This article discusses the impact of rental losses on working for families tax credits claims, and how certain advisors and also IRD have impacted on some unfortunate taxpayers.
Over the last six months or so, I’ve spent a considerable amount of time trying to assist a couple (now separated) who have become caught up in a structure that has implications for Working for Families Tax Credits.
Broadly, the circumstances were as follows:
- two individuals commenced a relationship
- at the time they each had children, and each owned their own home financed by mortgage
- with the encouragement and advice of a mortgage broker and an accountant they
- sold their respective properties to each other and rented them out, and
- set up two mirror trusts to jointly acquire a new family home
- around a year later they acquired a third rental property between the two of them
- the properties were all highly geared, and the three rental properties each gave rise to tax losses
- those tax losses were taken into account in the calculation of Working for Families tax credits
I always advise my clients to not make decisions for tax reasons, but rather to make commercial and personal decisions and then run the tax ruler over them.
It strikes me that given their financial circumstances, it was pretty obvious they were significantly over geared, and this was not an appropriate investment portfolio or structure for them.
Nonetheless, in good faith they did rely on their advisors.
The Working for Families claims attracted IRD attention, which commenced in February 2007 and continues to this day.
In respect of the tax outcomes, under applicable legislation the validity of the claim depends on whether the rental activity comprises a business activity. A number of tax cases have addressed this aspect. The larger the size and frequency of the transactions, the more likely they are to comprise a business activity. The most recent case is in the TRA:
- Case reported at http://www.nzlii.org/cgi-bin/sinodisp/nz/cases/NZTRA/2012/2
- details published by IRD at http://www.ird.govt.nz/technical-tax/case-notes/2012/cn-20120907-rental-property-partnership.html
In respect of these particular taxpayers however:
- we consider that there is no business activity in relation to the ownership of three rental investments [which is significantly less than the five rental properties in the TRA case];
- at one point, IRD explicitly wrote to the taxpayers and advised them that the activities were not a business activity, and that the losses would be taken into account in the Working for Families claim.
We also note that the derivation of passive rental income is not regarded as a business activity for purposes of exempting land transactions from taxation. And it is clear that there needs to be a good degree of regular and positive activity before holding financial investments can be said to amount to the carrying on of a business activity.
The IRD investigation and correspondence has then continued for five more years, and has included
- a great deal of correspondence with the previous accountants, (who I would have to say have been distinctly unhelpful in this matter)
- contradictory IRD positions as to whether the activity is a business
- issuing an “agreed adjustment form” even though it is obvious that the taxpayers don’t agree (this is an abusive IRD technique with which I have taken issue on many occasions)
- declining to engage on our case analysis showing why these people are not in a business
- proceeding to a formal notice of proposed adjustment, to which the taxpayer had to respond by way of notice of response otherwise they lose their appeal rights
This is all in the context of taxpayers who are very constrained in their ability to pay for professional advice, and from whom IRD will not be able to recover anything anyway.
It also interesting to reflect on who has been involved in getting them into the situation:
The taxpayers’ initial contact was Kerry Buddle, who was a mortgage broker on the Kapiti Coast north of Wellington. A Google search on that individual reveals a colourful history including allegations of:
- persuading people to take out mortgages and lend the money to her for investment schemes from which nothing is ever recovered, see
- using goods and services but not paying, see
We understand that Ms Buddle may have taken relatively large fees for setting up people with these arrangements. Ms Buddle also introduced them to a Palmerston North accountant who we understand has introduced other clients to arrangements to maximise Working for Families Tax Credits – but on a larger scale than our clients, including the taxpayers in the above mentioned TRA case.
Would I put low income people into such a structure? No way! However having shelled out large fees to people to get them there, and at least in part relying on IRD’s statement that the structure was acceptable, it is extremely harsh for IRD to change its mind and pursue them in such a relentless manner.
We suspect that IRD is pursuing the unwitting taxpayers as a way to ‘get’ at the designers and promoters of the arrangement. However IRD seems oblivious to the fact that they are merely persecuting the victims and are not impacting the promoters at all.
The victims are not in a position to defend themselves – unless they can find and rely on people who are prepared to work at a heavily discounted rate. Regrettably, these people have become caught between people they trusted on one side, who turned to be unprofessional and unscrupulous, and the IRD on the other side.
IRD is insensitive to both the impact that bringing its unlimited resources to bear on these small taxpayers has and indifferent to the fact that they can neither pay anything to IRD nor easily afford to defend themselves.