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Gains Tax pitfalls and false prophets
the last few weeks various economists and tax experts have
been trying to predict the economic effects of Labour’s capital
gains tax (CGT) proposal. What the experts do agree on is
the best tax is one that is simple, has a broad base and few exemptions
and incentives. A “good” tax should:
taxpayer’s ability to pay. (For this reason most taxes
are levied when income is earned or realised, not on the
change in notional values.)
income for the government much greater than its cost to
administer. (Hence the abolition of gift duty from 1
October this year.)
a low compliance cost to the taxpayer and be convenient to
pay (e.g. income tax and GST).
hard for taxpayers to avoid. In other words, have few
exemptions for lawyers and accountants to exploit, and
create distortions in economic behaviour.
measured against these criteria Labour’s CGT proposal has
been given the thumbs down, not because a capital gains tax as
such is necessarily a bad idea in theory, but because it is
unworkable in practice. In essence Labour’s CGT would tax:
in trust, when sold.
assets, when sold.
including non-family dwellings, machinery, stock.
sale of intellectual property.
other than inheritances.
assets that would not be taxed are:
such as cars, jewellery, art.
savings like KiwiSaver.
business exemption up to $250,000.
and gambling winnings.
residential homes would be exempt for five years.
Labour’s Finance spokesperson, David Cunliffe, was asked why
the family home was exempt he replied that to include it was
be upfront about it – Labour’s CGT is a political strategy
more than it is an economic policy. Anyone who has been around
politicians for more than five minutes would not be surprised
by that. What is surprising is that Labour thinks their CGT
will improve their electoral chances, and the number of
commentators who don’t see the CGT in its political context.
NZ economy has for many decades been tainted by politicians
putting their own agendas
above what’s best for the economy, and Labour’s CGT is a
fine example of that.
Not surprisingly Labour does not want to talk about the detail behind
their policy – “The
key point for us is not to be dragged down into the detail on
the CGT. The public don’t care and we get boring”, says
Labour strategist and MP Trevor Mallard.
probably explains why whenever they are asked a tough question
the party faithful reply:
“An Expert Panel will be established to deal with issues
that are technical in nature and involve areas where a high
degree of specialised knowledge is required before a final
decision can be reached.”
is important – it’s like the fine print on a contract –
it’s the detail that actually matters because that's where the
fish-hooks are. Here are some of the issues Labour does not
want to discuss in detail:
the family home will create what is called the “mansion
flows into the area of lowest tax – which will be family
homes. Less will go into shares and investment property.
Someone with a spare $50,000 or so will instead put an
extension on their home, knowing that when they retire
they can sell their home and buy something smaller and
cheaper and make what they expect to be a tidy tax free
property investors may do likewise. Instead of pumping cash
into their rental properties and putting up with the endless
hassles of dealing with tenants, they will sell up and put
all of the capital into a mansion so they can enjoy their
capital and reap a tax free gain when they sell. Others will
become recidivist home buyers and sellers. Buy, live in it
for a while, sell and buy something better, sell and buy
something better and so on.
a consequence, a large amount of unproductive money will be
invested in oversized homes and less money will be put in
rental properties. Rents will rise and the taxpayer will
have to provide more state houses instead of private
landlords. Art collections would also be
exempt so we could expect art to fill the cavernous vacant
spaces of these over-sized mansions.
assets subject to the CGT would have to be valued as at a
specified (“V”) date. I recently completed an exercise
valuing a two-bedroom unit in Whangarei. Three valuations
were obtained. The values were: $192,000, $215,000 and
$220,000. A $28,000 spread is significant, and this was a very
basic very typical unit. Imagine the difficulties if the
property is unique. Inevitably there will be all sorts of
rackets and disputes involving valuations.
adjustment will be made for inflation. As a result most of
the taxable gains will be “illusory”. Inflation this
year is expected to be 5.5%. Let’s say that results in
the value of an investment property rising from say
$300,000 to $316,500. At Labour’s 15% CGT rate the tax
payable on sale would be $2,475 even though the “real”
inflation adjusted value of the property has not changed.
