Land-related lease payments
Clauses 8, 9, 53, 56 and 123
Issue: Support for aspects of the reform
Submissions
(Corporate Taxpayers Group, Ernst & Young, KPMG, New Zealand Institute of Chartered Accountants, New Zealand Law Society)
We generally welcome the narrower/targeted focus of the rules aimed at taxing payments to transfer a lease paid in substitution for taxable lease premiums and lease surrender payments, rather than the original proposed broad reform which would have treated all land-related lease payments as being on revenue account. (Corporate Taxpayers Group, Ernst & Young, KPMG, New Zealand Law Society)
We support the amendment treating consecutive leases as a single lease for depreciation purposes. (New Zealand Institute of Chartered Accountants)
The amendment to clarify that retirement villages’ occupation rights should be excepted financial arrangements to align their treatment with leases of land under the financial arrangement rules, is supported. (New Zealand Institute of Chartered Accountants)
Comment
Officials welcome this support and note that it illustrates the benefits of the generic tax policy process.
Recommendation
That the submissions be noted.
Issue: Glasgow-type leases are akin to freehold estates
Submission
(Parininihi ki Waitotara Incorporation, West Coast Settlement Reserve Lessees Association (Inc))
Payments made in respect of Glasgow-type leases (with the usual term of 7, 12 or 21 years), which are renewable in perpetuity, should not be taxable to the recipient, and deductible to the payer. The reason is that Glasgow-type leases are more akin to freehold estates, and are different from ordinary commercial leases with a defined term. The payments for Glasgow-type leases can include a payment made on the transfer of a lease or on the surrender of the lease. The fact that the payments can occur between associated parties, for commercial reasons, should not change the non-taxable and non-deductible nature of the payments.
Therefore, the transfer of Glasgow leases should be excluded from the ambit of proposed new section CC 1B. The lease surrender provisions in section CC 1C should also be amended to exclude payments for the surrender of Glasgow leases.
Comment
Officials agree with the position that Glasgow leases are more akin to freehold estates because, in principle, the tenant has the right to use the land in perpetuity.
Officials recommend that proposed section CC 1B of the bill, and section CC 1C of the Income Tax Act 2007, be amended to exclude payments made for the transfer or surrender of Glasgow leases. The amendment to section CC 1C should apply from the commencement of that section.
Recommendation
That the submission be accepted.
Issue: Glasgow-type leases should be depreciable property
Submission
(New Zealand Institute of Chartered Accountants)
Glasgow leases should remain depreciable property. Glasgow lease payments are made for a fixed period and at the end of this period, if the lease is not renewed, the lessee’s rights are extinguished. A Glasgow lease is not like freehold land and an interest in such a lease should continue to be depreciable. This would ensure symmetry of tax treatment, and the recipient remains taxable on the payments under section CC 1.
The definition of “fixed-life intangible property” should also be amended to include Glasgow leases in order for a deduction to be spread over the initial lease term.
Comment
Officials consider that Glasgow leases are more akin to freehold estates because, in principle, the tenant has the right to use the land in perpetuity. Therefore, it is the correct policy that these leases are not depreciable property.
A tenant under a Glasgow lease may not claim depreciation deductions during the term of the lease (for premiums paid on the grant of the lease) because this type of lease has a perpetually renewable lease period. The tenant may be able to claim a depreciation loss when the perpetually renewable lease is sold for less that its adjusted tax value if the lease meets the definition of “depreciable property” in section EE 6 of the Income Tax Act 2007 – that is, in normal circumstances, the lease might reasonably be expected to decline in value. Officials consider it is likely that Glasgow leases are not depreciable under the current law.
Officials therefore consider that this amendment only clarifies the existing position.
Recommendation
That the submission be declined.
Issue: Application date of Glasgow lease amendment
Submission
(KPMG, New Zealand Institute of Chartered Accountants)
The amendment would capture Glasgow leases that have been in effect for many years. These leases would have been negotiated on the basis of lease premiums paid being depreciable property, and the deduction arising on termination/transfer of the lease. These decisions should not be affected by these changes. The proposed amendment should only apply to Glasgow leases entered into on or after 1 April 2015. (KPMG)
The amendment to section EE 7, which will apply from 1 April 2015, will change the tax treatment of a number of Glasgow leases part-way through the lease term. This will create uncertainty for taxpayers and involve some element of retrospectivity which is not justified. The proposed amendment should not apply to existing leases which were negotiated on the basis of the tax treatment in force at the time the leases were entered into. (New Zealand Institute of Chartered Accountants)
Comment
The amendment excluding Glasgow leases from being depreciable property currently has an application date of 1 April 2015. This is consistent with the application dates for all other land-related lease payments amendments in the bill. As noted above, it is likely that Glasgow leases are not depreciable under the current law. Given that the amendment is of a clarifying nature only, officials consider that the application date of 1 April 2015 is appropriate.
