Interest Deductibility for Non Residents

Posted on Wednesday, September 25 2013

Investing In N.Z Property As Non Residents

 

Summary:

• The Thin Cap rules apply to non-resident individuals, trusts and companies with non-resident shareholders
• The Thin Cap rules limit the deductible interest that may be claimed if the debt percentage is more than 60% of the property cost or value
• The Thin Cap rules should be considered if:
o you have rental property in NZ and you are looking to relocate overseas
o you are a non-resident looking to purchase property in NZ

Thin Capitalisation Rules (“Thin Cap Rules”)

If you’re based overseas and have an investment property in NZ, then you need to be aware of the Thin Cap rules. These are not new rules, just rules not widely known. The purpose of the Thin Cap rules is to set a limit on the level of debt funding that an overseas resident can have on an investment property situated in NZ.

The Thin Cap rules apply to a non-resident individual or trust and to a NZ company whose shares are owned 50% or more by non-residents. We see the Thin Cap rules applying to three groups of clients that we regularly deal with:

• Individuals living overseas (such as Australia, the UK or any other country) that purchase an investment property in NZ
• Individuals that own property in NZ and decide to move overseas and rent out their property in NZ
• Companies that own property in NZ where the shareholders decide to relocate overseas

From 1 April 2011, the debt percentage threshold under the Thin Cap Rules has been set at 60%. The debt percentage is the total debt (excluding non-interest bearing debt such as shareholder loans) divided by the either the value of the assets shown in the financial statements or the market value of those assets (your choice) on the first day of the relevant tax year.

In simple terms, that means that a non-resident can only claim interest on their loans up to 60% of the property cost or market value.

Let’s look at a few examples:

Example 1:

An Australian resident purchases a NZ investment property for $200,000. They put $40,000 of their own cash into the purchase and borrow the remaining $160,000 from the bank at a 7% interest rate. The debt percentage is 80% ($160,000 / $200,000).

Total Interest Paid $11,200 ($160,000 x 7%)

Interest Limited To $8,400 ($200,000 x 60% x 7%)

Under this example, the deductible interest has been reduced by $2,800 due to the debt percentage being more than the 60% threshold.

Example 2:

A NZ company purchases a NZ investment property for $200,000. The shareholders put in $20,000 of their own cash into the purchase and borrow the remaining $180,000 from the bank at a 7% interest rate. The debt percentage is 90% ($180,000 / $200,000). After two years, the property value is still $200,000. The shareholders move to the UK at this time.

Total Interest Paid $12,600 ($180,000 x 7%)

Interest Limited To $8,400 ($200,000 x 60% x 7%)

Under this example, the deductible interest has been reduced by $4,200 due to the debt percentage being more than the 60% threshold.

Example 3:

Following on from the figures in example 2, in the next year the property value has increased to $240,000. The debt percentage is now 75% ($180,000 / $240,000).

Total Interest Paid $12,600 ($180,000 x 7%)

Interest Limited To $10,080 ($240,000 x 60% x 7%)

Under this example, the deductible interest has only been reduced by $2,520 due to the debt percentage decreasing as the property value increased.

Conclusion

The Thin Cap rules may not be a large concern to those non-residents that have properties with a low rental yield as the property may still make a tax loss even if the interest is limited.

Those that should be more concerned are non-residents that have properties with a high rental yield as the property may make profit that is subject to NZ income tax without actually making a cash profit.

If this is the case, then you need to get regular market valuations for your NZ properties so that the increased value will result in increased deductible interest.

Tony Thorne
www.ThorneAccounting.co.nz
Auckland Accountants Thorne Accounting

 

 

 

 

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Expert's Bio

Tony Thorne

Thorne Accounting has been providing specialised accounting and tax services to residential and commercial property investors since 2004. Our mission is to provide the highest quality tax and accounting services to property investors. We are constantly fine tuning the way we work with property investors so we can provide this superior service at competitive prices.

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