Inland Revenue has published a scathing review of the Government’s proposal to make commercial and industrial property owners pay about $575 million more tax a year.

The Government is planning to prevent building owners from deducting depreciation as an expense from April 1 to bolster the balance of its books.

However, the tax department believes the change will hurt businesses and hamper productivity, which the Government says it’s committed to improving.

Inland Revenue also reckons the change will distort the tax system - an issue the Government claims it wants to address by allowing landlords to deduct mortgage interest as an expense to put residential property investment on the same footing as other types of business.

“We do not consider the removal of building depreciation to be a fair and efficient way of raising revenue,” Inland Revenue said in the regulatory impact assessment it prepared for the Government.

“We are particularly concerned about the efficiency impacts which will make New Zealand even more of an outlier in pushing up cost of capital for commercial and industrial capital.”

Ahead of last year’s election, both National and Labour campaigned on removing depreciation deductions as a way of helping pay for their policies.

While the change will hit building owners relatively hard, requiring them to pay an estimated $2.3 billion more in tax over four years, the policy has created little public fanfare.

Hence, it’s arguably an easy way - politically - of generating revenue.

Inland Revenue recognised the issue of whether commercial and industrial buildings do or don’t depreciate had been contentious in the past.

Treasury analysis done in 2010 found on average, buildings in New Zealand hadn’t depreciated in market value between 1994 and 2008. However, international evidence strongly suggests buildings do depreciate.

The National-led Government removed the ability of building owners to deduct depreciation in 2010.

Then in 2020, the Labour-led Government reversed this to stimulate growth in the face of Covid-19.

Inland Revenue said all the flip-flopping could create uncertainty and erode investor confidence.

It said even under the status quo, where 2 per cent depreciation deductions are allowed, New Zealand is likely to be the least attractive country in the OECD to invest in commercial and industrial buildings.

“Denying depreciation deductions will drive up these hurdle rates of return even higher and make New Zealand a less attractive location for investment,” Inland Revenue said.

It noted the cost of the tax change would be passed onto businesses, as well as their customers.

“It thereby negatively impacts productivity more generally.”

Inland Revenue feared businesses that rely more on the use of buildings than others would be disproportionately affected.

“A fundamental principle of New Zealand’s tax system is not to advantage any form of investment relative to other forms of investment, unless there is an overriding reason for doing so,” it said.

Perhaps the only upside of the analysis for the Government is that Inland Revenue expects the change to generate $200m more revenue over four years than what National accounted for pre-election.

Finance Minister Nicola Willis used this revision to defend herself in the face of criticism around cost overruns - for the removal of the interest limitation rule for example.

She argued that while some of the governing parties’ promises might cost more than anticipated, others would cost less, or generate more revenue.

The proposed change to the treatment of depreciation has been included in the Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill, which is expected to be passed before the end of the month.

The new rules will take effect as the commercial property sector is grappling with high interest rates.

One per cent of bank loans for commercial property were non-performing in January - a major deterioration compared to the six-year average of 0.3 per cent.

The ratio of non-performing commercial property loans was also higher than for general business loans (0.8 per cent) and housing loans (0.5 per cent).

The value of new bank lending for investment in commercial property development was also low through 2023.

Jenée Tibshraeny is the Herald’s Wellington Business Editor, based in the Parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.