Tax clampdown on boats and baches complicated and difficult
New tax rules clamping down on excessive deductions for the costs of holiday homes, yachts and similar leisure are overly complex and will be difficult for many taxpayers to administer.
The rules, introduced in the September 13 Tax Bill, will take effect from the start of the 2013-14 income year and apply to assets worth more than $50,000 that are offered for occasional hire. These are referred to as “mixed-use assets”.
There are currently no specific rules for deducting expenses relating to such assets. Many taxpayers simply deduct all expenses except those relating to the days when they used the asset privately.
For example, if a holiday house was used privately for just one month a year, the owners would deduct 11 months of expenses, even if the house was hired out for only a few days or weeks.
The new rules are more complex and apply to assets that are:
- Used to earn income; and
- Used privately; and
- Not used for at least 62 days (or 62 working days if the asset is typically only used on work days) in an income year.
Because the rules target assets that can be used for private purposes, the rules are focused on specific asset types owned in smaller businesses:
The asset must be held by an individual, trust, partnership or a close company (five or fewer individual or trust shareholders):
- Must be land (including buildings) or cost more than $50,000.
- Must be used privately, which means by the owner or anyone associated with the owner, including their partner, siblings, parents, children, grandparents or grandchildren.
- Any use below market value will also be regarded as private use.
Private use will not include use by the person if it involves expert or specialist knowledge for the asset to be used, the person uses it in that capacity and the income derived is at market value. The example here would be a helicopter owner hiring their piloting services with their helicopter.
Fortunately, the new rules do not apply to motor vehicles or situations such as home offices, where tax deductions are already taken based on the space used.
Private days defined
The apportionment formula provides for the amount of deductible expenditure, including depreciation, to be calculated based on the number of income-earning days divided by the sum of income earning days, plus private use days. Days the asset is not used for any purpose are ignored.
Private days includes any use by associated persons of the owner, even if market value is paid for the use of the property. This will widen the application of the rules and restrict deductions more than might have been expected.
For example, deductions for expenses incurred for a boat chartered for 20 days and used by the owner for 30 days would be calculated at 40% of the general expenditure, calculated based on 20 days’ business use of the total 50 days in use.
Other expenses specifically related to the private use would be non-deductible and expenses specifically related to the business use would be deductible.
In addition, a new rule of interest deductibility is introduced for close companies holding assets subject to the rules. Any interest expenditure incurred in relation to debt within the company, where the debt is equal to or less than the cost (or rateable value, if land) of the asset, will be subject to apportionment.
Further rules exist to limit interest deductibility for group companies, corporate shareholders and non-corporate shareholders, if applicable.
Complicated and unfair
This adds much greater complexity to the new rules and is unfair as it is based on the assumption that any debt in an ownership structure is applied to buy private assets first.
They are designed to prevent taxpayers side-stepping apportionment by using debt in other group companies to, effectively, fund the purchase of mixed-use assets.
Under current rules and, in many cases under the new rules, any overall loss from hiring out a mixed-use asset would be available to offset against other income earned by the owner of the asset (or group company).
However, a further twist is that “quarantining” of expenditure could occur if the gross income derived from the asset is less than 2% of the cost of the asset or, for land, 2% of the rateable value.
The quarantined expenditure would be denied as a deduction in the current income year and can be used in a later year when there are sufficient profits derived from the asset.
To prevent the inflation of income to get above the 2% threshold, income received from relatives and associated persons is excluded from the definition of income when applying this test.
The quarantining provisions do not apply to assets predominantly used in business.
Owners of mixed-use assets may be tempted to throw up their hands in frustration and give up the benefit of tax losses, which are now much reduced. The draft rules give you the option to elect out of the rules by treating the income as exempt (and not getting to claim the deductions).
However, this will only be available where the gross income (before deductions) in a year is less than $1000.
In trying to makes the rules “fairer,” the taxman has made them a lot more complex. Unless total income from their holiday homes or yachts in an income year is less than $1000, taxpayers will have no choice but to apply these new rules.
Spencer Smith is a director and tax specialist at Staples Rodway Christchurch