The Bright-line Test means if someone sells residential property within a set period after acquiring it, they may be required to pay income tax on any profit made through the property increasing in value. They do that by including the income in their income tax return (or adding it to their automatically generated income tax assessment). Up until this year, they were meant to add it to the Other Income box – it's not specifically labeled as due to the Bright-line test and there are other types of income that are added to this box also, so there is no easy way for Inland Revenue to know how much tax has been collected due to the Bright-line test.
However, Inland Revenue does know when properties are bought and sold, and we usually know the sale price, so we have a good idea what we expect to see being added to someone’s Other Income. We can also receive the information when someone fills out an IR833 – the Property Income Worksheet – but this is not compulsory. Each year we analyse all the transactions and follow up with those that are most likely to have not included the income they are meant to due to the Bright-line Test. Each year our analysis is getting more accurate.
What Inland Revenue is finding through its analysis
There is natural delay between when a property is sold and when Inland Revenue might investigate it. For example, if someone sells a property in April 2022, they would include any income required from the Bright-line Test in an income tax return due in July 2023, and payment of any tax due isn’t until February 2024. Inland Revenue will begin some investigations before then, but others will start after, and may continue for a while. So to get an understanding of compliance with the Bright-line rules we need to look at property sales from a few years ago.
In the 2018-19 tax year there were 28,552 property sales that happened within the Bright-line period.
Of those, 9,126 were potentially taxable based on the information we had at the time. The remainder were mostly excluded from the Bright-line Test because they were main homes or inherited, or sold by developers or property dealers who pay tax on those sales in other ways.
For those 9,126, we can see an appropriate amount of income being included in Other Income for 33% of them. So that leaves 67% where income may not have been properly included. It has been suggested that if most of those were people not declaring their income, then the non-compliance rate could be higher than 50%. But we know this is not the case because of what we’ve been finding when we investigate this in more detail.
Our investigations into those 9,126 property sales are still ongoing. But from our prior year investigations (of those people our analysis showed were most likely to be avoiding their obligations) we found the following:
- 37% were not subject to the Brightline at all. Mostly they were subject to the Main Home exclusion, but just didn't tick the box indicating the property was their main home.
- Of the remaining, 74% had already included the Bright-line income in their tax return - they just didn't do it in quite the right way. For example, they put the income in the wrong place.
- This means most of those we reviewed were actually meeting their Bright-line Test obligations.
- Of those we found did have tax outstanding, 80% corrected their return when we first contacted them.
Given this is a new process for most people, it is not surprising that many aren't getting it quite right, and it is not a sign of deliberate non-compliance.
Calculating a level of compliance
Over the past week there has been media interest in the current level of compliance with the Brightline Test. Inland Revenue will never be able to provide an actual compliance rate for any form of tax, as we do not audit every taxpayer. Nor do we usually provide formal estimates of compliance rates. Estimates are always unreliable and rarely help us target non-compliance better. For something like the Bright-line Test, which is not a category of tax in its own right, an estimate is even less reliable.
We have provided various numbers about our compliance activity to the media, leading others to make estimates of compliance rates. Because such estimates could differ widely based on how people understand the numbers, we felt it would be useful to outline how a rough calculation, based on the numbers we have provided, could be made.
Because this is only a rough calculation, and no actual year will conform to it exactly, we illustrate it with an imaginary year in which there were 10,000 property sales that on the initial information Inland Revenue holds look like they could be taxable under the Bright-line Test.
| Description | Number |
|---|---|
|
Number of property sales that IR's data shows are potentially taxable under the Bright-line test (an imaginary year with 10,000 such transactions for this illustration only) |
10,000 |
|
Less the number of people that included full Bright-line income in the tax return correctly (33% found in IR's investigations mentioned above) |
-3,300 |
|
Equals the number of property sales potentially not reporting some or all income required under the Bright-line Test |
6,700 |
|
Less the number of those that are not actually subject to the Bright-line Test (37% found in IR's investigations mentioned above, mainly due to the seller not ticking the main home box when they should have) |
-2,479 |
|
Equals the number of property sales still potentially not reporting some or all income required under the Bright-line Test |
4,221 |
|
Less the number of those assumed to have included the Bright-line income somewhere else in their tax return (74% found in IR's investigations mentioned above) |
-3,124 |
|
Equals the number of property sales assumed to actually be not reporting some or all income required under the Bright-line Test, before Inland Revenue starts any investigations |
1,097 |
Based on the above assumptions, the number of transactions actually taxable under the Brightline test would be 7,521 (the 10,000 potentially taxable less the 2,479 found to not actually be taxable). The number of people who proactively included that income in their tax return would be 6,424 (the 3,300 we identified initially, and the 3,124 where the income was included, but in the wrong place)
A rough calculation of those who proactively include their Bright-line Test income in their income tax returns would be 85% (6,424 divided by 7,521).
878 of the 1,097 who did not include the income will realise their mistake and correct it when IR first contacts them (80% found in IR’s investigations mentioned above).
That would leave only 219 requiring further enforcement, which is 3% of those required to return Bright-line income.
Next steps from Inland Revenue
While the above is only a rough calculation from early data, it indicates that the majority of people are proactively including their Bright-line income in their tax returns. That fits with NZ’s approach to tax compliance, where we trust most people to do the right thing, help them when they’re trying to get it right, and follow up with those we identify as most likely to be avoiding their obligations.
Inland Revenue continues to encourage people to meet their Bright-line Test obligations by:
- informing people of their obligations with our materials and advertising
- getting in touch with people when they sell properties that appear to be subject to the Bright-line tests
- making the process easier – for example creating a box for property related income on tax returns
- improving the targeting of our investigations through continually refining our data analysis
- pursuing through audits and prosecutions those who refuse to meet their obligations.