Let’s talk about tax (and imputed rents).
In one part of the now infamous interview between Gareth Morgan and Paul Henry; when Gareth is trying to explain to Paul that Paul owning a big house or a flash car did have value to Paul – Gareth is talking about imputed rents.
Michael Cullen’s tax review in 2001 – the one that had Shirley Jones as a member that wasn’t the mother of David Cassidy – produced an interim issues paper. In that paper from page 37 there is a proposal to tax imputed rents. I will define it in a minute promise – currently just doing the preamble flow. The media and news – coz in those days people didn’t get their news anywhere else – went absolutely nuts. There was a line doing the rounds that the Beehive’s switchboard was jammed following the release of the issues paper – and that was just from the 9th Floor (HC) to the 7th (MC).
I don’t think Helen Clark’s government could distance themselves from it fast enough.
So what is an imputed rent? Told you I would get there in the end. The way I like to think of it is the rent you save to the extent you own your own place. That value is then income to you as is the case with the dividend rules where a shareholder lives rent free in a house owned by the company.
Strictly speaking the ‘correct technical’ analysis has you both paying non- deductible rent and receiving taxable rent. In the same way renters pay non-deductible rent to landlords for whom it is taxable income. In this analysis you are both renter and landlord.
Yep I prefer my way too.
So it is a benefit or a tax break that owner occupiers get that renters don’t get. And it has been there for like EVAH so no one really realises. Except in their heart they do. Imputed rents is the basis of the received wisdom that you should always pay off your mortage ahead of making other (taxable) investments.
Now the thing is that strictly speaking under the ‘correct technical’ analysis if you start taxing the income you need to also allow deductions. But I am not sure if our friend the private and domestic exclusion for deductions would let it thru.
This isn’t a problem for TOP as their tax will be based on productive capital as measured in the capital account of the National Income Accounts. Ok good. There is though the small matter that nothing else in the tax system is actually based on this concept . So maybe – just maybe – there could be some tax design issues.
Now being the solutions focussed individual that I am – I thought I’d put together another way of taxing imputed rents. Yes I know there is more to the TOP tax policy than this – but there are limits to my powers. I also can’t do a blind thing about political acceptability either – so I am sticking with what I know.
How to tax imputed rents in four easy steps.
Step one. Divide the value of your mortgage by the value of your property. Council valuations will be fine.
Step two. Go to the MBIE website and look up your area, number of bedrooms and find the potential rent for your property. There are three bands. Take the median one. Why? Made it up. No one can be trusted not to self assess the lower band and I can’t cope with the arguing.
Step three. Take the rent in step two and multiply by 52 weeks or how ever long you have lived in your property. If no mortgage put this number in your tax return in the rents box. Joint owners – yes you can divide it by number of owners. Put that number on your tax return.
Step four. Those with mortgages who are still playing. Multiply step one’s number by step three’s number. This is the amount you aren’t paying tax on. Deduct it from the full amount in step three and put it on your tax return. Yes joint owners can divide here to.
Of course it still suffers from the problem all made up or presumptive taxes do that there hasn’t been any cash come in to help pay the tax. But I would hope – to paraphrase one of my commentators – it was more intuitive and less weird to the punters than something based on a percentage of value. Even if the outcome is broadly similar.
Now of course the economists may hate it. But as economists don’t have to explain things to clients or taxpayers – give the accountants this one.
Let’s talk about tax.
Or more particularly let’s talk about private and domestic expenses for farmers.
One of the key reasons I spent the greater part of my working career in tax was that I was rarely bored. Challenged – often; frustrated -sometimes but bored rarely. Add in the sense that I was a small cog in a system that tried to make sure the tax rules applied to everyone and you get almost 2 decades of socially productive and largely personally satisfying work.
The thing though about tax is that you could never drop your guard. You might think you have the answer but then find a transitional exemption; an unexpected definition or an obscure case could mean that the answer of Orange you gave from careful analysis was wrong and it should have been Pink.
Now I had thought that with blogging I would be relatively safe from that experience: I was choosing my topics and they were all pretty general. At worst I could invoke the ‘Not tax advice. Follow at your peril’ disclaimer.
After the recent post on private mortgage costs a reader pointed out to me a recent public consultation document from the technical side of Inland Revenue with the innocous title of Deductibility of Farmhouse Expenditure.
Now there was nothing actually wrong in the OP – original post look at me being all real blogger like – as that post related to someone’s suburban house. However I extravagantly branched off and concluded that there was no ‘country immunity’ from the private and domestic test for deductibility of expenses.
Boy was I wrong.
Clearly I have spent far too long in international tax. As what that document makes clear was in the 60’s after ‘negotiation with the industry’ Inland Revenue allowed interest on private farmhouses to be fully deductible.
Wow. Just wow. Mind blown.
