New interest deduction rules – still only a proposal
Due to the nature of a number of enquiries I have experienced over the past couple of weeks since the Government made its announcement that it was proposing to make changes to the interest deduction rules associated with d, I thought it was timely to remind you all that the proposed changes are still just that – a proposed change that has not been legislated for, and there will be a public consultation process completed, prior to draft legislation being released.
So once again the message to investment property owners is do not panic. Sure, appreciate the potential effect a rule change may have on your financial position, as any prudent investor should do, however, let’s at least see the draft legislation post the completion of the consultation period, before any firm decisions are made.
Therefore, a few things to consider, remember that this is just what is proposed, not a finalised position:
- Lesson number one – Nothing changes until at least October 1st, 2021. Until this date, all interest costs remain fully deductible.
- Lesson number two – Post 1st October 2021, your entitlement to interest deductions will depend on when you acquired your residential investment property (acquired being the date you entered into a binding agreement to acquire the land – not the settlement date) – was this date pre or post 27th March 2021.
- Lesson number three – If the date you acquired the land was post 27th March 2021, then effective 1st October 2021, your interest costs will no longer be deductible.
- Lesson number four – If the date you acquired the land was pre-27th March 2021, then you are still going to have some quantum of interest deduction through until at least 1st April 2025 (your claim entitlement will reduce by 25% each year).
- Lesson number five – If the date you acquired the land was pre-27th March 2021, but you have taken out new borrowings post 27th March 2021 (say to complete improvements to the land), the interest on the new debt will be non-deductible post October 1st, 2021.
- Lesson number six – If you are likely to pay income tax on any eventual disposal gain, it is likely you will still get to claim your interest deductions – either under existing rules (property developers) or in one lump sum (bright-line taxation for example).
- Lesson number seven – Those who invest in ‘new builds’ are unlikely to be impacted by the new rules. Many questions remain unanswered here however, including what will be considered a ‘new build’ – what if I buy bare land and construct a new dwelling to rent out – what if I buy an existing dwelling and plan to demolish and replace with a greater number of new builds to rent out, etc.
- Lesson number eight – Don’t be surprised to see a raft of anti-avoidance rules to prevent you from structuring in such a way to avoid the new rules – just like we saw with the introduction of the residential rental deduction ring-fencing rules.
Special report on new legislation released
Post the recent passing of the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021, IR has now released a special report on the new legislation.
The 105 page document covers amongst other things:
- Extending the bright-line test period from five to ten years – in this regard, note that when considering whether the five- or ten-year period now applies to you, firstly determine when you acquired your first interest in the residential land (entered into binding agreement) – was this date pre (five years) or post (ten years) 27th March 2021. Once you have determined which rule you are subject to, then your general rule for calculating the applicable bright-line period is date of title transfer through to date you enter into binding agreement to sell. Also note the change to the main home exclusion rule for land acquired post 27th March 2021 (existing rule still applies to land subject to five year bright-line period). Finally, I see the report makes no mention of the ‘new build’ carve-out, which was mentioned in IR’s fact sheet published in March 2021. New builds acquired post 27th March 2021 were supposed to remain subject to the five year bright-line period – I will monitor for any subsequent clarification in this regard.
- Feasibility expenditure – now potentially deductible over a five-year spreading period, where the expenditure related to completing, creating, or acquiring property (business assets) that is later unsuccessful or abandoned. Immediate deductions are also available for such expenditure that in total is $10,000 or less in an income year. Together, the changes are intended to set out the circumstances when expenditure can be deducted for property that but for abandonment would have been depreciable property or revenue account property.
- Purchase price allocation rules – requiring parties to a sale of business assets (post 1st July 2021 agreements entered into) with different tax treatments to adopt the same allocation of the total purchase price to the various classes of assets for tax purposes.
- Amendment to definition of eligible R&D expenditure – to clarify that expenditure must be closely connected with conducting an R&D activity to be eligible for the R&D tax credit. To ensure that expenditure claimed has sufficient nexus with the eligible R&D being conducted, the amendment clarifies that expenditure is only eligible if it is directly related to, required for, and integral to the R&D taking place.
This article from the ‘A Week in Review’ newsletter was originally published Monday 12th April 2021. If you have any questions or would like a second opinion on any national or international tax issues, please contact me email@example.com.
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