First Tax Bill of 2024 passed

On March 28, Royal Assent was given to the passing of the Taxation Bill (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters).

The Bill enacted some welcomed changes, balanced with the unfortunate news for some that the trustee tax rate would increase to 39%, effective this April 1.

I expect most of you will appreciate some of the following primary amendments to income tax legislation, particularly considering the media coverage of topical issues in our present cost-of-living crisis environment. These amendments include the reinstatement of interest deductions for residential land borrowings and the reduction of the residential land bright-line period back to its original two-year period.

Trustee tax

The tax rate is increasing from 33% to 39% for the 2024–25 and later income years.

There was a time when the maximum tax rates for individuals, trusts and companies were all aligned at 33%. However, since then, the corporate tax rate has been reduced to 28%, and the top personal marginal tax rate has increased to 39%.

The previous government floated their concerns about trusts being used as a tax shelter from exposure to the top personal marginal tax rate. They embarked on a project, with the use of new domestic trust disclosure rules, to ascertain exactly how real their concerns were in practice. Personally, I think the project was, in essence, window dressing for a decision that had already been made, its duration far too short to obtain any meaningful output from which a truly informed decision could be made.

However, I suspect that most of us were surprised that the incoming National government did not reference the proposed increase in their pre-election campaign and kept quiet about their position after their win. In fact, it wasn’t until early March, when the report was back on the Bill from the FEC, that we appreciated that this bad dream was about to become a reality.

As the saying goes, the rest is history now. So, what does the change mean for you if you are involved with trusts?

Unless your trust qualifies for the de minimis rule or has arisen from a deceased estate, trustee income for the year (that is not allocated as beneficiary income within the requisite time periods) will be subject to taxation at 39%. A few comments in this regard:

• The de minimis rule – trusts with trustee income not exceeding $10,000 (after deductible expenses) are still subject to a 33% tax rate on trustee income.
  
  
• Deceased estates are excluded from the 39% tax rate in the income year they are created and for the following three income years. This rule applies to any deceased estate (those pre- and post-enactment of the Act), and once the four-year period has expired, a deceased estate could also qualify as a de minimis trust. Otherwise, its trustee income will commence being taxed at 39%.
  
  
• Any minor beneficiary income will be taxed at the new 39% rate, regardless of the de minimis rule. This rule applies where the recipient beneficiary is under 16 years of age, and their income distribution exceeds $1,000.
  
  
• If you thought that perhaps you could circumvent the new rate, or at least defer its application for a period of time, by distributing beneficiary income to a corporate beneficiary (maximum tax rate of 28%), unfortunately, you can’t. A new rule will deem the 39% trustee tax rate to apply, treat the amount as excluded income for the corporate beneficiary, and create a deemed capital gain amount to ensure that the amount is not subject to taxation again in the event of the company’s liquidation.
  
  
• For a fair number of you, unless the trust’s beneficiaries earn more than $180,000 per year, the 39% rate may have minimal, if any, impact on you. All that will happen is an increase in beneficiary income distributions to mitigate any trustee income being subject to the higher rate.
  
  
• Finally, with application to those of you wearing more “creative” hats, plans to fragment your single trust into multiple de minimis trusts, is likely to be an action challenged by the Revenue as tax avoidance. So make sure you obtain quality advice upfront in this regard, before proceeding down the restructure path.

Interest deductions on residential land 

Another one of the unfavourable tax changes implemented by the previous government, effective from October 1, 2021, was the phasing out of deductions for interest incurred on borrowings related to residential land. I struggled with this rule, considering that one of the basic premises of tax legislation is that it should not be used as a lever to distort investment decisions. Yet, here the government was, allowing you to claim interest deductions on any other borrowings used to acquire income-producing assets (commercial land, shares, businesses), except residential land – unless it related to a so-called “new build”.

