Three categories of tax need to be considered in relation to housing: income tax, goods and services tax (GST), both of which are levied by central government, and rates, levied by local and regional government.
Income tax
Income tax applies to the housing sector in broadly the same way as it does to other sectors. Box 6.1 provides an overview of general principles underpinning the income tax system.
Box 6.1 Overview of the income tax system
Taxable income comprises returns to labour (salaries and wages) and capital (whether paid as interest or dividends, or retained profits). The net is cast wide to capture most ‘market income’; that is, the value that arises from economic exchange. In general, income is taxed in the hands of those to whom it accrues. Therefore, that part of a firm’s revenue that is paid as salaries and wages generally is taxed in the hands of its employees, and that part that is paid to providers of loan capital, as interest, is taxed in the hands of the lender. The taxable income of the firm is the residual profit, remaining after these and other costs incurred in generating the firm’s revenue have been deducted. Generally, the taxable income of a taxpayer is the combined amount from all sources, with losses from some activities able to be offset against positive income from others.
Two classes of economic income, however, generally fall outside the tax net.
First, the value that accrues to a taxpayer from using their own capital or labour, often referred to as imputed income, is not taxable. For example, the benefit from painting one’s own house (rather than employing a painter), or occupying one’s own house (rather than renting it out), is not regarded as taxable income.
Second, tax law and practice distinguish between transactions on ‘revenue account’ and those on ‘capital account’, depending on whether the transactions occur in the course of a trading activity. The former are tax assessable and the latter, generally, are not. This distinction can result in elements of economic value-add – economic income – not being subject to income tax. Examples include where a person builds or lives in their own house. Generally the value added – or capital gain – created in these ways is not taxed, even if the resulting asset is sold. The proceeds of the sale are considered to be on capital account, rather than revenue proceeds from ‘trading’. The
capital/revenue boundary is not precise, although there is a body of rules and official interpretations that cover most situations – for example, for determining when someone is and is not in the business of building houses. Essentially the same capital/revenue distinction carries over to the taxation of changes in the market value of already existing assets. Transactions on revenue account (trading) are assessable, those on capital account are not.
Another important distinction relates to when a tax obligation arises, as between when income is generated, or ‘accrues’, and when it is ‘realised’, that is, when it is converted into money. In general, salary and wage taxpayers are taxed on a realisation, or cash, basis. Businesses are generally taxed on an accruals basis, which means income is recognised when it is entitled to be invoiced and expenditure is recognised when it is incurred. Given the time value of money, income that is taxed long after it is arises is taxed lightly compared with that which is taxed at the time.
In the case of rental housing, rents received are assessable business income. To the extent that a rental house is financed by borrowing, interest is deductible for the landlord (and assessable for the lender). Similarly, expenses such as outlays on repairs and maintenance and for insurance are deductible for the landlord (and assessable in the hands of the recipient), leaving the residual profit to be taxed in the hands of the landlord.
For landlords, often the two largest items of expense are mortgage interest and depreciation. Where there is inflation and capital gains or losses, complexities arise in determining the appropriate amount to allow as deductions against gross rental income. As things stand, the full amount of interest paid, including that proportion that compensates the lender for the erosion by inflation of the loan amount, is allowed as a deduction. On the other hand, for buildings, allowances for depreciation and obsolescence were eliminated in 2010, on the basis of evidence that building values have been appreciating rather than depreciating. The tax treatment of owner-occupied houses differs from rental housing, in that the imputed income that owner-occupied houses deliver to their occupants is not taxed, whereas rental income is. This follows the general practice of taxing only income from market transactions, not the (imputed) income that people derive from using their own resources (capital or labour) for their own purposes. Hence, the imputed return on the equity that a home owner invests in their own house is not taxed.
One way of assigning a value to the return a home-owner gets from their home is to consider the
opportunity cost; that is, the return that could have been earned from an alternative investment. Another way is to base the value on the amount of rent that would have had to be paid if one did not own the house. In these ways one can put a value to the (untaxed) benefit, and hence on the tax value of that benefit.
An important qualification, however, is that an owner-occupied house that is entirely or partly debt-financed does not provide the same tax benefit. That portion of the return to the capital invested in a house that is financed by debt is taxed, in the hands of the lender. As things stand, it is only the equity-financed portion of owner-occupied housing that is tax preferred.
Income from building houses, as distinct from the return to the capital already invested in housing, generally is taxed, in the hands of building firms and of firms that supply building materials, for example. The exception is in the case of those who build, extend, or renovate, their own home. They can be thought of as generating imputed labour income, analogous to the imputed rental income that people benefit from when they live in their own house.
Changes in the market value of existing houses – ie, capital gains (and losses) – are generally not assessable (deductible), the main exception being if a taxpayer is deemed to have been ‘trading’ in houses. Those who are deemed to have been trading in houses are taxed no differently from other traders. However, the proportion of the turnover of existing houses that come within the scope of the tax definition of ‘trading’ is extremely small.
Overall, while income tax applies to housing in broadly the same way as to other sectors of the economy, there are some elements of a patchwork.
The imputed income from an owner’s equity in their own house is not taxed. This is consistent with the tax treatment of other forms of income from ‘own’ capital or ‘own’ labour, but creates an unlevel playing field between owner-occupied housing and rental housing, and other forms of ‘market’ investment, such as shares, bonds, bank deposits, and commercial property.