What’s fair about that? The more inflation the
government creates, the greater the tax it will collect.
all capital gains on the sale of investment property would
be taxed Labour would retain the existing “intention”
test (detailed shortly) so those who buy with the
intention of selling would still be taxed at their
marginal rate as though it were income. That would
actually add to the confusion that already exists. Most
countries with a CGT do not mix income and capital gains
in this way.
are just some of the problems with Labour’s CGT and have
been widely discussed over many decades by various expert
panels. For example, in 2001 the McLeod Committee concluded,
do not consider that New Zealand should adopt a general
realisations-based capital gains tax. We do not believe that
such a tax would make our tax system fairer and more
efficient, nor do we believe that it would lower tax avoidance
or raise substantial revenue that could be used to reduce
rates. Instead, such a tax would increase the complexity and
costs of our system.”
of the ironies in the debate is the lack of attention given to
the fact that New Zealand already has a capital gains tax
regime. Unfortunately its application is far from clear and
therefore not widely understood.
very simply, a taxpayer is liable for income tax on capital
gains if they deal or trade in an asset, or if they bought the
investment with the intention of resale at a profit.
If, on the other hand, they made the investment with
the intention of providing a taxable income stream then
capital profits, should any arise, would not be taxed.
take a hypothetical example of a young entrepreneur who sees
how well ebay has done overseas and decides to replicate the
service here in New Zealand. Let’s assume he has also seen
how IT entrepreneurs in the US start-up then sell businesses
and become fabulously and famously wealthy in the process.
“Why not here?”, he thinks and enters into the venture
with the intention of building the business and selling a few
years down the track. He
does so, with the help of some passive investors, and a few
years later they pocket many hundreds of millions of dollars.
Given those intentions, the capital gain would be treated as
income, and income tax would be payable.
on the other hand that entrepreneur says they started the
business with the intention of holding for the long-term to
reap the benefits of the substantial annual income BUT THEY
JUST HAPPEND to sell it a few years later for a very large sum
to a very willing buyer, then the gain on sale would not be
of course, is a state of mind. Only our young entrepreneur
knows what his intention was when the investment was made
but in tax law it is the IRD, not the taxpayer, who has the
say on this matter. The IRD will attempt to determine
intention by looking at the circumstances surrounding a
transaction, and it is for the taxpayer to prove otherwise
should they disagree with the IRD's assessment.
the IRD determined that our young and now very wealthy IT
entrepreneur intended to sell (perhaps from evidence of their
past investment habits, how much equity they had in the
business, whether they drew profits, the correspondence
surrounding the transaction, and so on) then tax would be
payable. Conceivably the young entrepreneur could say, “It
is soooo unfair that I did not pay tax on the gain, so I
hereby declare it was my intention to resell at a profit and
therefore I would pay tax on my gain”. Usually taxpayers are
not that obliging.
is fair to say that many investors have conveniently not taken
a lot of notice of this rule and blindly assumed gains to be
non-taxable. Many property investors now know differently
given that over the last few years the IRD has actively
“reminded” them of their obligations and collected many
hundreds of millions of dollars in additional tax revenue as a
the IRD tends to send these reminders to investors AFTER a
boom has past. It would be more appropriate to do so during a
boom, when investors would be in a better position to pay.
is no doubt the current law regarding the taxation of gains on
the resale of an asset should be clarified and simplified, if
only because that lack of clarity
puts the taxpayer at risk of an unexpected and potentially
ruinous tax liability.
unfortunately, takes us further away from the clarity
required, and worst of all has put politics before prosperity.
from fruit and vegetables is another example of a policy
promoting what sounds good rather than what will
work in practice. While
retailers may initially reduce prices to reflect the absence
of GST (and when all eyes are on them to do so) there is no
guarantee that over time the retail price would not increase
to its former price point.
our Labour MPs really are tax experts and know a lot more than
those with a high degree of specialised knowledge who have
already looked at and rejected a CGT. I don’t think so. If
this country is to reverse the slow economic decline we need
to wise up to the fact that the heavy handed interventions of
our politicians are a dead weight on our economic future.
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