Now I guess it isn’t as bad as it seems as then farms would have been massive and houses small in comparison. And like didn’t Mrs Farmer have to feed shearers and stuff which is business related. And apportionments are such a pain so close enough is near enough and let’s call it fully deductible.
Only thing is didn’t actually comply with the law; was a concession and would defo have been a tax expenditure if it had been legislated for.
But it is kind of a while ago and things are different now. In the sixties women weren’t paid the same as men; the Rugby Union was criticised for its lack of diverse perspectives and a National government was approaching its fourth term. So you know like completely different.
And while I could make a number of cheap shots like – seriously it has taken you 50 years to apply the law properly – I won’t. It would have required a high degree of intestinal fortitude to take the small farmers concession away. So nice one. Carry on Mrs Commissioner.
Only thing is while proposed change is a massive improvement, the practical compliance cost friendly option for large farms is still in your correspondent’s view unnecessarily concessionary. Particularly as there is no actual reduction in compliance costs.
So in terms of my dinner party companion’s comment: ‘This is the country – we get tax deductions for all sorts of things…’ Yeah mate you do. Fewer than before and more than I realised. But yeah you do.
Let’s talk about tax.
Or more particularly let’s talk about tax; interest deductions and private expenditure in companies.
Your correspondent has returned from her ‘retirement cruise’; is recovering from jetlag and has returned to what passes for work these days. That will dear readers include a return to twice weekly posting. As a change from some of the more political posts I thought I’d return to a technical issue for a bit of light relief.
Earlier this year while I was still inside I went to a dinner party in a provincial city. At the party was a delightful gentleman I had met previously and was more than pleased to see again. The feeling appeared to be mutual and our conversation broadly went like this:
DG – Now Andrea tell me – which is better? To pay my mortgage or to pay my tax?
Me – cough, splutter, mumble – well the thing is it isn’t a choice as tax is a legal obligation.
DG- oh don’t be silly of course I know that. What I mean is it better to have a mortgage on my house get the tax deductions and then have money to invest in shares and things for capital gains or have no mortgage not get the tax deductions but have more disposable income?
Me – Ah what makes you think you get a tax deduction for the mortgage on your house?
DG- This is the country – we get tax deductions for all sorts of things and besides I’m the director of a land owning company!
Me – Is that wine over there?
Now dear readers I am sure after Zen and the art of tax compliance you all know that to get tax deductions the expenditure has to be:
- Connected to the earning of income or in the ordinary course of a business and
- not private or domestic expenditure.
So therefore if DG owns his house in his own name – or in a family trust – as neither 1) or 2) is met there is no deduction for interest expenditure.
There is the possibility that if the money were borrowed on his house and used to buy shares THAT WERE DIVIDEND PAYING then the interest would be deductible. But if the money is borrowed to construct the house for him to live in – nuh.
The complication though is the comment about being a director of a land owning company. The rules above do not apply to a company and interest deductions. From about 2000 or so the rule broadly became:
- Are you a company resident in New Zealand?
- Have you incurred an interest expense?
If yes to both, then ‘would you like interest deductions with that?’
The private and domestic test still applies to such expenditure but I have always struggled to align any concept of private and domestic to a company.
So at first pass – yep – if DG holds his house in a company – in your correspondent’s view – he will get an interest deduction.
And yeah the Mixed Use Asset rules won’t apply here because ironically it isn’t a mixed use asset – it is wholly private and domestic.
But – not so fast – the music hasn’t stopped.
While there are special rules for companies and interest deductions there are also special (dividend) rules for transactions involving companies and shareholders aka ‘are policy makers really that dumb?’
These dividend rules say where ever there has been a transfer of value from a company to a shareholder there is a taxable dividend to the shareholder to the extent of the value transfer.
Ok again in English.
If a company gives a shareholder stuff – goods or services – that is a taxable dividend for the shareholder. Here the company has given the shareholder use of a house – so the shareholder DG – gets a taxable dividend.
And by ‘taxable dividend’ yes this means you need to put that value on your tax return and pay tax on it. And yes I know you didn’t get any actual cash but that doesn’t matter. You know how when you tick the box for dividend reinvestment on your publicly listed shares – you know how the dividend is still taxable even though you didn’t get any actual cash. Consider this as the same.
So what is the value that DG has received from the ‘land owning’ company? He has received the benefit of living in that house. And what do people usually pay for the benefit of living in a house they don’t own? You’re onto it – rent.
DG is then up for tax on the value of the rent not paid to the company as a dividend. And once more with feeling – it doesn’t matter that no cash has been paid from the company to the shareholder.
So the benefit DG received – use of the house without paying rent – is taxable to DG.
Now if DG has a tax rate of 33% – as the company tax rate is 28% – there will be a net 5% tax paid on the ‘imputed’ or deemed rent. That is he pays tax at 33% on the deemed rent and the company gets a deduction at 28% on the interest expense. In other words a gift to the people of New Zealand and how tax planning can go wrong. And if he didn’t know this was the case until my former colleagues come along – it will be 33% tax plus interest at about 8% plus a penalty of between 10% and 100%.
