Housing tax changes a threat to SMEs
BY NICK SMITH
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The backbone of the New Zealand economy the small to medium-sized enterprise (SME) sector dodged a potentially crippling bullet when Prime Minister John Key ruled out a land tax.
But the sector is not out of the woods yet. Tax changes around housing expected in the May Budget could still severely affect the ability of smaller firms to access funding.
The reason a land tax posed such a threat to SMEs was because most of these companies get some or even all of their credit by means of mortgages held against personal property.
A land tax, which could have reduced the value of property by 16 to 26 per cent, depending on the calculation, would have wrecked the debt-to-equity ratio of many highly leveraged businesses.
As KPMG tax partner John Cantin says: "It is a double whammy. It affects their ability to finance their business and the wealth that they have outside the business.''
Bank credit, adds James Mitchell, ASB relationship banking chief executive, is increasingly unavailable and more expensive. Banks are running the ruler over SME balance sheets and, in some instances, asking owners to reduce debt.
Reserve Bank figures show businesses are responding to bankers' demands, but such efforts will be in vain if a company's primary asset is going down in value.
It is easy to imagine a scenario where a leveraged medium-sized firm, faced with falling house prices, breaches its banking covenant, triggering a forced sale, then a receivership or liquidation.
This impact was not publicly raised by the Tax Working Group, says Paul Dunne, a member of the group and a KPMG tax partner. He notes that any impact on land values would be a one-off and might even reduce property price volatility.
Instead, a de-facto exemption to agriculture, because of its importance to the economy, was raised.
But the small business sector is just as important. It is the major employer of New Zealanders and bears the lion's share of job creation, a critical function in a time of relatively high unemployment.
Four out of 10 Kiwis are employed by SMEs, which also produce 60 per cent of new jobs.
In the end, the Government decided to forgo a land tax in favour of a rise in GST as a way to claw back the estimated $1.6 billion in lost revenue from reducing top personal tax rates.
But whatever reforms the Government unveils in May will still weigh heavily on house prices, Westpac economists Brendan O'Donovan and Michael Gordon suggest.
Key ruled out new measures aimed at property, such as taxes on land, capital gains or a deemed rate-of-return mechanism.
But depreciation allowances on buildings remembering that some small companies are at-home operations are likely to go, and ring-fencing investment property losses seem certain.
O'Donovan and Gordon have done a lot of work around how tax policy affects house prices, but given the uncertainty around what the Government will do, "the combined effect on housing is difficult to untangle''.
Even so, there will be downward pressure as beneficial tax losses are constrained, they say.
"Ring-fencing and depreciation largely have an impact through the timing of cashflows,'' O'Donovan and Gordon say of the impact on property investors. Needless to say, those same cashflow issues will harm small businesses.
As the pair note: "Applying either of these changes would fall hardest on cash-poor investors''.
No-one knows what percentage of household mortgages is used for small-business purposes, but anecdotal evidence suggests that SME reliance on personal property credit is high. It is likely that many businesses will fall into the highly leveraged mortgage space.
O'Donovan and Gordon say it is ironic that changes to the tax code will succeed in reining in the housing sector, something for which it was not designed, when all the efforts of monetary policy were in vain during the boom middle years of the decade.
Of course, a rise in GST could, by increasing the cost of construction and thus discouraging new building, put a floor under house prices, as net migration gains will create demand.
But increasing GST will also add to inflation pressures, potentially accelerating the Reserve Bank's eventual tightening of monetary policy. This scenario, too, will add pressure to SMEs reliant on mortgage credit.
As the Westpac economists note, GST applies to more than 90 per cent of the inputs to the consumer price index, the measure of inflation, and could be expected to add 2 per cent to the headline rate.
It is going to be a hard year for the small business sector
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Nick no arguement about banks fascination with houses as security. There are two real issues
1. Guess which party is most exposed if property prices fall to long trem average of 3-4 times avg income (and it aint the mortgagee)
2. If banks concentrated on the efficacy of the business itself instead of blindly accepting "property security" then you might have less dumb businesses getting funds. That would mean of course bankers would have to start actively thinking about lending policies and the businesses they fund instead of having them mandated from oz HO on spurious ratios.
I say we had an excellent chance of realigning our tax system away from the current lunancy, instead we will end up with some ineffective tinkering from a government who's primary focus is getting re-elected next year.
