"The glaring hole" in the tax system - no tax paid by rental property owners:

Sunday 4th October 2009

The $200 billion rental property sector not only pays no tax, but is actually getting refunds when it might fairly be contributing tax of $500 million to $900 million a year, says a report from the last meeting of the influential Tax Working Group.

The TWG calls widespread and growing tax minimisation using rental property investments, especially by top bracket taxpayers on the 39% tax rate, "the glaring hole in the current tax system".

Led by Victoria University, with input from the Treasury and Inland Revenue Departments, the TWG's latest report was issued Friday and all but rejects a capital gains tax on property as an option for New Zealand.

Instead, it turns its guns on the rental property sector with proposals to apply the so-called Risk Free Rate of Return method to assumed income from rental property, which the TWG estimates could be worth $500 million to $900 million in additional tax revenue every year.

"Recent data show that revenue from the approximately $200 billion rental property sector is negative and has trended downward since the introduction of the 39% tax rate in 2000," the working paper says. "The glaring hole in the current tax system is the rental property sector.

"There are efficiency and equity problems with the different treatment of savings in the form of bank accounts, and savings in the form of rental property."

Under an RFRM tax, "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 if a CGT was rejected, then "the TWG considers that the RFRM for rental properties is an option worth considering".

The downsides would be the potential for rents to rise and hurt low income renters to meet new tax obligations; lower property values; the potential to make debt-funded rental property investment more attractive than equity-funded; and tax being payable on loss-making properties.

Applying such a tax only to rental properties might also encourage further personal home ownership as a preferred investment by New Zealanders.

The working group paper on the RFRM proposed, prepared jointly by the IRD and Treasury, also suggests $1.3 billion a year in tax is not being collected because of the questionable practice of allowing depreciation deductions for buildings.

While buildings were a normal business expenses and should perhaps be depreciable for consistency's sake, the group noted that only industrial buildings are allowed to depreciate under United Kingdom tax rules.

The group identified an alternative option as ring-fencing losses on rental property and making them non-deductible against other income, although previous ring-fencing attempts had proven "reasonably easy to circumvent".

Along with a land tax, such a tax on rental property could go a long way to creating the substantial new sources of income the Government requires to help fix looming Budget deficits, without seriously distorting economic activity.

A rental properties tax might also potentially discourage speculation in residential property, which is commonly blamed for imbalances in New Zealanders' savings and investment habits that lead to high foreign indebtedness.

The TWG's land tax paper suggests between $160 million and $460 million could be collected in land tax applied at a rate as low as 0.1% of capital value.

The group has a day-long conference scheduled in December, and its final report is expected to have influence on government deliberations on tax reform, which Prime Minister John Key has signalled is one of his Government's top six economic policy priorities.

Businesswire.co.nz

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