make sense that they cannot get a tax deduction on negative cashflow, due to the effect of loss ring-fencing.
  
  
• The unanticipated consequences of this policy are distortionary. Investors start dumping second-hand houses to buy new ones, or building new houses, or preferring social housing due to the tax break on it. People are literally thrown out of their long-term tenancies because of tax changes. Or they lose their house to a community housing provider (CHP) tenant, because the landlord gets to deduct interest if they lease their property to a CHP.
• There is no symmetry in the treatment of interest deductibility with other asset classes, including commercial property. Good tax policy is typically neutral in the way it applies to all asset classes and entities alike. But this government doesn’t like residential landlords one bit, so they ignore this and distort the property economy with rifle taxes.

A Labour ‘Capital Gains’ tax for 2024?

I’m speculating here, but Labour have been clear in their messaging that while they want to see a wealth tax or full blown capital gains tax introduced into New Zealand, Jacinda Ardern said that it would not happen ‘while she was prime minister’. Well folks, she is no longer prime minister, and if Labour get a third term, I would bet my last dollar on a wealth tax emerging. But just as interest non deduction rules and bright-line rules are  back-door capital gains taxes with different labels, I’m sure they will have a different label for a new wealth tax.

We have also heard through the traps that Labour are contemplating increasing marginal tax rates on high income earners. Mike Hosking among others was talking about it on radio. It’s all rumours and could be false, but I encourage you to think ahead about how this country is going to pay for all the costs that have been wracked up in the last six years, and who will pay for the increasing public expenditure from a well-meaning but very fiscally loose Labour-led government.

2023 Election Position of the Parties: Tax Changes

Below is a quick precis of the current stated position of from the left and right leaning political parties of New Zealand. I asked New Zealand First for their policy, but they had not responded at time of writing.

I’ll keep you updated if these policy positions change later this year.

Property Investors Tax Score of Party Tax Policy – by GRA as at March 2023 

Act seem to be the most friendly to property investors’ tax plight; they get a B+.

• Note on bright-line period:
  • Bright-line rules mean the sale of a residential dwelling (other than your family home) is taxable within the stipulated timeline.
    
    
  • National are saying two years, Act want it repealed and gone.
    
    
  • Personally I think five years was balanced. It caught up with speculators pretending to be investors (changing their mind a lot to get a tax advantage), but didn’t catch most people legitimately changing direction over the longer term.
    
    
  • IRD have a very hard time proving ‘taxable intention’, meaning without bright-line rules, investors are encouraged to take risk, and IRD end up with a lot more work to do. 
    
    
  • Five years was a good balance, and particularly caught the plethora of foreign investors we see out there that seemed to change their minds two years after they brought their properties. A 5-year timeline weeds out these sorts of people and makes it a lot easier for IRD. A 5-year bright-line rule would serve the public and private interest best, in my view.

Summary

It has been a rough ride for property investors under Labour. This government is attacking middle New Zealand with their property tax reforms, as it’s ordinary people being hit, not a tax-cheating landed gentry of wealthy property oligarchs (as the government rhetoric in 2021 implied).  

Let us not forget the difficult to navigate residential tenancy rules rammed through this term, and the tinkering with LVRs and finance rules under the CCCFA shambles. It will be interesting to see if property tax becomes a significant election issue in the mainstream media for the 2023 election. I doubt it because there is no sympathy for property investors in the public eye. For residential property investors with debt, we know the interest non deduction rules are a hot election issue. That’s 50,000+ annoyed residential investors affected, all of voting age.

It remains to be seen whether Labour talk transparently about tax changes, and especially about wealth taxes. Meanwhile, I am pressing Act and National for their policy to improve on the loss ring-fencing changes that occurred. Their position on interest non deduction rules is excellent; these need to be reversed along with the other changes. I will keep you all informed as information comes to hand; David Seymour appears sympathetic to the property investors’ plight, and very responsive to policy queries. I encourage you to talk to your local National MPs about the issue – it’s worth impressing on our political contacts the importance to our part of the community of these tax changes being reversed.

More from GRA

For those of you interested in tax and legal structures, check out our  blogs at www.gra.co.nz/#gra-blogs. I note we held a particularly popular webinar on Tax and Trust Structures that is trending, which you can watch at https://www.gra.co.nz/seminar-recordings/trusts-and-tax-webinar . For year end tax prepping and latest tax changes, you might like to have a look at https://www.gra.co.nz/seminar-recordings/year-end-prepping-update-webinar presented by GRA partners John Rowe and Anthony Lipscombe.