Imputed Rent of the Owner-Occupied Home

7.42. At present one very large item of non-money income—imputed rent of the owner-occupied home—is omitted from the income base and thereby escapes tax altogether. This has not always been so. In the earliest years of Federal income tax, from 1915 to 1923, 5 per cent of the capital value of an owner-occupied residence was included in assessable income; deductions were allowed against this amount for expenses by way of repairs, rates and land taxes, and mortgage interest. In 1923, however, the provision for including imputed rent was discontinued; repairs and mortgage interest became non-deductible, but the owner-occupier was still permitted a tax deduction for rates and land taxes. This remains the situation today, with two qualifications. In 1973 a ceiling of $300 was placed on the amount of rates and land taxes an owner-occupier might deduct, and the deduction was henceforth to be confined to a principal place of residence. More recently a scheme has been introduced, restricted to home-purchasers in the lower and middle income ranges, making some portion of interest paid on home loans tax deductible. Where the combined actual income of husband and wife is $4,000 or less, the whole of interest paid on a principal residence is deductible. On incomes above $4,000 the deduction is reduced by 1 per cent for each $100 of the excess, disappearing altogether when income reaches $14,000.

7.43. Only a few countries, including West Germany and Sweden, treat the rental value of the taxpayer's own home as income for tax purposes. In West Germany, for example, the basis of valuation varies between one-family homes and other types of housing. For one-family homes, 3 or 3½ per cent of the assessed value is used (depending on the date of erection) to determine the rental value; for other types of housing, a rental value is established by comparison with the market rental value of dwellings of equivalent standard. Deductions are allowed for mortgage interest, taxes on real property, depreciation, repairs and maintenance, and insurance.

7.44. The arguments for imputation merit some consideration though, as will appear, the Committee does not propose to recommend that imputed rent be taxed. A substantial inequity between home-owners and tenants is involved under the present Australian system. And though a case can perhaps be made for treating home-ownership specially favourably on the grounds that widespread ownership is socially desirable and good housing benefits the whole community, it is questionable whether exempting imputed rent is an appropriate way of encouraging home-ownership. For one thing, low-income tenants are exluded from the benefits of non-imputation; for another, home-purchasers may in fact be made worse off because of the higher prices they must pay for their homes in the face of greater public demand for housing.

7.45. If imputed rent is to be taxed, the amount subject to tax can be calculated in one of two ways:

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  • (a) The first way involves the determination of the gross rental value of the home. From this repairs, depreciation, and local rates are deducted to arrive at a figure representing net rental value. A further deduction of interest on money borrowed and invested in the home is then made in order to establish the net rental of the owner's equity. This is the amount subject to tax.
  • (b) The second way avoids some of the complexities of the first, though, in the result, it involves elements of arbitrariness. A percentage of the capital value of the home is assumed to be the net rental value. Interest on money borrowed is then deducted and the residual is the amount subject to tax.

Whichever method is adopted there is the prospect, especially when borrowing has been made at a high interest rate, that the imputed rent will be a negative figure.

7.46. However the calculation is done the taxing of imputed rent is open to two major criticisms, one concerned with hardship for some taxpayers, the other with administration.

7.47. Where the owner's equity in his home is substantial, a considerable amount of non-cash income could well be involved. In times of high interest rates, annual imputed rent on a house with a capital value of $40,000 may amount to $4,000. If this is added to a retired person's investment income of, say, $6,000 and the total amount of $10,000 is taxed, hardship may result. The inclusion of imputed income in the income tax base will, it is true, make possible some reduction in rates of tax, but the reduction may not be enough to obviate hardship in many cases. One could visualise similar difficulties arising for other classes of taxpayers: for example, a widow with young children may have been left the family home, now freed of mortgage by the proceeds of an insurance policy taken out by her husband, but she may have only modest cash income and few other assets.

