The Tax Working Group: Will it bring back depreciation of buildings?

Wednesday, 16 January 2019

The pundits are picking the Tax Working Group will advise the Government to bring back depreciation on commercial and industrial buildings in its final report - but not on most residential buildings.

The Tax Working Group is likely to advise Government to reinstate tax deductions for commercial, industrial and multi-unit residential buildings but will the Government run with that?

But the trickier question is whether the Coalition Government will pick up and run with that recommendation and how much of a priority this will be.

Reinstating depreciation on commercial and industrial buildings and on multi-unit apartments and townhouses could cost the Government about $900 million a year in lost taxes.

If it allowed tax deductions for other residential buildings too that could cost another $500m and was probably unaffordable, the experts said.

*Tax relief of about $1 billion a year for building owners possible

Leonie Freeman, the new chief executive of the Property Council of New Zealand, said depreciation of buildings should never have been removed in 2010 by the Government.

*Capital gains tax: What's fair for one person may hurt another

*Capital gains tax gets tick from most - but not all - Tax Working Group members**

Tax experts believe the case for reinstating depreciation is strong because international evidence showed buildings did depreciate but they acknowledge the substantial cost.

The Government had asked TWG to recommend how to 'recycle' additional revenue from a possible capital gains tax into personal tax cuts for lower earners so the cost of that might not leave much room for and compete with the cost of reinstating depreciation.

And for Government, making decisions on these trade-offs would be complicated by the need for a three-party discussion.

One way to bring back depreciation might be to delay its restoration for a few years, say until 2023, because by that time more tax might be accumulating from extending tax on capital gains.

Buildings do depreciate

IRD has advised TWG there is good evidence in international studies that buildings do depreciate, that commercial and industrial buildings depreciate faster than other types of residential buildings, and that in not allowing depreciation for tax that New Zealand is out of step with most other developed countries.

The decision to remove depreciation on buildings, commercial, industrial and residential, was taken in 2010 by the National Government though it took a couple of years to take effect.

That decision delivered about $1b in extra tax and helped fund tax cuts, the pundits said.

Tax deductions for commercial, industrial and multi-unit residential buildings could cost the Government $900m in lost taxes.

Deloitte partner Patrick McCalman said at the time the IRD said buildings did depreciate and Treasury said they did not.

McCalman said from a pure policy perspective commercial property owners were being overtaxed by not being being allowed tax deductions for depreciation of buildings which created distortions, such as tilting investment towards residential because of the perceived tax benefits.

IRD said in its September advice to TWG it was a judgement call whether or not to reinstate depreciation for residential buildings.

'Our recommendation is to reinstate depreciation for multi-unit residential buildings as well.'

Stuff understands TWG might recommend depreciation for multi-unit residential buildings like apartments and blocks of townhouses.

Recycling tax

IRD said commercial, industrial and multi-unit residential buildings do depreciate and recommends reinstating depreciation for those buildings.

McCalman said the question was if the Government brought in some form of capital gains tax would it use that extra tax income to offset the loss of taxes from restoring depreciation on certain buildings.

TWG was signalling the Government should start with commercial and industrial buildings.

Another question was what rate of depreciation would be allowed. Previously the buildings were depreciating at around 3 per cent diminishing value a year.

TWG might recommend starting at 1 per cent and phasing in the higher 3 per cent rate to spread the cost over several years.

He said they were told that for every 1 per cent of depreciation the cost was $300m in lost tax revenue.

Tax from capital gains would take some time to accumulate and could affect the timing of any reinstatement of depreciation.

'I think if you said to the Tax Working Group, do you think buildings depreciate, the answer would be yes. Therefore I think there's a high likelihood they should come out and say we need to do something about it.

'They would, I think, then likely give Government a range of options as to ways they might be able to do it.'

Seismic strengthening a priority

Deloitte national technical director tax, Robyn Walker, said they expected TWG to give a recommendation on depreciation of spending on seismic strengthening.

At present Government regulations required property owners to complete seismic strengthening in certain timeframes but no depreciation was allowed on this spending.

Stuff understands allowing depreciation on seismic spending is a priority for the TWG. If the Government did not want to reinstate full depreciation on commercial and industrial buildings, at least it should allow that on seismic strengthening.

No-brainer

Property Council of New Zealand chief executive Leonie Freeman said the case for restoring depreciation was strong and principled.

'We think the Tax Working Group will recommend depreciation on commercial and industrial buildings be reinstated.'

The council hoped the Government would act on the advice of TWG and agreed with officials' recommendation of reinstating a 2 per cent straight-line or a 3 per cent diminishing value rate.

That would recognise the substantial contribution of the commercial property sector in the economy.

It would also remove the current tax disincentives to earthquake strengthening, necessary to promote safe and sustainable buildings, Freeman said.

'Reinstating depreciation should be a no-brainer. It should never have been removed in the first place. We hope the Government will recognise this,' she said.

Fiscal considerations

KPMG national managing partner, tax, Ross McKinley, said not allowing depreciation was a disincentive to property owners to refurbish, upgrade, and complete seismic strengthening or other capital works.

How popular would it be to use some of the extra tax from capital gains to offset lesser tax from commercial property owners if depreciation was once again permitted?

'Obviously, it depends on who you're talking to but for a large number of property owners they would see it as being an equitable outcome.

'At the moment it isn't the right policy setting and all this is seeking to do is address that issue,' McKinley said.

Was there any political benefit to the Government in reinstating depreciation?

EY New Zealand tax leader Matthew Hanley said it depended how the government 'sold' its decisions.

If the Government introduced some form of capital gain tax it might be more palatable if voters could see benefits of that shared in the community.

There could be benefits to Kiwisaver funds which invested in large property companies and trusts.