Many people come to New Zealand having retained property overseas and there are lots reasons for doing do. For some, it’s an emotional attachment to their previous homeland, for others it’s a long term investment and a source of recurring income, or possibly just a financial reality of a flat housing market.
Whatever the motivators, there are a number of misconceptions, pitfalls and unexpected outcomes related to owning property overseas. In this article we explore some of the less well known considerations and often overlooked issues.
When someone first arrives in New Zealand they are automatically considered to be “transitional resident”. As a transitional resident you are only taxed on your worldwide business or employment income and your New Zealand sourced investment income. Initially, there are therefore generally no New Zealand tax implications of owning property outside New Zealand during the transitional residence period. However, when your transitional residence period expires (or if you don’t qualify as a transitional resident) that’s when the “fun” starts!
Taxation of rental income
Rental income generated from overseas is taxable in New Zealand and it is a common mistake to assume that by declaring your rental income in a tax return in the other country you don’t need to declare it in New Zealand. New Zealand taxes its residents on a worldwide income basis, which means that you should declare your overseas rental income in your New Zealand tax return if you are no longer a transitional resident. You can claim deductions for rental expenses such as loan interest, agent’s fees, repairs and maintenance, certain depreciation expenses, insurance and other running expenses. You can also claim a foreign tax credit for any tax correctly paid in the other jurisdiction.
Losses are real
Previously, if you generated a loss from your rental activities you were able to claim the loss as an offset against your other taxable income. Compared to some jurisdictions, that was a fairly generous position. However, as of 1 April 2019, this concession is no longer available and losses can only be utilised against other rental income. Any current year losses or unused losses brought forward from prior years are effectively now ring-fenced until future rental profit is generated.
Tax free allowances and exemptions
Some countries, such as the UK, allow an annual amount of tax free income and this means that you may not be required to pay tax in the other jurisdiction even if you file a tax return. However, the fact that your rental income may potentially be tax free in the other jurisdiction does not mean you can assume it is tax free in New Zealand. New Zealand does not have any tax-free threshold and does not have a nil tax rate band.
Capital Gains Tax
New Zealand does not impose capital taxes and in some cases other jurisdictions do not impose capital gains tax on non-residents. However, it is important to remember that this does not mean that capital taxes or capital type taxes cannot be imposed just because you now live in New Zealand.
For example, New Zealand imposes income tax on the profit arising from properties bought and sold within 5 years and this includes properties owned outside New Zealand. Whilst the UK generally does not impose capital gains tax on non-residents the disposal of residential property specifically remains subject to UK capital gains tax provisions for non-residents, following rule changes effective from 6 April 2015. The US typically imposes income and capital taxes on its citizens, regardless of wherever they reside in the world.
Many people don’t realise that when they pay interest on a loan related to an overseas rental property then the lender is deemed to receive interest that has a source in New Zealand. This is the case even if the loan is arranged outside New Zealand and interest payments are made from outside New Zealand. It is the payer of the interest that dictates the source, not the origin of the funds or the account from which the payment are made. Where a recipient of interest (the lender) is a non-resident of New Zealand then the payer (the borrower/property owner) must deduct Non-Resident Withholding Tax (NRWT) from any interest payments, and pay this tax over to the New Zealand Inland Revenue. Where the lender is resident in a country with which New Zealand has a double tax agreement the NRWT rate is 10%. However, most overseas lenders would not be happy receiving only 90% of their expected interest payment and therefore the borrower typically has to gross up their mortgage interest payment to account for the tax component. This means that a usual interest payment equivalent to NZ$100 now costs the borrower NZ$111, with NZ$11 going to the New Zealand Inland Revenue.
This cost can be mitigated somewhat by the borrower electing to become an “Approved Issuer” and accounting for Approved Issuer Levy (AIL) at 2% rather than withholding tax at 10%. Anyone required to account for NRWT or AIL must file additional periodic returns (monthly or six-monthly) to Inland Revenue to declare and pay over NRWT or AIL. Elections to become an Approved Issuer cannot be backdated so it is important that this is considered before the expiry of transitional residence status.
Foreign exchange gains (or losses)
In addition to the tax implications of mortgage interest, owners of overseas properties with foreign currency denominated loans can also be subject to New Zealand taxation on the value of their loans by reference to the New Zealand dollar equivalent. The “Financial Arrangement” regime seeks to tax realised and unreleased gains from loans, bank accounts, terms deposits etc. In many cases, individuals might only need to take account of this whenever a loan is repaid or if they depart New Zealand. However, depending on the amount of unrealised gain this may need to be accounted for on an annual basis.
As an example, let’s assume someone has an interest only loan of GBP100,000 on a property on the date they cease to be transitional resident. The equivalent value at that date in NZ dollars is NZ$197,000. Three years later they sell their UK property and repay the outstanding loan of GBP100,000. However, the equivalent value in NZ dollars at the date of sale is NZ$195,000. Under New Zealand tax law they have repaid NZ$2,000 less than they originally owed and therefore have taxable income of NZ$2,000 to declare in their New Zealand tax return in the tax year the sale occurs. This applies even though the loan has remained in GBP throughout. If the exchange rate swings the other way and they repay the equivalent of NZ$199,000 they have a loss of NZ$2,000.
(These provisions don’t apply to private or domestic arrangements, such as a mortgage on a private home, but the concession does not apply once the property is rented out).
Nothing can be said to be certain, except death and taxes
Few people realise that, despite having lived in New Zealand for many years, the value of their estate can still be subject to taxation in another jurisdiction when they die. For example, the UK typically reserves the right to subject UK based assets to UK Inheritance Tax. Whilst the nil rate band of GBP325,000 offers some exemption, the value of many properties will be well above this threshold. Furthermore, for British expats living in New Zealand continuing ties to the UK, including property ownership, can mean that the whole estate is subject to UK Inheritance Tax even if most of the assets are outside the UK.
Hide & Seek is getting harder to play
Whilst ignorance of the rules is no defence in taxation matters it is perhaps fully understandable that these more obscure issues are often missed, particularly by lay-people with less knowledge of the technical aspects of international taxation. However, with a greater flow of financial information between international revenue authorities (via banks and other financial institutions) it is safe to assume that overlooked obligations will be far more visible going forward and the hiding places will be far fewer.
As of the beginning of September, the New Zealand Inland Revenue issued its first wave of over 200 letters to taxpayers following the first significant exchange of information under the “Common Reporting Standards” multilateral agreement. The second exchange of information has also just completed and it is therefore likely that a further wave of “have you told us everything?” letters will be hitting mail boxes any time soon.
If you think these issues might be relevant to you, now is the time to get your house in order.
If you need help with your overseas rental property issues or broader personal tax obligations contact TaxBridge Limited for further information.
© TaxBridge Limited 2019
PO Box 100, Waikawa Bay, Picton, 7251
This publication contains generic information only and TaxBridge Limited is not providing any specific advice. TaxBridge Limited is not responsible for any loss sustained by anyone relying on the contents of this publication. TaxBridge Limited recommends that specific taxation advice is sought for all matters covered by this publication.