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Held in Trust Headlines
How to play the interest rate game - part 2
How to play the interest rate game
Snakes and ladders, and the Budget
Is the Government taking my dough?
Wasps' nests and gifting
The gifting programme
Christmas message from the professional trustee
Money flies out the window and love flies out the door
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The survivor's pain
Held in Trust
Snakes and ladders, and the Budget
Thursday, 17 June 2010
By Janet Xuccoa
Now that the dust has settled on what was one of the most anticipated Budget announcements in recent memory, it’s time to ask what the Budget’s proposed changes really mean for New Zealand’s economy and for New Zealanders personally.
The Budget in a nutshell
The 2010 Budget has heralded in the following:
A drop in personal marginal tax rates
An increasing of the GST rate to 15%
The removal of depreciation claims on buildings
Proposed changes to the LAQC regime
Extra funding for audit activity at the IRD
An alignment of the highest personal marginal tax rate and the Trust tax rate
An increased attractiveness and competiveness of New Zealand.
The Government’s been thinking
There is no doubt about it. Some deep thinking has gone on behind the scenes. This Budget has been brought in to stimulate the economy by encouraging productivity and savings. An additional aim was to dilute the love affair New Zealanders have with residential property with an objective of enticing people to invest in areas such as investing their capital in businesses.
How has the Government managed these goals? Well, to start with a nice ladder up the money chain has been introduced. Marginal (personal) income tax rates have been reduced from 1 October 2010. This change has been instituted because research has shown that when income tax rates are high, they act as a brake or a disincentive to increase income. This of course has a run on effect on productivity. After all, there is no point in producing more if all you are going to do is pay more in labour costs and tax and earn yourself very little in the process.
Additionally the thinking behind lowering the tax rates is that this should lead to an increase in productivity and labour. That’s got to be good for the country as increases in productivity and labour mean a greater demand for labour and consequently a decrease in unemployment.
From an economic perspective an increase in productivity and labour and a decrease in unemployment should mean more people will have money in their pockets which should lead to more spending. In other words, the gold starts travelling around the economy.
Now you might be aware that traditionally New Zealanders are not good savers. In fact, we’ve historically liked to spend more than what we have coming in. Not a course of action I recommend by the way.
The Government is well aware of this behaviour of ours and so has taken steps to help us rein in our spending habits. Yes, they have increased GST from 1 October 2010 to 15%. You see when we receive our well earned tax cuts we are likely to feel wealthier than what we actually are. This may lead us to spend more. So, GST has been increased.
Remember, GST is a consumption tax and so often we have the option of incurring that tax or not as the case may be. Hence, the increase in the GST rate is hoped to lead us to decrease our consumption and increase our savings.
On the basis that we do develop good savings habits, where will we put our hard earned moo-la? Historically, we’ve invested in bricks and mortar. The Government however wants us to be a bit more diverse in our choice of investments and so through the Budget is intending to introduce changes which will remove our preference or bias to invest in property.
From 1 April 2011, property investors will not be able to claim depreciation on buildings. Depreciation will still be permitted to be claimed on chattels and we will still be able to claim for the repairs and maintenance expenses we incur. This denying of depreciation on buildings however will definitely have a cash flow effect. This is because it will decrease the amount of expenses that can be claimed, which in turn will decrease the amount of loss that can be ‘cashed up’. Alternatively, it could mean some properties will become profitable which will increase the amount of tax liability a shareholder has.
Overall however, for many property investors, the impact of denying depreciation will be offset by the gains they personally experience via their marginal tax cuts. Accordingly, I don’t see the denying of depreciation as being a big deterrent for investing in residential property.
The second thing the Government is proposing to do to sway New Zealanders away from residential property investing into other investing choices, is to tinker away with the tax rules that Loss Attributing Qualifying Companies and Qualifying Companies are subject to.
Until these changes come into force, these companies can produce a loss which can be deducted at a shareholder’s marginal income tax rate. That could be as high as 38%. Profits, however, are taxed at the company’s tax rate which is currently 30%.
The Government has said that this tax treatment is inconsistent because Loss Attributing Qualifying Companies, Qualifying Companies and Limited Partnerships all distribute gains and losses to their shareholders and partners and, therefore, all these vehicles should be governed by the same tax rules.