Well, the new government has decided to phase back the interest deductibility. Most people have not seen a change to the 2024 income year just finished (it’s still 50% under the old rules). However, your claim will increase to 80% for the 2025 income year and back to 100% for the 2026 income year. The change applies to all borrowings (non-new-build related), regardless of whether the borrowing or residential land acquisition occurred before or after March 27, 2021. 

Residential land bright-line rules

When the bright-line rules were first introduced on October 1, 2015, the relevant bright-line period was two years. To enhance the existing intention of sale rules, which have existed in some form or another (far longer than I’ve existed), it was a rule to acquire a piece of land with an intention or purpose of sale at the time of acquisition, and the disposal of that land is taxable whenever you sell it (subject to a few exclusions). All bright-line did, was essentially remove any question as to what your subjective intention or purpose may have been at the acquisition date (usually the date you entered into a binding agreement to buy – conditional or unconditional), if you dispose of your land within the two-year bright-line period, and unless it qualifies as your main home, the disposal is subject to tax – no mucking around, black and white.

Subsequently, the bright-line period was increased to five years in March 2018 and then to ten years in March 2021 (unless newly built land retained the five-year period). The government of the day promoted the increased bright-line periods to deal with ‘speculators’. But I’d question what speculator acquires land to hold for five years, yet alone ten years? The real reason, I’d suggest, was simply to win political favour and try to be seen as doing something to deal with Auckland’s overheated residential property market. To me, that issue actually stems from basic economics – you don’t have enough supply to feed demand, and then price increases.

Making a raft of changes to the tax rules surrounding residential land (ringfencing deduction rules, bright-line, interest deduction removal) was never going to fix the supply issue, and sure, while the odd speculator may have gone elsewhere, so did your true investors, who were necessary to provide a reasonable stock of residential homes to the rental market. Frighten away your investors with negative tax changes, rental stock shrinks, returning to classic economic supply and demanding implications – the cost of renting goes up – further negatively impacting those already struggling, trying to save enough for a deposit on a first home.

From July 1, the bright-line period will revert back to its original two-year period. So, enter into a binding agreement to sell your residential land after this date, and provided your bright-line period (usually purchase settlement date through until the date of binding agreement to sell) at the time exceeds two years, you will have no exposure to taxation under the bright-line rules (although do check whether any of the other land taxing provisions may still apply to you).

The ”main home” exclusion will also revert back to the original rules – more than 50% of your residential land used for main home purposes, for more than 50% of the time you have owned the land (although now any reasonable construction periods will be excluded from the time calculation).

The most positive change, I feel, is the expansion of the roll-over relief rules, post-July 1, to transfer the residential land between any associated parties – trust to beneficiary, company to shareholder (>25%), parents to kids, etc. Roll-over relief, in essence, sees the transferee stepping into the transferor’s shoes, both in terms of the acquisition date and cost base. Note that you can only claim the roll-over relief once in a two-year period – company to trust shareholder, to trust beneficiary – all within two years, and the trust would have bright-line taxation exposures to consider.

Removal of depreciation deductions on commercial buildings

It’s not the first time this has occurred in recent history, as a 0% depreciation rate on commercial buildings took effect from the 2010/11 income year. At the time, you may recall that if you had not separated the commercial fit-out as a separate asset, there was a 15% cost allocation, which could then be depreciated on a straight-line basis at 2%.

However, with Covid came the entitlement to claim depreciation on commercial buildings acquired in the 2020/21 income year and subsequent.

Well, effective from 2024/25 and later income years, a 0% rate will again apply. Now, for those of you who have acquired your commercial building between the 2020/21 and 2023/24 income years and made a decision not to separately identify the commercial fit-out to be depreciated as a separate asset, you will be entitled to file a section 113 request to the Revenue, requesting a reassessment of any income tax returns already filed for these periods, to accommodate a separate fit-out asset (there’s a market valuation requirement to determine the amount) which can be depreciated accordingly, at a 1.5% straight-line rate.

If you would like to discuss any of these proposals further, please contact me at here.