From 1 July 2016 we lawyers have been chosen for the honour, by the grace of her Majesty’s New Zealand Government, of becoming unpaid tax collectors for the Inland Revenue Department, whether we like it or not.
From that date we will need to deduct Residential Land Withholding Tax from the proceeds of some residential property sales and pay it to the IRD. This is a new witholding tax that is intended to stop the perceived flight of taxable gains out of New Zealand to overseas speculators. Whether there is actually a problem in this regard no one really knows, but few things move quicker than a government which suspects it is missing out on tax.
It’s not really a new tax. It’s more about deducting money on suspicion, ie “witholding” it, and putting it aside in the government’s bank account until the tax status of the transaction is clear.
You then have to file your returns and show the transactions, properly evaluated, weren’t taxable. You hope. If the sun shines upon you a refund may be forthcoming.
When is tax withheld? The withholding tax will only apply when the property being sold is located in New Zealand and:
- is “residential land”
- the vendor purchased or acquired the property on or after 1 October 2015
- the vendor owned the property for less than 2 years before selling
- the vendor is an “offshore RLWT person”
There are exemptions where inherited properties are being sold and for transfers of relationship property.
What is an “offshore RLWT person”? An “offshore RLWT person” is not the same as an offshore person in the tax statements introduced last year. An “offshore RLWT person” will include:
- A NZ citizen who has been overseas for the last 3 years or more continuously.
- Someone with a resident class visa who has been overseas for 12 months or more continuously. (Student visas or work visas are not resident class visas.)
- Someone who is not a NZ citizen or NZ resident, whether they are in or out of NZ.
- A company if more than 25% of its directors or more than 25% of the decision making rights are held or controlled by the types of individual persons described above.
- A trust where the trustees or certain beneficiaries are the types of individual persons described above.
- A limited partnership if 25% of the general partners or 25% of the partnership shares are held or controlled by the types of individual persons described above.
- For partnerships each partner will need to determine if they are an offshore RLWT person and they then might have tax deducted from their share of the property sale income.
How much is the tax? An online calculator is available on the IRD website to help work out the amount of the tax to be deducted and paid to the IRD. This will be the lowest of:
- 33% (except for companies which is 28%) of the gain on sale
- 10% x the sale price
- Sale price less rates and amount needed to discharge the mortgage (where the mortgage is with a NZ registered bank or licenced non-bank deposit taker)
Agency commissions cannot be deducted out of deposits if there are insufficient funds. Neither can body corporate levies, usual LINZ fees or conveyancing costs.
This last bit will leave law firms in the ridiculously stupid position of having to refuse to perform some low equity conveyancing because the law firm partners would otherwise end up not only unpaid, but personally liable to Inland Revenue for more money than the sale yielded. This has been pointed out to the government, but they have, using moderate language here that is much kinder than is deserved, “failed to take these concerns on board”.
To explain: Let’s say there is only a small surplus on sale of an apartment, less than 10% of the sale price…because, for example, the loans are in default and the equity is getting swallowed up by mortgage penalty interest. So the third option applies – all the sale price less mortgage repayments needs to go to the IRD. The vendor manages to arrange a sale of its apartment that would yield it a small profit.
Yet there are body corp levies and fees to pay (less the rates component, which we can deduct), we want something for doing the conveyancing, LINZ want fees on the e-dealing, and the real estate agent has already quite properly taken their commission and marketing from the deposit, which raises an argument that under the legislation the lawyer should have prevented them from doing so until the witholding tax position was clear.
The vendor’s lawyers, if we were stupid enough to do the conveyancing, would find ourselves with a personal obligation to make payment out of our own pockets of the shortfall in the surplus to the IRD for having failed to retain the necessary amount. We would pay the LINZ fees, levies, arguably the agents commission and marketing (the wording is not completely clear), and get paid nothing ourselves. And let’s not forget that lawyers cannot hide behind a corporate structure – when I say personal liability, it means personal.
In practical terms, on such a sale we simply won’t settle unless the vendor funds us up front for the amount of the agents commission/marketing and other selling costs like body corp levies, LINZ and legal fees. If the vendor can’t pay, we won’t do the sale, and the vendor is in default of settlement. The only option, without being funded, will be a mortgagee sale, because the costs of sale can then be included under mortgagee charges.
How unjust is it that a vendor who would otherwise come out of a sale with a small surplus, is going to be effectively forced to raise money to pay a witholding tax that almost certainly exceeds anything they could actually owe in tax, or be faced with a mortgagee sale? That will happen.
Anyway. Offhore vendors need to be aware that their property sales may well result in witholding tax being assessed and paid to the IRD, and will need to adjust their cashflow expectations accordingly.
Documenting your intention on purchase to hold property long term and not in the expectation of sale has never been more important.