Tax report takes aim at property investors

Today's final report from the Victoria University Tax Working Group could see multi-billion-dollar changes for property owners, landlords and investors.

Experts expect the major tax changes will be aimed squarely at the real estate sector, a point backed up by Prime Minister John Key at his first press conference of the year last week and restated yesterday.

Jason Lindsay, Credit Suisse research analyst, has just released a detailed analysis on the effects of the changes to be announced at 1pm.

He predicted axing of property owners' rights to claim tax depreciation on buildings - which could raise $1.3 billion annually - and a new land tax as the two most likely changes.

But he flatly ruled out a capital gains tax on all properties to raise about $9 billion a year if it was applied to all houses or $4.5 billion if it was applied only to rented houses.

Key and Finance Minister Bill English had both rejected this tax for owner-occupied houses "and appear close to ruling out a capital gains tax full stop, citing the complexity to implement and administer it," Lindsay said.

Last week, Key indicated personal tax cuts and wider tax reform were on the Government's agenda this year. The working group had identified some "big holes" in the New Zealand tax system, he said.

"Shoring up the tax base and ultimately lowering personal tax rates are important," said Key.

Lindsay said axing building depreciation was the most likely move but that would have a detrimental impact on thousands of investors who get millions of dollars in distributions from the big NZX-listed property businesses.

Investors in these trusts and companies would suffer an annual drop in cash distributions of 6 to 9 per cent, he predicted.

"We believe a land tax or denying depreciation on buildings are the two most likely outcomes. While a land tax may be purer and would raise more money for Government coffers, political considerations may mean denying depreciation on buildings is an easier option for the Government," Lindsay said.

He predicted the NZX-listed property sector would probably be subject to any new depreciation rules but also said the Property Council would decry the move on commercial property. The council had been successful in its lobbying in the past, he said.

"The third possibility is a risk-free rate of return on rental investment. We think this is a distant third, in part because it does not raise enough money for the Government. It is unclear if commercial property would be included if such a scheme was adopted, although our analysis assumes it would.

"We think a capital gains tax is unlikely. The fact it is unlikely to be applied retrospectively means the Government is unlikely to generate sufficient income in the near term (not the big bang the Government requires). Further, the Government does not appear to favour a capital gains tax," Lindsay said.

Westpac chief economist Brendan O'Donovan and research economist Dominick Stephens estimated the effect of possible tax changes on house values and said last month the decline could be as high as 34 per cent.

This is because the changes could be aimed at housing landlords' pockets. Residential landlords' rental income would not be taxed but expenses including interest would not be tax deductible. Instead, income tax would be applied to a deemed rate of return on the net equity on the property. Owner-occupiers would be unaffected.

Other commentators have predicted changes that would deny residential landlords the right to claim depreciation on buildings, making depreciable buildings taxable on sale and denying the offsetting of rental losses against other income.

Lindsay said axing depreciation was a big change. Under the existing system, building owners can claim depreciation on the value of their building. But if that building is sold for more than the acquisition cost, the current tax rules recover depreciation deductions allowed from the date of acquisition to the date of disposal, according to Lindsay.

"In practice, a vendor will try and apportion as much value into the land to minimise tax on depreciation recovered. There is also an investment asymmetry that arises when a building is sold for a higher price than it cost.

"In such case, the new building owner gets to depreciate the building for a higher amount even though the vendor is not taxed on the amount received," Lindsay said.

"The tax working group estimates that denying depreciation on buildings would raise $1.3 billion per annum."

TAX WORKING GROUP
* Chairman Victoria's Professor Bob Buckle.
* Met from June to November last year.
* Comprised business/academic experts.
* Treasury and IRD staff also on it.