7.48. Employee taxpayers with imputed rent, whose employment income is subject to the system of collecting tax by instalment, would not be as conscious of the hardship if the taxing of imputed rent were keyed in some way into the instalment system. There will be administrative problems in doing this; but if it were not done and employees had to pay tax on assessments, the system of collecting tax by instalments would be seriously weakened.

7.49. The adoption of the second way of calculating imputed rent avoids some administrative difficulties at the cost of a certain degree of arbitrariness. But the difficulties inhering in the determination of capital value in the second way are no less than the difficulties of determining gross rental value in the first. Both ways involve defining and applying principles for determining whether money borrowed has been invested in the home.

7.50. Either way poses administrative problems in that it creates a demand for valuation services, a need for a verifiable record of valuation that the taxpayer may quote in his tax return, and a mechanism by which the taxpayer may contest that valuation. The existing State valuation services throughout Australia provide valuation information on a variety of bases. But the information collected is not always relevant or consistent. In New South Wales, for example, the Valuer-General values only the unimproved capital value of residential land: the provision of both improved capital value and assessed annual value was discontinued in 1973. By contrast, the Victorian system employs both net annual value and unimproved capital value. A further problem is the revision of valuations over time—not necessarily annually—to ensure they reflect current market values.

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7.51. If the first way of calculating imputed rent is preferred, there would be administrative problems in regard to depreciation allowances and repairs. The problems of depreciation allowances and deductions for repairs are considered in wider context in Chapter 8.

7.52. Difficult problems arise when interest, to be deductible, must be shown to be related to a particular kind of income. Taxing imputed rent would multiply the occasions when these problems have to be resolved. The availability of a deduction of interest would open up avenues of tax planning for the well-advised who will consolidate their debts into the borrowing for home finance.

7.53. The Committee recognises the arguments for including imputed rent in the tax base; but having regard especially to the administrative difficulties it is not prepared to recommend a change in the law to this end.

7.54. The Committee does however propose that the deduction for rates and land taxes, now limited by amendments in 1973, be further reduced and eventually abolished. It is a relic of the time when imputed rent was included in the income tax base. No doubt the availability of the deduction is of some financial benefit to local governments in providing an indirect form of Federal financial assistance. However, the Australian Government is already making direct grants to local governments, and any revenue difficulties for these governments arising from the abolition of the deduction could be dealt with by extending such grants.

7.55. The Committee also proposes that the recently introduced deduction of interest on home loans be discontinued. Allowing such a deduction accentuates the inequity resulting from the failure to tax imputed rent. There is, indeed, some irony in this: the reason given in paragraph 7.52 for not taxing imputed rent is the complexity involved in the allowing of a deduction for interest on a home loan and the opportunities for tax planning to which it gives rise.

7.56. If the deduction for rates and land taxes were abolished, some of the tax advantage owner-occupiers have over tenants would disappear. The advantage might be reduced still further if a deduction were allowed to tenants for some part of the rent they pay. The allowance of such a deduction would be novel: so far as the Committee is aware, a concession of this kind is available only in Columbia. Because of the limit on deductibility, the advantage would generally remain with the owner-occupier; though where because of interest payments imputed rent is a negative amount, the advantage would move to the tenant.

7.57. The Committee has not explored in detail the administrative feasibility of a rent deduction but considers it worthy of serious examination. The amount of the rent deduction would seek to express the net rent element in what is paid by the taxpayer. It would be necessary of course to proceed by way of allowing a fraction of the rent paid, since the taxpayer would not be in a position to know the expenses incurred by the landlord. A ceiling would need to be placed on the amount deductible, perhaps related to the number of persons dependent on the taxpayer and living with him: the Committee would not wish to encourage the over-consumption of housing further than may be inherent in the continued exemption of imputed rent. There would, it is true, be difficulty in separating out a payment for rent in a composite payment for provision of rent and services: for example, where the accommodation is a serviced flat or where lodging and board are involved. However, the ceiling on the amount deductible might justify ignoring the element of service.