Contributed by Associate Professor Justin Dabner, Law School, James Cook University, Cairns, Australia; Adjunct research fellow in Business Law and Taxation, Faculty of Business and Economics, Monash University, Australia
The 2016/17 Federal Budget included measures intended to address housing affordability. It would seem that the government’s desire to differentiate itself from the Opposition meant that it could not address the primary tax drivers of property prices: negative gearing for investors and the CGT 50% discount and main residence exemption. That left tinkering around the edges. However, with the introduction of the legislation into parliament it now appears that one aspect of this tinkering may be more significant than the Budget announcements had let on.
Refer to CCH Books – Australian Master Tax Guide 2017/18 and Australian Income Tax Legislation 2017 – 3 Volume Set for more guidance on CGT and Income Tax.
The Budget announcements and the Housing Tax Integrity Bill 2017
The Budget announcements directed at housing affordability included two curious measures, one denying travel expenses to inspect a rental property and the other directed at subsequent owners of rental properties claiming depreciation deductions in excess of the value of assets acquired with the rental property. Treasury Laws Amendment (Housing Tax Integrity) Bill 2017 containing these measures was tabled on 7 September. Notably, the provision purporting to implement the second of these proposals is the proverbial sledge hammer to crush a walnut, requiring complex exclusions.
The travel expenses denial
A new s 26-31 of the Income Tax Assessment Act 1997 (ITAA 1997) will deny a deduction insofar as it relates to travel incurred in gaining assessable income from the use of residential premises as residential accommodation from 1 July 2017. Furthermore, such expenditure cannot form part of the property’s cost base.
There are various exceptions, such as if the expenditure is incurred in carrying on a business or by a corporate tax entity. Furthermore, if the premises are also used for other income-producing purposes (the draft Explanatory Memorandum (EM) referred to solar panels feed-in tariffs as an example but this example has been removed from the tabled version) then travel for those purposes remains deductible. It would seem from the drafting of the provision (namely the term “insofar”) that apportionment is possible in the event of mixed travel purposes.
The EM confirms (para 1.35) that the exception for businesses will mean that deductions will remain available for a taxpayer conducting a boarding house or similar type arrangement that falls over the line into a business and also for estate agents acting on behalf of a landlord client. Also, according to the EM, where the agent passes on the travel costs in their fees the landlord is not to be denied a deduction (para 1.24), a point not clear from the legislation and not canvassed in the draft EM.
The availability of travel expenses by a company (although not a corporate trustee) may admit to some planning opportunities depending on a client’s circumstances.
The depreciation deduction denial
The problem identified in the Budget announcement was the revaluing upwards of depreciable assets acquired with a rental property thereby allowing the subsequent landlord to, effectively, double dip on the depreciation deduction provided by a depreciable asset. That this is the case says more about the inadequacies in the tax law relating to valuing second-hand assets and the ATO’s enforcement activities. The structure of the ITAA 1997 is that the vendor landlord should be returning a balancing adjustment by reference to the value at which the asset is transferred, which value should then be the depreciable base for the new owner. Where this occurs then the complaint identified in the Budget announcement evaporates.
However, it would seem that successive landlords may have been allocating the sale/purchase price for the property in different ways. That this is conceivable can be attributed to changes in the stamp duty laws. Back when duty only applied to the realty a negotiation would take place as to the allocation of the purchase price over the various chattels, which might be reflected in a schedule to the sale contract. Of course, the higher the allocation to chattels the lower the stamp duty for the purchaser but then the vendor might have an assessable balancing charge. Thus, barring exceptional circumstances (or, at least, exceptional negotiation skills on the purchaser’s part) the written down value of the assets was typically accepted by the purchaser. With the existence of a schedule of chattels with agreed values any subsequent attempt to revalue these assets by the new owner was likely to lead to a bad outcome in the event of a tax audit.
Since the States have imposed duty on the whole purchase price the impetus to agree a value for the chattels has been lost, hence the opportunity that the Budget papers complain about.