Recommendation
That the submission be declined.
Issue: Premium paid on grant of Glasgow leases
Submission
(Corporate Taxpayers Group, KPMG, New Zealand Law Society, Russell McVeagh)
Treatment of payments for perpetually renewable leases should be consistent for payer and recipient. Payments to landowners for the grant of a perpetually renewable lease should be excluded from section CC 1, so that the treatment for the landlord and the tenant is consistent. Otherwise the effect of the proposal would be to treat a perpetually renewable leasehold interest as akin to a freehold interest to the lessee (such that the lessee would have no deduction for the expenditure) but like any other leasehold interest for the landowner (such that the landowner would be taxed on the receipt). This would be inconsistent from a policy perspective, and contrary to symmetrical tax treatments, which have been a significant driver on recently enacted and currently proposed reforms to the tax treatment of lease-related payments.
Comment
There is no universal principle of tax symmetry in the income tax system. Tax asymmetry is inherent and inevitable in a system that distinguishes between capital and revenue items. For example, lease transfer payments are generally non-taxable to the recipient but depreciable to the payer.
Lease premiums paid on the grant of a Glasgow lease should continue to be taxable to the owner of the land under section CC 1, which has been the tax treatment since 1915.
Recommendation
That the submission be declined.
Issue: Lease transfer payments amendment is not necessary
Submission
(KPMG)
In practice, in commercial settings, payments to assign commercial leases will have different drivers to lease premiums and lease surrender payments. These payments are therefore unlikely to be substitutable, without some degree of artificiality and a high degree of structuring. This also introduces additional legislative complexity. (KPMG)
Comment
Officials note that during extensive consultation on the examples of certain lease transfer payments being substitutable for taxable lease surrender payments and lease premiums, the validity of these examples was not disputed. Officials consider the examples remain valid and that there is a risk to the tax base if such lease transfer payments are not made taxable.
Recommendation
That the submission be declined.
Issue: Drafting of the lease transfer payments provision
Submission
(New Zealand Institute of Chartered Accountants)
Drafting of new section CC 1B(3) requires improvement as it uses double negatives which make the provision difficult to understand.
Comment
Officials have considered the points raised in the submission, but have decided that the current drafting is sufficiently clear. Re-drafting of the provision so that the current exceptions in section CC 1B(3) are included in the opening subsection would make the drafting significantly more complex.
Recommendation
That the submission be declined.
Issue: Scope of lease transfer payments amendment
Submission
(Corporate Taxpayers Group, Russell McVeagh)
If a landlord, as part of a broader commercial relationship, provides funds to a new tenant, part of which is to be applied in an arm’s-length transaction for a lease transfer payment, this should not be taxable. Any transfer payment in this case is not a substitute for a lease premium or lease termination payment paid to or by a landlord. So the tax treatment should not be dependent on the source of the lease transfer payment funds, and section CC 1B(3)(c) should be more appropriately targeted. (Corporate Taxpayers Group)
Proposed section CC 1B(3)(c) could result in lease transfer payments being taxable to the outgoing tenant who may have no knowledge or control over the arrangement. For example, if the landlord makes a loan to the incoming tenant to enable the new tenant to purchase the outgoing tenant’s business (including the lease), the lease transfer payment made by the incoming tenant as part of the business sale would be taxable. By contrast, if the incoming tenant borrowed from a bank rather than from the landlord, the lease transfer payment would not be taxable. (Russell McVeagh)
Comment
Officials agree that the scope of section CC 1B(3)(c), which taxes payments sourced directly or indirectly from funds provided by the landlord, is too wide. Officials agree that situations involving an arm’s-length transaction between the landlord and the incoming tenant should not be caught, and the provision should be amended accordingly.
Recommendation
That the submission be accepted, subject to officials’ comments.
