Terry Baucher asks if the 'bright-line test' is an example of 'enact in haste, repent at leisure'

By Terry Baucher

“We do not believe that the introduction of a bright-line test for residential land is sound tax policy.”

That was the Chartered Accountants Australia and New Zealand’s (“CAANZ”) opening sentence in their submission  to Parliament’s Finance and Expenditure Committee regarding the Taxation (Bright-line Test for Residential Land) Bill (“the Bright-line Bill”). 

The introduction of the bright-line test was one of the bigger surprises in this year’s Budget. At first sight it would appear to be a welcome move, given the IRD’s Policy Advice Division advised the Tax Working Group in 2009 that the tax treatment of capital gains is “inconsistent… lacks an overall coherence and creates uncertainty”. The speculative behaviour the bright-line test seeks to address is a reflection of this overall incoherence and uncertainty. 

The Bright-line Bill’s objectives were set out in paragraph 13 of the accompanying Regulatory Impact Statement as being:

  1. Provide an easier rule for Inland Revenue to enforce to target short-term speculation in residential property;
  2. Minimise the number of sales made taxable that were acquired without an intention of resale;
  3. Minimise compliance costs for taxpayers in complying with the bright-line test.

These seem laudable objectives, so, I was surprised to see the level of opposition to the measure from CAANZ, the New Zealand Law Society (“the NZLS”) and several of the major accounting and law firms.  

The NZLS questioned why the bright-line test was needed at all given that the burden of proof falls on the taxpayer. CAANZ suggested there was a “high risk that the overall package of reforms will lack the coherence that it requires and will not provide taxpayers with an appropriate degree of certainty”. 

Critics questioned whether it would raise any significant revenue (the Regulatory Impact Statement estimated it would raise an additional $5 million per annum).  

A critical part of the proposal is when the two year period starts and finishes. The Bright-line Bill proposes the two year period should start on the date of registration of title rather than the date of entry into a sale and purchase agreement. Submitters were particularly critical of this because it differs from the general definition used for the purposes of the land provisions in the Income Tax Act 2007.

Despite the fierce criticism (one submitter called the Inland Revenue’s arguments supporting this change “fallacious”), the new date of purchase definition was left unchanged. An exception has been made for purchases “off the plan” to allow the period between entering into an agreement to purchase the land and the date of registration to be included for the purposes of the two year period.  An exception to what is already an exception is a tailor-made recipe for confusion.

The NZLS and other submitters noted that speculators targeted by the Bright-line Bill would probably change their behaviour to ensure land is held for the two year period. Consequently, those most likely to be taxed under the Bright-line Bill would not be speculators but selling because of a change in their circumstances such as financial hardship, mortgagee sale or insolvency. Submissions suggesting exceptions for such circumstances were dismissed.

Submitters also raised concerns around the “main home’ exemption, particularly for such properties owned by trust. There was near universal opposition to the “ring-fencing” of losses arising from sales solely due to the bright-line test. Such losses can only be offset against income from sales made under other land provisions.  

The overall conclusion is that the Bright-line Bill is not likely to meet its objectives, especially that of minimising compliance costs. It’s not likely to raise much additional revenue either.

Many of the problems with the Bright-line Bill stem from its sudden introduction outside the usual Generic Tax Policy Process. Normally, proposed changes to tax legislation are signalled well in advance. The proposals are then worked through a consultation process usually lasting between 12 and 18 months before the relevant legislation is introduced.  

By contrast, the haste with which the bright-line test is being implemented is illustrated by the following timeline:

14th May Initial announcement of proposed bright-line test
29th June Issues paper on the bright-line test released
24th July Closing date for submissions on issues paper
24th August Taxation (Bright-line Test for Residential Land) Bill introduced into Parliament
9th September Call for submissions on Bill
17th September Closing date for submissions on Bill
1st October Bright-line test comes into effect
20th October Bill reported back to Parliament
4th November Bill passes its second reading

The last piece of major tax reform crashed through outside the Generic Tax Policy Process was the abolition of loss attributing qualifying companies and introduction of look-through companies. It’s not a happy precedent. The qualifying company changes resulted in considerable and ongoing complexity, which a recent issues paper hopes to resolve. (The NZLS’s view: “The Issues Paper proposes to resolve perceived complexity by creating more rules and exceptions.”)

What is troubling is that major technical issues identified by CAANZ, the NZLS and others during the truncated consultation process have not been properly addressed. In particular the decision to introduce a separate definition of the date of acquisition of land for the bright-line test from that used for other land transactions seems set to cause endless confusion.

Consequently, the concern is that far from creating “an easy to enforce rule”, the bright-line test will further complicate an already incoherent situation and fail in its objective of targeting property speculators.

Good tax policy would take steps to remove inconsistency and improve coherence. The bright-line test does the opposite, all for the sake of maybe $5 million additional tax revenue.  

Ultimately the bright-line test is an example of politics in the form of being seen to do something trumping good tax policy. Whenever this happens it’s invariably only to the benefit of tax advisers earning fees as they pick a path through the resulting morass of poor legislation. 

This was what the Generic Tax Policy Process was designed to avoid and it would be wise if governments kept that in mind when introducing tax legislation. Otherwise we will end up with more legislation “full of sound and fury, signifying nothing.”


*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »