Capital Gains Tax Review 2019

After months of deliberations, public consultation and an interim report, the Tax Working Group (TWG) last month delivered its final report.

As expected, the TWG has recommended, amongst other things, an (effective) comprehensive capital gains tax.  Some critics have described the proposed regime as one of the “harshest” in the world, with many gains potentially being subject to tax at the top marginal rate of 33% with no discounts, concessions or allowance for inflation and very little in the way of exemptions, exceptions and roll-overs.

In many ways, such proposals pave the way for a grateful public when the Government inevitably announces which watered down version of the proposals it will adopt.  That is, of course, assuming the “harshness” of the proposals hasn’t put the voting public off the idea of capital gains tax altogether, and importantly that the Government can gain the political support it needs to get any changes it wants to implement across the line.

Whether you are for or against a capital gains tax or sit somewhere in between, it is worth noting that the proposals outlined in the TWG’s final report are at this stage just that – proposals.  And while it is helpful to understand what the proposals are, there is little to be done until we know exactly which of those proposals the Government intends to pick up and run with, and then what is likely to make it through the political minefield that will follow.

In a nutshell, the TWG recommends CGT will apply to:

• Land – all land including improvements to land and leasehold interests.  Will include residential, private (holiday homes/second homes), commercial, agricultural, industrial and foreign land.  Excludes the main home (see What’s excluded, further below).
• Intangible Assets – Includes all intangible property that is owned or created for business purposes, such as goodwill, patents, trademarks, copyright, software, debt instruments, contractual rights and insurance policies.  Certain exclusions apply.
• Shares – Capital gains made on New Zealand and foreign shares will be taxed.
• Business Assets – Capital gains on the sale of assets held by a business, or for income-producing purposes – such as plant, equipment and goodwill.

What’s excluded?

• The primary or family home (the excluded home).  This was one of the terms of reference of the TWG, so no surprises here.  What is surprising is the pages and pages of commentary and proposed rules around what is a family home, when it doesn’t qualify for the exemption and when a gain on a family home may be partially taxed.  This gives some insight as to the level of complexity and detail we can expect if the proposals are adopted.
• Personal use assets – cars, boats, personal and household effects, intangible property not used for business or income earning purposes, as well as artwork, taonga and collectibles.

What’s controversial?

• CGT will apply at marginal rates, with no allowances for inflation or de minimus concessions.
• All existing assets held will need to be assigned a value on “valuation day”.  Gains from this value will be taxed on sale.  Not only is there a compliance cost in calculating this value, but it is also harsh compared to other countries.
• Not all losses can be claimed or offset against other income.  Losses from private assets (holiday homes, baches) cannot be claimed as the TWG see this as “private consumption” – yet they propose to tax any gains from the same assets.  Losses from pre-CGT assets and certain asset classes (crypto-currencies, derivatives) will be ring-fenced.  The restrictions around crypto-currencies and the like seem reasonable, but what is the rationale for limiting the loss on all currently held (pre-CGT) assets?  Particularly if a robust valuation can be provided.
• The family home exemption isn’t as broad as you think it is.
  • You can only have one excluded home – so if you have a family home and an apartment in the City (or a holiday home where you spend a lot of time), you have to choose which is exempt.
  • If you are building a new house, you can have two excluded homes while it is being built, but only for 12 months. Let’s hope there are no untimely delays!
  • If you have bought a new house and are in the process of selling your old home, you have up to 12 months to sell – otherwise one of your homes won’t qualify as excluded, meaning part of the capital gain on your family home will be taxable.
  • If you are a couple, you can generally only have one home between you.  But if you are a couple that genuinely lives in two separate homes then you have up to three years to decide which house doesn’t qualify (or to sell!), meaning the capital gain on a family home will be taxable if your situation doesn’t change.
  • If you live on a lifestyle block or farm, only your house and curtilage are excluded, up to a maximum of 4,500 square metres.  So if you genuinely use a larger area for the enjoyment of your family home, a portion of any capital gain will be taxable.  Equally, don’t assume that you will automatically receive an exemption for up to 4,500 square metres as it is only the area which is required for the reasonable occupation and enjoyment of the house which is excluded.
• The way you use your home could mean part of the capital gain on sale will be taxable.  In a nutshell, if you claim expenses against income earned, then you will pay CGT on a portion of the gain on sale of your home.  The only way to avoid CGT in this situation is to return income but claim no expenses.  There are some options here, provided your home is at least 50% used as your home:
  • If you have a home office – you can either not deduct your costs OR pay tax on a portion of your capital gain.
  • If you use your home for Airbnb (but at least 50% still as your home) you must declare the income, and you can either not claim any expenses (no CGT on sale) OR claim the expenses but also pay tax on a portion of your capital gain on sale.
  • The same applies if you have flatmates – you must return the income, and you can either not claim expenses (no CGT on sale) or claim expenses and pay tax on a portion of your capital gain.
  • If you have boarders and rely on the IRD’s determination to return no income (i.e. because you earn less than the amount set by IRD per boarder), then you will have to pay tax on a portion of your capital gain.  You can avoid paying CGT if you account for the income received but deduct no expenses.  This is likely to catch a lot of people out.
• There will be a tax on capital gains made from New Zealand and Australian shares.  Foreign shares will be taxed under the existing foreign investment fund rules which is likely to provide preferential treatment to that proposed for New Zealand and Australian shares.
• There is no minimum level for small business goodwill – this means that every business with some goodwill will be required to pay tax on any increase in that value from the acquisition or valuation date.  This equally applies to intangibles such as software, copyright or other IP.

And even more controversial

The most contentious aspect of the TWG’s final recommendations is that three of the eleven TWG members disagreed with its findings.

The dissenting members are Robin Oliver, former deputy commissioner at Inland Revenue and current principal of Oliver Shaw tax advisors, Joanne Hodge, former tax partner at Bell Gully and Kirk Hope, chief executive at Business New Zealand.  The dissenting members are extremely credible, well respected and they come from a variety of backgrounds.

The crux of the dissenting members’ report is that the tax system should not impede experimentation and innovation and they consider the cost of implementing a comprehensive capital gains tax regime outweighs the benefits.

The dissenting members instead consider that the Government would be better off amending some current rules, such as gains made on residential rental properties and enforcing the existing rules better (especially around evasion and enforcing the current property rules more effectively).

The dissenting view in a nutshell:

• The tax system must not hinder the economy – as a country our economy must become more productive and environmentally sustainable.  Productivity and sustainability will be achieved by businesses that embrace change and who are encouraged to take risks and experiment.
• The compliance and administration costs of implementing a comprehensive capital gains tax regime are not outweighed by the increased revenue, fairness perceptions and possible integrity benefits of a broad CGT.
• The only case that can be made for extending the tax to capital gains currently is in relation to residential rental property.  Taxable income is low compared to economic income – in many cases, the rental yield is below the risk-free rate of return, meaning investors are relying on the capital gain to provide a market return on their investment.
• If CGT were limited to residential rental properties, this would raise around 40% of the expected revenue.  However, this would result in a reduction in rentals and higher rental costs, but relief could be targeted by other Government measures.
• Countering tax evasion and properly enforcing existing rules would collect a significant amount of tax over the same time, without the costs and risks of implementing a CGT.
• Extending CGT to other asset classes such as business assets and shares increases complexity, compliance costs and risks to Government as taxpayers take advantage of the complex rules and exemptions which will inevitably be required.
• Extending CGT to shares is overly complex, involves potential double taxation and double deductions (and complicated rules to counter this).  It creates inconsistencies between investment types which risks damage to our markets.  The overall result will be to increase tax on New Zealanders who own New Zealand shares.
• The dissenting TWG members also question the short time-frame for implementation of a complex new regime, and they don’t consider it is feasible to have robust and workable legislation enacted in time.

There are a huge number of issues and views to consider, and in that regard, the TWG was faced with no insignificant task.  What will be interesting is how the Government decides to implement the findings and proposals of the TWG, taking into account the dissenting views and also general public reaction to the final report.