Hence, from 1 April 2011 it is proposed that an alignment of the tax treatment of Loss Attributing Qualifying Companies and Qualifying Companies to that of Limited Partnerships occur.
There are however some snakes shareholders should be aware of.
The first snake is the amount of loss a shareholder can claim will be limited to the proportion of their shareholding and investment in the company. What this means is that the loss that is able to be claimed, is limited to the capital/equity a shareholder has invested in the company plus any legal promise they have made in respect of their company eg: guarantee.
For those readers who want to think about this a bit deeper, I am inclined to think this ‘limiting of loss claiming’ is a bit like ring fencing of losses. For example, if the loss is greater than what a shareholder can use then a portion of it will have to be carried forward into the next financial year and maybe, into future years. This will come about if a shareholder has only a limited amount of equity in the property and hasn’t signed a debt guarantee.
For the majority of Loss Attributing Qualifying Companies and Qualifying Companies shareholders, I don’t expect this limiting of loss claiming will be an issue. Most shareholders will have guaranteed the bank borrowings of their company and so will still be able to claim 100% of the loss that is produced. Hence, I don’t see this proposed change as a nail in the coffin of the property investor.
The second snake that will affect some shareholders in Loss Attributing Qualifying Companies and Qualifying Companies is that profits will now be attributed to them at their personal tax rate rather than those profits being taxed at a company rate. This could have an effect of increasing the tax they are liable to pay.
The final snake I want you to be aware of is all the extra funding IRD is going to get under the Budget - $119.3 million over 4 years. That’s a very, very big number and I happen to know IRD is already recruiting staff to work in audit and focus its energy towards reviewing the property industry.
Moving away from snakes and turning our attention back to the Budget, you should know that the Government is aligning the top marginal income tax rate with the Trust income tax rate. The Government has said that this alignment should further the integrity of the tax system because it will remove the incentive to use Trusts to shelter income to avoid income being taxed at the top marginal income tax rate.
But remember - Trusts aren’t just about tax. One of the main benefits they bestow is asset protection. Furthermore, income might be received by a Trust and paid out to a beneficiary who has a very low tax rate, as low as 10.5% so a savings in tax could still result.
One last aim I want to tell you about is how the Government has wanted to make little old New Zealand attractive and competitive overseas. To bring this about, they have reduced down the corporate (company) tax rate to 28%. That’s lower than our friends across the ditch and we’ve got the jump on Australia by about 4 years. Hopefully this will mean we will retain the much needed labour we need in New Zealand and the money we save in tax will be pushed back into our companies as working capital.
What you should be aware of
I’ve always said life is a bit like a game of snakes and ladders. You can take some steps to capitalise and climb the ladders that are put in front of you. Likewise, you can easily be pulled down and backwards by the snakes that cross your path.
You can however do a bit to play the hand that is dealt to you. Stacking the cards or game in your favour is something I strongly encourage. You do this by taking all the steps you can to get some winning cards in your hands. Here are some tips or steps you can take:
Check your cash flow and make some calculations. Work out what difference the change in tax rates mean to you.
If you are involved in a Loss Attributing Qualifying Company or a Qualifying Company, check what effect the denying of depreciation will have and the changes in the tax rules will mean to your loss or profit.
If you are a property investor, ensure you are working with professionals in the preparation and filing of your tax returns.
Under all circumstances, make sure you are getting appropriate tax advice in relation to all property transactions.
Summary
Overall the Budget is great for New Zealand, in my humble opinion. It should stimulate the economy, increase productivity, decrease unemployment and increase savings - all good stuff from a macro perspective.
From a micro viewpoint, the Budget needs a bit of weighing up. Sure we’re all going to get the benefits of tax cuts but GST has increased and those of us who enjoy investing in property will be wary about the proposed changes to depreciation and taxation rules.
In summing up, burn this date into your minds - 1 APRIL 2011. That’s the date you need to ensure your deck of cards is in order. Get your structures checked, including the family Trust; work out what effect the Budget is going to have on your finances; get the advice you need and above all, talk to your professionals about taking advantage of the opportunities the Budget has just delivered to you.
You can contact us at Gilligan Rowe & Associates by emailing me at jx@gra.co.nz.
© Gilligan Rowe & Associates Ltd
Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.
