Tax group targets building depreciation

The tax working group has suggested removing the ability to claim depreciation on buildings. This could raise up to $1.3 billion in revenue. Photo / Herald on Sunday.

Tougher rules for depreciation and thinly capitalised companies are among the more targeted base-broadening measures proposed by the tax working group.

These are measures the Government could adopt quickly, it says.

It regards it as illogical that taxpayers can claim depreciation on assets that are in fact rising in value.

It suggests denying depreciation on buildings if, as it suspects, evidence suggests buildings do not depreciate.

Officials estimate it could raise up to $1.3 billion a year in revenue, though that could be reduced by up to $600 million if an offset was allowed if buildings were subsequently sold at a loss.

The working group also suggests reducing or eliminating the 20 per cent loading that applies to the depreciation rates for new assets other than buildings. This is estimated to be worth about $300 million a year.

It also suggests reducing the 'safe-harbour' threshold for thin capitalisation from 75 to 60 per cent.

The thin cap rules are meant to curb the scope for foreign-owned companies to reduce the tax they pay in New Zealand by funding their local operations mainly by debt, which gives rise to deductible interest payments.

But Deloittes tax partner Thomas Pippos opposes such a change.

He argues it would put New Zealand out of step with other countries and does not address the issue, which is that the thin cap regime is not being applied as it was originally intended.

Institute of Chartered Accountants tax director Craig Macalister questioned the case in principle for tax changes targeted at property investments when the rules are in fact consistent with those applying to other investment classes.

PricewaterhouseCoopers chairman John Shewan, a member of the working group, pointed out that the more than $200 billion invested in rental properties yielded less than nothing in tax - between $100 million and $200 million less - because of the ability to use losses to shelter other income.

"It is very hard to justify that outcome. It is not a sustainable ongoing position," Shewan said.

Pippos agrees and said the short-term answer to the issue was to remove depreciation deductions for residential properties.

Ring-fencing or quarantining losses might also need to be considered in the medium term if the Government continued to sustain losses from the sector, he said.

In this context there was also a case for tighter rules on the ability to claim deductions relating to "mixed-use" assets such as holiday homes which were used partly to generate an income as well as providing an amenity for the owner's use. These could give rise to material tax losses, Pippos said.

Deloittes opposes a land tax, a view strongly held by tax partner Mike Shaw, a member of the working group.

He argued it was distortionary in imposing a tax on one asset class, land, that others escaped. It did not address the issue of losses being generated in the residential rental sector.

"It raises a plethora of other issues, including cash flow and valuation concerns and whether certain sectors should be exempt," Shaw said.

Some members of the tax group favoured applying the risk-free return method to residential rental properties. This was advocated much more broadly by the 2001 McLeod tax review.

Investment properties would be taxed on a deemed return equivalent to the risk-free rate (set by a Government bond) adjusted for inflation, implying tax of between 1 and 2 per cent on the value of the property.

But it presents several design issues, and is especially problematic for investment properties that are already cashflow negative.