The Canberra property market has been ensnared in the legal system on two counts in the past week: tax treatment and the anti-gazumping legislation.
First to tax.
It would be difficult to devise a more expensive, cumbersome, time-consuming and unsatisfactory system of dispute resolution than the English-Australian legal system.
A week ago a Canberra couple’s taxation matter was resolved in the High Court – eight years after they put in the tax return.
It was not a difficult case. The facts and issues could be explained in half an hour. The couple borrowed some money to buy an investment house and a house for themselves. Each house had, say, a $200,000 mortgage on it. The interest on the investment house mortgage was tax deductible. The interest on the residence mortgage was not. All the bank cared about was that the total debt never exceeded the $400,000 and the total interest on that was paid each year. Let’s say the interest was 10 per cent, for ease of explaining what the couple did. In the first year, they paid $40,000 to the bank – the notional total interest. But they told the bank to apply all of that money to paying off the capital on the residential loan while allowing the investment loan to blow out. So in Year Two the investment loan outstanding was $240,000 and the residential loan $160,000. At the end of five years, the residential loan would be cut to zero, but the investment loan would have blown out to $400,000. In Year One their tax deduction was just $20,000 (only the interest on investment loan). By Year Five, however, their tax deduction was $40,000 because according to the bank all the $400,000 owing was on the investment property.
It was a fairly artful scheme. It was marketed as a “wealth accumulator”. It took eight years and thousands of pages and hundreds of hours of oral argument for the courts to come to the obvious conclusion that it was a scheme to minimise tax.
It gets worse. This was run as a test case. The Tax Office behaved as a model litigant. Instead of picking randomly on one poor bunny who might cop ruinous legal bills it agreed to pick up the bills of both sides whatever the result. But despite the years of argument, the courts did not resolve some major questions that arose in the case. These will have to be fought in another trough with another set of lawyers on another day (or many days).
The High Court held that the Canberra couple were engaged in an avoidance scheme. Their deductions were disallowed. The deductions were clawed back to the level that would have applied if they had paid interest (and principal) on each loan in the ordinary course of events.
The big unanswered question is what happens if you are not part of an artful scheme of loan splitting and egg-timing (in which the sand flows from an undeductible personal-residential loan to a deductible investment loan). What if there was some other reason for allowing the investment loan to blow out with unpaid interest so the following year there is a bill for interest on unpaid interest.
It should not take eight years to answer this question.
The first question is why should anyone get a deduction for just a liability to pay interest when they have not actually paid it?
But the pervasive influence of accrual accounting suggests it could be a deduction subject to the next questions — a real deduction for an unpaid debt. The next question should be: why was the debt unpaid leaving interest on unpaid interest to run up? If it was because the taxpayer was such a hopeless businessperson that there was no money to pay, then it should be a deduction. If it was because the taxpayer was off on another business frolic in the hope of make profit and so had no money to pay the interest, then the interest on the interest in subsequent years, too, should be a deduction.
But if the taxpayer ran up a bill for interest on unpaid interest purely because they were busily paying off the capital of an undeductible personal residential loan (even if from another bank), surely that is a personal purpose, not business-related, and therefore undeductible.
But despite eight years of argument the courts did not answer this question. We are left in the air. I think, though, it would be very foolish to allow an investment loan to blow out while you pay the capital off a residential loan. Sure, pay the capital of a residential loan off as quickly as possible, but by being more frugal, not by allowing an investment loan to blow out. Otherwise, you might end up in one of our legal system’s eight-year test cases.
Now to gazumping.
About nine months ago, in the midst of the property boom, the ACT Government felt pressured to do something about gazumping – the practice of sellers having agreed verbally to a price with one buyer then selling to a buyer who offers more. The seller is not legally bound to sell until written contracts are exchanged. In the meantime, the prospective buyer has wasted money getting building and pest reports and title searches.
The ACT Government thought it would protect buyers by demanding that sellers have the reports available upon advertising the house so that buyers could exchange contracts almost immediately. Real-estate agents could supervise the exchange.
This law comes into effect at the beginning of next month. The real-estate industry is screaming and there is much to scream about.
The position of the ACT Law Society and the real-estate industry that the law was unnecessary has been vindicated. Gazumping is fairly rare and only happens in a fast rising market. The market has now fallen. There is no gazumping. Indeed, there is “gazundering” – where they buyer reneges and reoffers at a LOWER price. The upshot is that everyone (12,000 plus sellers a year) is being put to a lot of unnecessary red tape for a couple of isolated gazumping cases every half dozen years when we have a fast rising market.
A lot of buyers do not want pest reports or building reports, the cost of which is passed on to them. Quite a few are going to demolish or extend, or are happy to view the building themselves. Most are only interested in the land component anyway.
These new requirements are added to the ridiculous Energy Efficiency Rating statement which does exactly nothing to improve energy efficiency of houses. At best it gives trite advice about curtains and insulation after it is too late to reorient a house north. By all means force people to build new houses to a high efficiency standard (which is not happening because the star-rating system is flawed), but after a house is built buyers do not need to be told on pain of a fine if it is an energy guzzler. It is easy enough to find out themselves.
In all, sellers are to be saddled with about $1200 worth of utterly unnecessary bureaucracy before they can put a house on the market.
The housing market is an equal one. It is not a case of some multi-national pulling the wool over buyers’ eyes. Both buyers and sellers are usually just ordinary people going about their business and do not need the state to demand they be armed with pest, building and energy reports before they enter a transaction.
Well done ACT Government. After carrying on about housing affordability for so long you have just added about $15 million a year to the cost of buying a house in the ACT – undoing much of Treasurer Ted Quinlan’s excellent work in cutting land tax and stamp duty.
Even that work was slightly marred because he signalled the stamp duty cut so far in advance that first home buyers have pulled out of the market till July 1.
Small wonder the real-estate agents are screaming.