How would I change negative gearing?

Simply I wouldn’t. 

But having worked in an office at Parliament House and in the Federal Treasury, sometimes you have to do things you don’t agree with. And it looks like someone is going to be told yo do this 

First, can we be clear there is no such part of the tax law that allows “negative gearing”. Like almost every other tax system in the world, our tax laws allow people to claim a tax deduction for expenses – like interest on a mortgage – that relate to gaining income – like rent from an investment property.
Second, can we be clear that people claiming “negative gearing” deductions are claiming the deduction on actual cash they have paid out. They are spending real money on their rental property and are getting tax deductions for it.
And thirdly, “negative gearing” can apply to anything you buy using borrowed money to make income from, not just property. I could borrow to buy shares and if the interest on the loan I pay is greater than the dividends I get in a year the shares were negatively geared. I could borrow to buy a piece of software I want to licence to others in Australia and if the interest on the loan is greater than the licence fees I get the software is negatively geared.
And after reading these three point “negative gearing” now sounds a whole lot less scary and evil than when it is described in the media.
So lets get to making the changes to negative gearing. But first we need to know why we are doing this. To take property investors out of the market? Lets be honest and say we are doing this so we don’t have to cut expenditure. We are just doing it to raise money. And if this is the reason we need to ensure we understand flow on effects. For example, if all we do is drive investors to buy low yield shares that might have high potentially capital gains we will raise no income tax, and reduce stamp duty collected.
So to avoid these flow on effects we have to either “cover the field” by closing negative gearing on all asset classes (property, shares, …) or only cut negative gearing deduction on property to a point where no one will change their investing practices.
“Wont people just move to super?” Super fund can’t borrow (limited recourse borrowing are dead – trust me). And you can only get a deduction for $30k into super each year.
Lets start with covering the field. We need to limit interest deduction (or equivalent to interest) on purchasing any asset where the asset is used to make passive income (rent, licence, royalty, …). I would actually like this to the definition of “active asset” in Division 152 of the ITAA1997.
So how much of the interest deduction do we limit? Either the amount above the passive income or just a percentage of the interest based on the equity invested. These two options already exist in the tax laws.
In Division 35, if you run a business on the side and it makes losses (called non commercial losses) you cannot offset it against your other income. In Division 820, we have the Thin Capitalisation rules which only allow deductions on a part of any interest expenses base on a debt to equity ratio.
I would love to use a thin cap model. If you borrow more than 70% of the value of the asset to gain passive income (“to acquire an asset that is not an active asset”) you cannot claim the deduction for interest or interest equivalents on the amount borrowed above the 70%. Each year the taxpayer can, at their election, revalue the asset to see if the initial loan is now less than 70% of the current value of the asset.
I am not sold on 70%, and would leave it to the actuaries to work out a percentage.
But this would slow investors who would wait till they have 30% equity before they buy.
The reason I prefer the thin capitalisation model is there are just to many problems with the non commercial losses model. For example:
I buy a rental property on a mortgage, incur interest but can’t find a tenant. This goes on for a year. I then sell the property. Under the non commercial losses rule equivalent I never get to claim the interest as a deduction. Now I had no idea my property would be negatively geared when I bought it. So I had no idea that interest would be non deductible.
With the Thin Capitalisation model you know what you will be able to claim as an interest deduction.
Now lets look at option two – Change negative gearing enough to raise some tax but not too much so that people change their practices. But isn’t this the model I recommended above but just with a higher percentage – 80%.
If interest is only on 70% or 80% then the interest expenses will be less, and the rent is set by the market so there is no change in income.
This only applies for new non active assets.
So we have raised some money… I think. And the chattering class can pat the government on the back (and ACOSS WILL HAVE TO FIND A NEW BOOGYMAN). But this is a great reason to change taxes and to change the fundamental proposition that you can claim a tax deduction for expenditure incurred in gaining income.

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