With New Zealand’s residential investment tax scene in a state of hibernation until we see a change in government, you might be wondering about the challenges of investing overseas in places like Australia or the UK.
First up, the bad news is that the Brightline rules do apply to overseas residential rental property. That said, the good news is that interest on loans used for overseas properties remains tax deductible. This is the case whether the loan is borrowed in NZ$ against other security in New Zealand, or borrowed in foreign currency and secured by the foreign property itself.
However, if you fund a New Zealand property with foreign debt, it doesn’t result in an interest deduction here.
So, what about the historical issues with buying overseas residential rental property?
As a New Zealand tax resident, you’re required to declare your worldwide income in New Zealand, which includes any income from foreign rental properties. Identifying and taxing foreign income has actually been an area of focus for the IRD in recent years. The IRD use information shared by foreign banks to identify New Zealanders with interests abroad, and use rating information to identify Kiwis with foreign properties.
Despite this income being assessable in New Zealand, you’ll generally also have a filing obligation in the country you’ve invested in, because the income is generated there. If there is tax payable on this income overseas, the New Zealand authorities give credit for this up to the level of your effective tax rate in New Zealand. This means, for example, that if you paid 20% tax overseas and are on a 33% tax rate in New Zealand, you’ll top the tax up by 13% in New Zealand. However, if you’ve paid 40% tax overseas, you only get credit for the 33% equivalent here.
Some countries, including Australia, have different balance dates than New Zealand. You can generally ignore this by electing to return the foreign sourced income in the same New Zealand tax year (under section EG1).
Rules around what can and can’t be claimed differ country to country, so adjustments may be needed to overseas financial statements. These can then be converted and adjusted for New Zealand based rules.
You should also remember that foreign financial statements will be denominated in the foreign currency, but must be reported in New Zealand dollars here, so you’ll need to adjust them accordingly.
IRD publishes monthly conversion rates, so if you’re spread-sheeting your income and expenses you can complete this foreign currency conversion month by month.
Right, that’s the easy stuff. Now, the hard part… dealing with foreign denominated bank loans.
These essentially introduce a wild card into your tax affairs. This is because the gains and losses caused by movements in exchange rates, when applied to your foreign debt, are taxable in New Zealand under the financial arrangement rules.
Let’s consider an example.
Joe has a mortgage in Australia for AUD$700,000, which he used to buy an apartment on the Gold Coast. When he borrowed it, the conversion rate to NZD was 90 cents. This meant that the debt in New Zealand dollars was $777,777.
However, by balance date the NZD had strengthened against the Aussie to 95 cents. So, his Australian loan now only requires NZ$736,842 to repay it – representing an on-paper gain of NZ$40,934. This gain is taxable in New Zealand, potentially on an unrealised basis year on year. Deductions are also available if the exchange rate goes the other way.
While the tax bill hurts, if New Zealand income is being used to pay down an Australian debt a strengthening New Zealand dollar is ultimately what you want.
It doesn’t end there with foreign debt. When interest is paid on foreign loans, New Zealand does not get to tax the profit the foreign bank makes out of you. This leads us to the Non-Resident Withholding Tax (NRWT) regime, which requires tax to be withheld from interest payments to foreign banks at a rate of 10%. This essentially creates a sharing of the tax take between the country with the property owner and the country with the bank.
An alternative to the NRWT system exists because many foreign lenders will simply not accept anything other than the full interest payment each month. This system is known as ‘approved issuer levy’, which you can apply for through IRD. It means you pay a 2% levy on the interest you’re paying overseas and, in effect, opt out of the requirement to deduct NRWT. Be warned though, you must set this up at the outset, as IRD will not grant it if there are arrears of NRWT outstanding.
To make NRWT even more confusing, some foreign banks are exempt from it due to banking licenses in New Zealand. This is because they operate in New Zealand through fixed branch establishments. It’s a distinct advantage to deal with a bank that has an NRWT exemption, so some due diligence on the lender you choose is advisable on this point.
Another thing to watch is local taxes.
In Australia they have stamp duties on land purchases and these are particularly high for non-resident buyers.
While New Zealand doesn’t have a capital gains tax (although the 10-year Brightline feels a bit like one!), many other countries do – including Australia and the UK. You will be expected to comply with this local tax obligation in those countries.
New Zealand’s residential loss ringfencing rules also continue to apply to losses from overseas rental properties.
One final point. If you’ve moved to New Zealand from overseas or you’re a Kiwi who has been abroad for 10 years or more, any overseas rental property you own is generally exempt from having to be declared as foreign income for four years. This grace period is designed to allow you time to rearrange your affairs as you see fit. After this period, you’ll need to declare and comply with the tax rules on your worldwide income.
Ultimately, our advice is to always seek specialist tax advice both in New Zealand and in the country you’re planning to invest in before buying abroad.