Issue: Aligning section DB 20B with new section CC 1B
Submissions
(New Zealand Institute of Chartered Accountants, New Zealand Law Society)
Current section DB 20B provides a deduction for the existing section CC 1B where the payer is the person who owns the land right, the estate from which the land right is granted and the payment is to the person who is obtaining the land right. New section CC 1B(1) will apply if there is a transfer of the land right from the holder of the land right to another person. This should be clarified to ensure that the person who pays the amount is entitled to a deduction. Section DB 20B requires a corresponding amendment to provide a matching deduction. (New Zealand Institute of Chartered Accountants)
As currently drafted, proposed section CC 1B may cause mismatches between the income and deductibility treatment of some lease inducement payments. The bill should harmonise the income and deductibility treatment of lease inducement payments for the transfer of land rights. This could be done by amending the criteria in section DB 20B to reflect more closely the exemption criteria in proposed new section CC 1B. (New Zealand Law Society)
Comment
Officials consider it is not necessary to expand the deductibility criteria in section DB 20B(1)(a) to refer to payments for the transfer of land rights from the holder of the land to another person. This is because the transferee of the land right (the incoming tenant) would receive a deduction for the payment under the depreciation rules, being a payment for the right to use land under schedule 14 of the Income Tax Act 2007.
Officials consider that a deduction would not be denied to the owner of the land in a case where the owner uses an agent to make a lease inducement payment to the prospective tenant. This is because section YB 21 of the Income Tax Act 2007 treats anything done by a nominee of a person as being done by that person. Therefore, the owner of the land would still be treated as the payer under section DB 20B(1)(b), and be entitled to a deduction.
Recommendation
That the submissions be declined.
Issue: Residential premises exemption needs amendment
Submissions
(Ernst & Young)
Section CC 1B should be amended to remove the “natural person” requirement from the section CC 1B(4)(a) residential premises exemption. If necessary, the reference in that provision to residential premises should be amended to ensure the exclusion relates to premises in the nature of dwellings occupied, intended or available for occupation by individuals as residencies.
Transfers of shares in cross-leased properties could fall within the proposed provisions. A large number of cross-leased family units may be owned as family trusts, the executors or trustees of deceased estates, or companies that may or may not be charging rentals. Transfers of such properties to associates may occur.
There is no reason why the structural nature of an owner of any such residential premises should be critical in determining whether amounts derived or deemed (when subparts FB or FC apply) for their assignment or transfer would be taxable. If expenditure on acquiring such leased or licensed residential premises would not meet the general permission criteria for deductibility for the transferor, application of the proposed section CC 1B should be excluded, regardless of the nature of the transferor.
Comment
Officials consider that the current “natural person” requirement in the exception for residential situations is necessary to maintain the integrity of this exception. The “natural person” requirement in new section CC 1B is consistent with the residential exceptions in current sections CC 1B and CC 1C.
The submission refers to transfers of residential property by the executors or trustees of deceased estates. Such transfers do not involve the payment of consideration and would therefore be outside the ambit of section CC 1B(1), which requires a transfer in exchange for the payment of an amount of consideration.
Recommendation
That the submission be declined.
Issue: Wash-up of deductions if the lease is terminated early
Submission
(KPMG)
This issue is in relation to section EI 4B, enacted by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013. Section EI 4B allows spreading of income and deductions for the lease inducement payment over the term of the relevant lease. An exception to this is when a person ceases to hold the lease or land from which the lease is granted, before the end of the lease term. However, section EI 4B(5) does not provide a wash-up of deductions for landlords if a lease is terminated early (for example, for reasons of insolvency); the landlord is still required to spread deductions over the original term of the lease. This outcome is inconsistent with the policy rationale for having the wash-up mechanism. For consistency, a wash-up mechanism for lease inducement deductions for landlords (that is, lessors and sub-lessors) should be provided in section EI 4B(5).
Comment
Officials agree it would be consistent with the policy of the wash-up provision in section EI 4B(5) to allow a landlord to receive the balance of deductions for a lease inducement payment, if the lease is terminated early. This would be consistent with the treatment of a lessee who is taxed on the balance of income from a lease inducement payment if the lease is terminated early.
Recommendation
That the submission be accepted.
Issue: Permanent easement exclusion
Submission
(Matter raised by officials)
Comment
Clause 8 of the bill excludes all payments for permanent easements from being taxable to landowners. It should be clarified that the exclusion does not apply to ongoing periodical payments for a permanent easement, as such payments should be on revenue account.
Recommendation
That the submission be accepted.