Test case rules out self-rent tax dodge

Thousands of people who have been claiming back potentially millions in tax on losses through special property owning companies called LAQCs could face more heat from Inland Revenue after a test case.

Inland Revenue has scored its first victory against a "Loss Attributing Qualifying Company", set up to make a private home tax deductible. The owner in effect rented the home from herself and claimed tax deductions on her losses.

It is unclear how many LAQCs involve people claiming tax losses against the costs of living in their own homes, but tax advisers said it could be thousands.

For them, the game is up, although for others using an LAQC to own property rented to outsiders, the tax deductions are still acceptable. IRD seemed to accept deductions on beach houses, as long as people actively tried to rent them.

"But if it is your own home, [IRD] will go for it," Deloitte tax managing partner Thomas Pippos said.

Last year, Inland Revenue sent out about 40,000 letters to directors of LAQCs with a possible involvement in rental properties and later carried out an audit check on companies "at risk".

Residential property investment leads to tax losses of about $500 million a year, which if offset against other income at about 30 per cent, would cost the Government about $150m a year in lost tax, experts say.

The IRD has just won a case involving a "Mrs B", who bought a home with a $292,000 loan through an LAQC which "rented" it back to Mrs B.

She claimed losses over four years totalling almost $71,000 and as the LAQC's shareholder Mrs B set this off against her income tax.

Inland Revenue said the case was a tax avoidance arrangement, but the LAQC challenged that.

Taxation Review Authority Judge Barber agreed the effect of the arrangement was tax avoidance.

If Mrs B was on a 39 per cent tax rate that avoidance would have amounted to more than $25,000, which must now be repaid, plus interest.

There was no penalty imposed in this case.

IRD's assurance manager, investigations, Richard Philp, said the case clearly showed a taxpayer could not use a LAQC in order to claim deductions for expenditure that would otherwise be of a "private or domestic nature".

The case was the first "own-home LAQC" to be tested in the courts, he said.

"We are pleased the court agreed with this view and confirmed our assessments."

Deloitte's Mr Pippos said: "It is a bridge too far to use the LAQC or a similar structure to create a taxable loss from the home you live in.

"My gut [feeling] is that there are a lot of impacted tax payers.

"This goes down to the grass roots, mum and dad in New Zealand, and would have widespread application," Mr Pippos said.

Wellington tax adviser Brent Gilchrist said "Mrs B" was not a great test case because the arrangement was not cleverly executed, with no tenancy agreement or rent payment.

It would now be a "brave" taxpayer who took IRD on for a stand-alone private home LAQC, Mr Gilchrist said, even if it was set up properly.

But if the property was one of a few investment properties owned by the LAQC and the family was treated like an arms-length tenant, then there was still room to allow losses from such an arrangement to survive an IRD "attack", he said.