The operative new provision is to be s 40-27(2) of the ITAA 1997. Rather, startling for those who recall the Budget announcement this section does not merely deny a landlord a depreciation deduction for any asset acquired with a pre-existing rental property but also denies a deduction in relation to an asset that was bought new but used by the landlord for a non-taxable use (for any period other than occasional use). The later element is a real sting for those who were intending to rent out their homes in the future. If the owner’s plan was to move into other premises the tax imperative will be to take their old chattels with them and either lease the property unfurnished or replete with splendid new assets. Of course, there will be plenty of potentially depreciable assets that might not be (sensibly) removed, including a share of common property assets in the case of apartments. In fact, the denial of depreciation deductions related to common property might be quite significant yet it would be unusual for these values to be able to be manipulated in the way envisaged in the Budget announcement.
According to the EM (para 2.39 and 2.41) use for occasional purposes that would not engage the deduction denial might be staying in investment premises overnight while attending to maintenance or spending a weekend in a holiday home. It can be expected that this will be a flash point given the common practice of owners of holiday let units to perhaps stay a week or two a year in their apartments. Such practices may need to be reconsidered or managed carefully by property managers in order to not deny future depreciation deductions in relation to the property after the two-week holiday.
The draft provision issued for consultation presented a conundrum for developers having trouble selling their new properties. While there is a carve out from the deduction denial for new residential premises (s 40-27(4)), should a developer be having trouble selling in the current market and then decides to lease to a short-term tenant for a few months in the hope that the market will improve, prospective investor purchasers might have walked away upon identifying that their anticipated large tax deductions were much smaller than expected. In response to concerns raised during consultation, the exclusion in s 40-27(5) from the denial of deductions was extended in such a case provided that the acquisition was within six months of the premises becoming new. Depending on the circumstances, the identification of exactly when a property became new could be problematic and a simpler requirement might have been implemented to address the issue (eg the property was rented out for no more than six months).
The exception also places focus on the meaning of new residential premises. For these purposes, a definition is added to s 995-1 incorporating the definition in the GST legislation, contained in s 40-75. Importantly, judicial consideration of the term has resolved that an objective test applies such that the actual use of the premises is not decisive. Thus, if the premises provides minimum shelter and basic living facilities and is capable of occupation then it is residential premises (see Goods and Services Tax Ruling GSTR 2003/3) regardless of its use. Then, broadly, if the premises has previously been sold or subject to a long-term lease then it is not treated as new.
The definition does recognise that premises subject to substantial renovationsmay thereupon become new again. Substantial renovations is also defined in the GST legislation as, broadly, renovations in which substantially all of a building is removed and replaced, not necessarily involving structural alterations. This is clearly a problematic definition. The EM (at para 2.52) provides the example that the installation of a new kitchen and bathroom in an existing home would not, on its own, be substantial renovations. The ATO’s views are outlined in GSTR 2003/3at para 53 to 83.
The denial also flows through to appropriately adjust the calculation of any balancing adjustment, reducing any additional amount returned as income or claimed as a deduction, while amendments to s 104-235 and 104-240 envisage that a capital loss (or gain) might, nevertheless, arise upon the disposal of the asset.
The provisions are to apply from 1 July 2017 tax year for assets purchased at or after 7.30 pm (ACT time) 9 May 2017. However, it should be noted that the provision can also apply to assets acquired before 9 May 2017 where they have not been available for a depreciation deduction at any time during 2016/17. The EM suggests that this retrospective element was necessary as an integrity measure. It denies a depreciation deduction for earlier acquired personal assets that are subsequently used in rental properties.
While it is unlikely that these measures will be a deal breaker for property investors the depreciation measure in particular will impact on the after tax return to the extent that the property is purchased with depreciable assets. The ultimate beneficiaries may be tenants as the tax imperative on the landlord will be to provide new chattels with the property. Alternatively, unfurnished rentals may become more common, in which case removalists may be the winners. Alternatively still, lease arrangements for rental property assets may become more popular.
Curiously, although the denials may reduce some of the perceived excesses of negative gearing (by virtue of reducing the tax deductions available) the measures, of course, also impact positively geared landlords. Southern investors with holiday let units on the Gold Coast or in North Queensland, who travel up each winter to inspect their property and stay in it for a couple of weeks, will be particularly impacted.