News reports of recent tax changes have spread far and wide. What were the previous rules? Why did they change?  We’ve highlighted three items which have will have a financially huge impact and explain why the change came about.

Trustee Tax Rate

What’s changed

For trustee taxable income lower than $10,000, it is taxed at 33%. If taxable income is more than $10,000, all income is taxed at 39%.

Up to and including the 2024 tax year, trust income was taxed at a flat 33%.

Impact

The purpose of the new rule is designed to discourage ‘high-income-earning’* individuals from moving business profit into a trust. 

Just a wee note about the terminology. For the current tax year, profit that isn’t distributed to beneficiaries is called trustee income – the trust is responsible for paying the tax. After paying income tax, we call the result after-tax income. In the same tax year, beneficiaries declare that distribution as taxable income – the beneficiary is responsible for paying the tax. All trustee after-tax income for the current and previous years is added to accumulated profits. 

This problem with the current situation arises because distributions from accumulated profits from a trust can be distributed tax-free to beneficiaries. 

Inland Revenue used to be quite happy for a beneficiary to receive a tax-free distribution from accumulated profits – tax of 33% had already been paid. An individual in the top tax bracket* would receive this distribution tax-free. For the 2023 tax year, the ultimate result is that accumulated trust profit has been taxed at 33%.

Now that the top tax rate for individuals is 39%, concern arises from the trust’s accumulated profits still taxed at 33% and distributed to a taxpayer who should be paying 39% tax. With the new rate, distributions of accumulated profits to a top-tier taxpayer (tax free) will have had tax paid of 39%. The taxpayer receives this tax free. Inland Revenue is perfectly fine with that. Those in lower tax brackets would probably prefer receiving distributions in the current year, as they’ll be taxed at their individual rate.

* Income more than $180,000 is taxed at 39% (2023: income more than $70,000 was taxed at 33%)

Interest deductibility on residential rental properties

What’s changed?

Finally – common sense prevails, and residential property owners will eventually be allowed to deduct 100% of interest. Other businesses can claim 100% interest, so it’s logical that residential rental property businesses not be excluded from making this deduction.

Impact

The deductibility of interest will now be:

• Year ended 31 March 2024 – 50% (no change)
• Year ended 31 March 2025 – 80%
• Year ended 31 March 2026 – 100%

The ‘ring-fencing’ rule still applies though – rental losses can only be offset against rental profits.

Bright-line – selling a second property

What’s changed?

• Bright-line start date – for purchasing an existing property, this is usually the date on the signed sale and purchase agreement. For new-builds, the bright-line start date is the date on which the code of compliance is issued.
• Bright-line end date – for selling a property, this will usually be the date on the signed sale and purchase agreement.

In other words, if you buy that second property and sell it within two years, you may need to pay tax on the profit.

Impact

This change doesn’t only apply to residential rental properties! Previously, the profit on selling a second property (for example, a holiday home or bach) could be taxed under bright-line because it’s not a ‘main home.

The new rule will encourage these property owners to sell a second property and make it available to the market without having to wait 10 years. 

Bright-line was initially intended to tax property speculators who would usually buy, renovate, and sell within a short period of time – usually called ‘flippers’.

However, in the tax world, they should be captured under the specific land laws which tax on certain transactions where (amongst other considerations):

• You have a regular pattern of buying and selling houses for a profit; and/or
• You are in the construction industry; and/or
• You are related to a person in the construction industry.

Conclusion

Transactions involving properties and trusts remain complex, so we always recommend seeking professional advice. There are still niggly technicalities which could catch you unawares and result in a large tax bill. 

Feel free to get in touch with our friendly team and we can provide advice on your specific situation.