Awesome. Can only hope he didn’t also pay an agent for this wizard advice.
If his tax rate though is lower than the company rate this is where it could get really interesting. Technically even with DG putting the value of rent on his tax return there will still be a net tax deduction that ostensibly can be offset against other income.
In this case though the structure – or ‘arrangement’ as my former colleagues may start to call it – is really putting pressure on the whole ‘companies can’t have private expenditure’ thing. And from here we move into a complete world of pain – or ‘good case’ depending on which side you are on this – known as tax avoidance. Now the entire interest deduction is at risk with tax avoidance penalties of between 50% and 100%. Fun huh.
And don’t even think of paying rent to your company and making it a look through company so you get the deductions directly against your other income. The department was very clear with look through companies – the prequel – that this was tax avoidance too.
So DG I am not sure there really is any ‘country immunity’ for interest on your personal mortgage. Pay it but step away from the tax system. There be dragons.
Let’s talk about tax (and yoga).
Now dear readers you may not realise but next to my family and friends there is nothing I love more than yoga. Well except maybe learning French, films, travel and … anyway you get the idea so work with me. And as this is a tax blog I thought I really should combine the two very early on.
A few years ago when I was both a runner and a Treasury official I was using yoga as a form of physical and mental carbon offset. One Sunday I was queuing up in a very calm mindful way to swipe my card. I was noticing my breathing and feeling very at one with the universe.
Ahead of me the yoga teacher for the class was checking us in. Now it seems to be a yoga studio thing for the teacher to do the pre class admin. I am coming around to this. On one level it is nice to be greeted by the teacher but at times it does seem like a lot for them to cope with. I guess that is part of why they are so special.
So here I am in the queue noticing but not really engaging with my surroundings as I was going internal. Until the teacher says to the person in front of me ‘here is your receipt as you’ll need it for your tax’.
Bong!! My left-brained self returned. What was that about? When I was a gym member no one ever said that. What is this ‘need it for your tax’ thing ?
Now dear readers who are also tax geeks you know where I am going with this. But a key piece of contextual information for non-yogis is that the yoga community is about the nicest kindest most peaceful community I have ever come across. They are definitely bottom of the triangle people.
For yogis who are not tax geeks I need also to provide some contextual information. In the tax system pretty much all forms of income are taxable: your yoga teaching; events you run for profit and your day job. Now that won’t be a surprise to anyone. The more difficult part is what you can claim as expenses. So it really does depend on whether or not you need that receipt for your tax.
Before I go on what I offer is my best advice which is wholly up to you whether you accept it. In the same way you tell me – from a place of your knowledge; experience ; and concern for my joint health – that I should micro bend my hyperextended joints and I don’t. I too offer this from a place of my knowledge; experience and concern that you could get to interact with my former colleagues outside your classes. Whether you follow it is completely up to you.
In the tax system, if you are not an employee, expenses related to the earning of that income are deductible if they are:
- Directly connected to the earning of the income or connected to the cost of running a business and
- not private or domestic expenses.
An example. I went back to work in 2000 as a junior official watching the winter of discontent when my boys were 5 and 2. I used pretty much all my post tax income to pay for a nanny without whom I could not go to work . But NONE – and I repeat NONE – of those costs were deductible as they were considered private or domestic expenses. Yes tax friends there is also the employment limitation but just let it flow – this is a yoga post after all.
Now all yogis know how life changing yoga is and not just for your joints so all yoga inherently has a private and domestic element to it. But then so does any occupation that has a personal or social benefit to it.
And here ‘occupation’ is key. If yoga teaching is ‘what you do’ then by definition you will have a dedicated home practice and so any classes you take or courses you go on will be personal development for your teaching and not your core personal practice. Therefore fully deductible for tax.
But part-time yoga teachers this is not you. If you have a day job and just teach a couple of classes a week, this does not mean that Wanderlust; that advanced training in Bali and your studio subscription is necessarily tax deductible. It will be tax deductible to the extent it isn’t a private expense.
Now sorting that out that deductible/non-deductible line in practice would be a total headfxxk. So I would suggest following the approach in Inland Revenue’s guidance on holiday houses before the Mixed Use Asset rules came in and claiming expenses up to the level of income earned from yoga teaching. There is no technical analysis on this point – strangely for the Office of the Chief Tax Counsel as they are all about the technical analysis – but to me they have applied the private limitation but not spelt that out as it is a headfxxk even for them.
So parttime yoga teachers – if it is personal development you can claim up to what you earn.
Oh and that other yoga special – Karma Cleaning. Barter is in the tax system. For the studio they are substituting taxable income for deductible cleaning costs so they net off. But for the cleaner it is taxable income paying for a non-deductible yoga class. So stick the value of each yoga class on your PTS and we’ll all be sweet.