Capital gains/losses are not taxable/deductible unless they arise in the context of ‘trading’.
The full amount, including the inflation component, of interest payments is allowed as a deduction against rental income (though a proportion of that is a repayment of capital rather than expense). Deductions that allow for depreciation or obsolescence of rental houses have been removed. These aspects of the taxation of housing are discussed in section 6.4.
GST
GST, at a rate of 15%, is required to be paid by GST-registered businesses on their sales of new goods and services within New Zealand.56 This is invoiced to the buyer and, where the buyer itself is registered, the GST content of its own input costs can be claimed as a GST credit. The effect is a tax on the value added at each stage in the production chain, which is passed forward until it reaches the final ‘consumer’ (anyone who is not GST registered).
Housing is subject to GST in essentially the same way as for all other goods and services. Building firms and property developers are liable for GST when they sell a new house and/or section and can claim credits for the GST content of the inputs they use. In this way, GST is built into the price of new houses in the same way as it is built into the price of any other consumer good or service.
In one respect, however, the GST treatment of rental housing is unique. Generally, the renting, or hiring out, of goods is treated as a taxable supply. Hence, a hire firm is liable for GST on the rental it charges to its customer (which is passed on to the customer), and can claim GST credits for the GST content of its inputs. For example, a car rental company is required to charge GST on the rental it charges, and can claim a GST credit for the GST content of the price paid for its cars.
If the same approach applied to rental housing, landlords would be required57 to pay GST on the rents they charge their tenants, and would be eligible for GST credits in respect of the GST content of their input costs, including of the house. For rental housing, however, landlords are treated as if they were the final consumer. This does not mean that residential rents escape GST. While GST is not applied directly to rents, indirectly it is, as rents generally incorporate allowance for the GST landlords absorb.58
It may also appear that GST does not apply to the consumption of the accommodation services that owner- occupied houses provide to their owners. However, all new residential houses, whether rental or owner- occupied, are subject to GST on the purchase price when they are first sold, whether to a landlord or owner-occupier. GST can be viewed as an up-front payment, in present value terms, of the GST applicable to the flow of accommodation services that the house will provide over its economic life. In effect, GST on housing is paid as a lump sum at the outset, rather than over the economic life of the house. Section 6.5 considers the implications of this in the housing affordability context.
GST is levied only on new houses. But new houses and existing houses are substitutes, and the closer they are in vintage, the closer the substitutability. Owing to this substitutability, GST tends to become
incorporated over time into the market value of all houses.59 In effect, each successive owner of a house bears the proportion of the GST attributable to the services provided by the house during their tenure as owner. In this way, existing houses, as well as new houses, bear GST.
Local and regional government taxes (rates)
Rates are the principal source of revenue for territorial authorities and, as a compulsory levy against landholders, can be regarded as a tax.60 Rates are applied at a prescribed rate determined annually by the territorial authority, mostly on the basis of the assessed value of the real estate in question, and are simple
56 Registration is mandatory for those with turnover exceeding $60,000.
57 If their rental income exceeded $60,000; otherwise it would be open to the landlord to choose whether to be registered, or as is currently the case for
all residential landlords, to be unregistered.
58 To see the equivalence of the landlord or the tenant being regarded as the ‘final consumer’ in the case of residential rental dwellings, consider the
following example, based on a house worth $300,000 ex GST, a GST rate of 15%, and rent set to yield the landlord 5% pa. If the landlord is GST registered, then the cost to the landlord of the house is $300,000, rent is $15,000 pa, on which the GST would be $2,250. If instead, the landlord is not GST registered (ie, is regarded as the final consumer) then the cost of the house is $345,000, and to obtain a rental yield of 5%, the annual rent would need to be $17,250, of which $2,250 is attributable to the GST content of the house value.
59 Although if the colonial villa has been refurbished and renovated, its market value will tend to incorporate a GST element attributable to the GST
content of the cost of the refurbishment.
60 There may be a closer connection between ratepayers and the services provided by territorial government than those provided by central government,
to administer.61 They average about 0.6% of the capital value of residential real estate, although this varies amongst local authorities (OECD, 2011).
Rates can be expressed as the equivalent of a tax on the income (imputed or actual) from residential
property, by making some assumptions about the level of that income. There is a range of possibilities. One is to attribute income to houses on the basis of the return that could be earned from an alternative
investment; for example, a financial asset like a bank deposit. On that basis, and assuming a bank deposit rate of 5%, the rate of tax applied by territorial government, in income tax equivalent terms, can be estimated at about 12% (0.6/5.0 = 0.12).
That approach, however, may overstate the real economic returns to housing, and understate territorial government rates when expressed as a tax on that real income. Financial assets, like bank deposits, are fixed in money, and the interest paid generally includes a component to compensate for erosion of money by inflation. That is not the case for returns on ‘real’ assets, such as houses, whose values are not fixed in money and hence, on average tend to rise with inflation. Hence, where there is inflation, the returns achievable on ‘real’ assets, tend to be lower than the interest rates paid on financial assets, by the amount of the inflation compensation component of interest. On that basis, if the real rate of return on housing is, say, 3%, territorial government rates are equivalent to an income tax rate on real income of about 20% (0.6/3.0 = 0.2).62