@@@#### damn
My SME was an importer/distributor. We had several hundred customers - the debtors ledger averaged about $600k and the average age of debt was about 45 days. We had to pay for and hold about 4-6 weeks of stock. There were about 8 staff, we had been trading several years and the business had always been comfortably in the black. If that's not a "good" business I don't know what is. The debtors and stock comfortably exceeded the amount of working capital required.
But the bank had to have the house ......
Both Darth and Remove... ignore the fact that before a SME gets to be "good" it is new and the banks just do not want to lend anything unless their money is secured against your property. (So that's where we got that idea). Couple to this handicap the perception that any slight procedural incongruity in staff matters could see the employer forking out thousands in fees and costs, regardless of the rights or wrongs of it, and it is easy to see why ordinary people take a lot of persuasion before they will try to turn an idea into a business venture.
I think you need to readjust your definition of sme. I work closely with a lot of sme's. Not many of the good ones - especially those employing any number of people depend on their homes as security. Good businesses are funded by a combination of earnings, careful management of costs and external equity investment.
Now imagine if the money that is currently wasted on unproductive rental properties was put into some of these businesses? Or what about putting some of that wasted money into basic business and investment education?
@ Clunking Fist #2
Fair call. I meant to say "property speculators".
Some property developers are very productive members of our economy. But, more than a few just build cheap crap (spot the leaky homes) and sit back waiting for the "value" of their assets to grow in the speculative bubble while the productive members of society maintain the mortgage for them while the developers holidays in Bali.
There are no free lunches. Gummint needs more money to fill the hole left by the amount they are printing/borrowing right now. We all more or less agree (I think) that this borrowing etc is a good idea, given the alternative in this global economic crisis.
We are the only country in the OECD without a simple and comprehensive capital gains tax. We know better it seems than socialist countries like the US and Canada who have had one forever. A buck is a buck is a buck.
I used to own an SME with about 8 staff. Bad debts were something like 1% of sales, the inventory turned over every 2-3 months and the whole thing was very profitable. The bank was willing to lend me 25% of the debtors and nothing (!) on the inventory. They wanted the house.
Realistically, if this housing value slump happens (and it's only someone's best guess that it might) the banks supporting SMEs with house-secured finance will adjust their criteria and collectively pretend that their loans are all good. That's about where the farming sector is right now. The alternative would be to wind up the business, probably lose money and precipitate more of the same.
If the SME is able to service its debt, the bank will studiously ignore possible value problems. That's more or less what happens to negative equity people at present. In the long run if the business is unable to service its debts, it will fold.
So I just don't see why capital appreciation has to be tax-free. It's not fair. We - like the rest of the world - will cope if it happens.
"Property developers build homes, warehouses factories and office. How is that nothing?"
Depends on where the money came from to build these things Chuck and what perception they are being built on. If the money was borrowed from oversesa thus becoming debt then its 'less' than nothing. Infact commercial property is in a huge slump at the moment. If having a "productive" economy was 'only' about 'building stuff' then why has the economy faultered? A little more complex than your argument
Darth Michael: "Take a quick look at New Zealand's rich-list. It's packed with property-developers who produce NOTHING while ignoring the productive economy." ? Property developers build homes, warehouses factories and office. How is that nothing?
"The land tax is necessary because, while land is tax-free and everything else is taxed, New Zealand's economy is distorted to the point of absurdity." Land is not tax-free: it is subject to GST. When you buy a new home & section from a property developer, he gives one-ninth of that money to the IRD in the form of GST.
I am passionately opposed to the taxation of owner-occupied dwellings/land. A man's (or woman's) home is his castle.
That said, I have NO sympathy for those parasites who have become millionaires due entirely to the speculative economy that artificially inflates housing prices - and the wealth of property developers - while squeezing more and more young New Zealanders out of the possibility of buying their own home.
Take a quick look at New Zealand's rich-list. It's packed with property-developers who produce NOTHING while ignoring the productive economy. This cannot be good for New Zealand's economy.
The land tax is necessary because, while land is tax-free and everything else is taxed, New Zealand's economy is distorted to the point of absurdity. That distortion has created gross economic injustices for home-buyers, especially among poorer New Zealanders.
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Justice @ #3 Thanks for putting words in my mouth. Sure, in an unbalanced economy, too much building is a poor investment.
Mate, nearly ALL money borrowed in NZ comes from overseas: NZers are NOT saving $240million a week to help fund the gummint's deficit. Nor to fund the purchase of homes, nor fund business investment, etc, etc.