Foreign trusts and the two year test

The Shewan report into foreign trusts was tabled at the end of last month. As expected, it found the disclosure laws relating to foreign trusts were “inadequate”. It said, “The rules are not fit for purpose in the context of preserving New Zealand’s reputation as a country that cooperates with other jurisdictions to counter money laundering and aggressive tax practises.”

While the report said they found no evidence of illicit funds being hidden in New Zealand-based foreign trusts, it said, “based on the work undertaken, including a review of IRD files, the inquiry considers it is reasonable to conclude that there are cases where foreign trusts are used in this way.”

In essence, NZ is not a tax haven but the disclosure regime was so light-handed that it creates an opportunity for foreign investors to use New Zealand based foreign trusts to hide assets or shield income that would otherwise be taxed in a foreign tax jurisdiction.

The upshot of the report is that foreign-owned trusts based in New Zealand will be required to disclose more information when registering, and that data will be available to regulatory authorities to inspect. The information collected at the time of registration would include: the identity of the trust’s settlors, protector, non-resident trustees, and beneficiaries; their email address, foreign address, country of tax residence, and tax numbers.

The solution is a sensible one, and logical. What was illogical was the lack of candour from the government when first challenged on this issue, and why they had not acted on this matter when these concerns were first raised by the IRD some years ago.

Bright-line test

Readers will be aware that a two-year “bright-line” rule applies to residential properties bought on or after 1 October 2015, but the fine-print is only now being questioned.

To recap, the bright-line test treats capital gains on residential investment property sold within two years of purchase as taxable income unless it’s the seller’s main home or another exception applies.

A number of areas have caused confusion, including exactly when a purchase and sale is deemed to have taken place. Different tests apply for the ‘date of acquisition’ and the ‘date of disposal’. The date of acquisition is taken to be the date of registration of transfer of the land. By contrast, the date of disposal will generally be the date that the seller enters into an agreement for the sale of the property (i.e. a conditional agreement that is subsequently settled), not the later registration date.

This means that the date of disposal for the seller (eg conditional agreement to sell) will be earlier than the date of acquisition of the same property by the buyer (registration of transfer). This is deliberate, to prevent the bright-line test being thwarted by sellers, merely by extending the settlement date.

When calculating profits or losses the costs of disposal and acquisition, such as conveyancing costs and real estate commissions, will be deductible in determining the net gain or loss, as are the costs incurred in improving the property. Where a loss is incurred the losses cannot be offset again other income. The losses are ring-fenced and only able to be offset against taxable income from other land sales.

Another area being questioned is whether the bright-line test applies where the shares in a company owning residential property are sold. In simple terms, where 50% of the shares in a land-rich company are transferred in a 12 month period then a disposal of residential land will be deemed to have occurred. So, selling shares in a company owning a residual investment property instead of the property itself will not side-step the tax man’s net, and those selling shares may unwittingly find themselves caught by the new rules.

Another area causing confusion is situations where the disposal of the property is forced upon the owner – for example residential property bought by compulsory acquisition under the public works act, or sold via mortgagee sale. These situations are captured by the two-year rule.

Last week the Reserve Bank’s deputy governor Grant Spencer signalled property investors are likely to be the target of tightening loan-to-value ratios. He said this was to “to counter the growing influence of investor demand in Auckland and other regions, and to further bolster bank balance sheets against fallout from a housing market downturn…Such a measure could potentially be introduced by the end of the year.”

By not acting sooner the Reserve Bank has, in effect, sent a very strong signal to property investors that they should get in quick before the new limits come into effect.

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