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Home / New Zealand

<i>Mary Holm:</i> Referee needs to blow the whistle

Mary Holm
By Mary Holm,
Columnist·
16 Mar, 2007 04:00 PM8 mins to read

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KEY POINTS:

It seems that escalating house prices are causing the Government and the Reserve Bank great concern.

Some commentators have suggested we should have a capital gains tax, as in Australia. But this has always been regarded as political suicide and shunned by vote-chasing political parties. There was even
Michael Cullen's idea of a mortgage interest rate surcharge, which shows some courage on his part, but of course that was soon buried.

It is my impression that most people believe the gains from selling real estate are exempt from income tax (because we have no capital gains tax), and they are encouraged to hold this view by the many people with vested interests, such as agents, builders and financiers.

Anyone who reads and understands the Income Tax Act's provisions in relation to property transactions (not easy) should realise that many activities, which most people would not think of, are subject to income tax.

The simplest principle of the legislation is that anything bought with an eye to profit on sale is subject to income tax, be it shares, antiques, houses, second-hand goods, or whatever.

The intention at time of purchase is the determining factor - not how long it has been held, or whether the purchaser has done it only once or twice before. Those who make a practice of such dealings are, of course, conducting a business and should be making returns - but are they?

Subdivisions, development schemes, refurbishments, rental properties, all have tax implications which most people would not wish to know about and which none of those promoting such ideas would dream of telling them about.

I wonder what would happen if the IRD examined every property sale and checked whether proper income tax returns had been made.

If, as a result of such a blitz, it became widely known that many people were being caught for tax evasion on property sales, it would be my guess that the problem of escalating prices would be solved overnight.



What's more, it would be rather difficult for most people who have bought investment properties in the past few years to argue that they bought them for any purpose other than selling at a profit.

"More individuals now report tax losses than tax profits from property investments," says a report to the Reserve Bank.

Property prices are so high that the interest on an investment property with a fairly big mortgage, plus maintenance, rates, insurance and depreciation, often amounts to more than rental income. In many cases, losses are expected to continue for years.

How can landlords who report such losses deny that they bought with the intention of making a gain on sale?

One landlord said recently that he would tell Inland Revenue that, at purchase time, he had expected to make ongoing rental profits years down the track, and he bought the property for that distant income.

But taking into account that a dollar now is worth more than a dollar later, it would take many years of profits next decade to make up for years of losses now.

Pull the other leg! And don't forget that the burden of proof is on the taxpayer, not Inland Revenue.

The situation hasn't escaped the Reserve Bank. A report to the Reserve Bank Governor, Alan Bollard, in February last year explored the idea of having Inland Revenue more strictly enforce thelaw on investment property gains.

Nobody took a lot of notice then, but last week Bollard referred to it in his monetary policy statement.

"The [central] bank has identified several policy options that it believes could usefully play a part in dampening the housing cycle and thereby promote financial stability over the longer term," he said.

Potential measures included "greater emphasis on the enforcement of existing tax laws regarding capital gains made on investment properties, and changes to the tax rules around investor housing".

On taxing gains on investment property sales, last year's report acknowledged that "this would be a departure from current practice [and] ... there are significant challenges in trying to prove intent under the current law, as case law has shown".

In light of this, it was inconclusive about whether the law should be more closely enforced. More research was needed, it said.

But perhaps that's happening. "Development of these options with the relevant agencies is progressing," said Bollard last week.

If Inland Revenue did get stricter about taxing gains, landlords could hardly complain about a change in rules halfway through the game. The rules wouldn't be changed, just the watchfulness of the referee.

Bollard did, however, also mention possible changes to the tax rules. He was referring to ring-fencing losses on investment properties, so the losses couldn't be deducted against other income.

The losses could still be carried forward and deducted against future profits on the property. But in many cases rental profits never happen. The only profit is when the property is sold.

And there's the irony. Given that most people don't pay tax on their sale proceeds - the very thing you are suggesting should be changed - some of them would never be able to use the tax losses.

The report is lukewarm about that idea. It would "discriminate in an arbitrary way against a particular form of investment", and sophisticated investors would find ways around it. Also, by reducing the appeal of rental properties, it could reduce supply and so raise rents, "affecting lower income groups more heavily".

Furthermore, in the countries that do ring-fence property losses - including Canada, France, Germany, the Netherlands, Sweden, the United States and Britain - house price cycles don't seem to be less marked than elsewhere.

On the other hand, the report said, New Zealanders were more into investment properties than people in other countries, so things might be different here. And Bollard certainly implied that the idea was still alive.

Who knows what's in store? Landlords would be wise not to count on the status quo continuing.

A final point: I hate New Zealand's law about tax on capital gains, and the way it leaves landlords - and some share investors and others - uncertain about their liabilities. It's time it was made clearer.

* * *

Regarding the increase in the official cash rate by the Reserve Bank and subsequent increase in mortgage rate by the bank, please advise me what I should do to stop myself tearing out all my hair and beating my head against a brick wall.

I have a mortgage.

I do not have a credit card.

I do not book exotic holidays or new cars on my mortgage.

I do not own any investment properties or use negative gearing.

I save up for the things I need and pay for them at the time. I do not have any hire purchase or credit agreements.

Why am I being punished for the sins of others, and what should I do to prevent the fiscal thrashing I am copping for no apparent reason?



My advice: a cup of tea and a lie down. Or better still, a brisk walk.

If you want to view the rise in interest rates as an unfair attack on you, I guess you could look at it that way.

But you're not hit nearly as hard as those who do have long-term credit card debt, or who own mortgaged investment properties or buy goods and services on credit. Any and all interest rates may rise because the official cash rate has risen.

In any case, I'm sure Alan Bollard isn't motivated by punishment. It's just that he wants to keep inflation under control. His job tenure depends on it.

And everyone, including you, is better off if he succeeds. High inflation hurts - especially for those, like you, who are not high-interest borrowers.

While it's true that people with mortgages have had an unusually bad run with rate changes in recent times, anyone who borrows runs the risk that will happen.

If you hate the uncertainty, perhaps you should move to a fixed-rate mortgage, which at least gives you certainty for a period.

* * *

Not often do I find something that needs response in your columns - pretty much right on the button. But, as they say when it comes to regulations and laws, the devil is in the detail.

I'm referring to your recent correspondent who wrote, "Investors should stay away from an investment company whose advertisement contains one or more of the following".

The list included the words "first ranking secured debenture stock".

New Zealand Securities Regulations 1983, Part 2, Advertisements, s14, Unsecured and secured securities, states: "No advertisement shall refer to any debt securities (other than securities the issuer of which is the Crown) without also stating either that the securities are unsecured or the nature and ranking in point of security of the securities."

In other words, if the debt securities are "secured" it is mandatory for an advertisement to say so, and "the nature and ranking".

Seems to me that advertisements that contain the words that your correspondent is taking exception to are simply complying with the regulations.

Advertisements for debt securities which do not contain the word "secured" or the word "unsecured" are breaking the law.



We live and learn. Still, it pays to note that just because an ad includes "secured debenture stock" we shouldn't assume it's safe.

There's security and security. If you want to go into debenture investments, it pays to know about the quality of the security.

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