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G & J

Capital Gains Tax –a Web of Unintended Consequences

New Zealand has had a capital gains tax for many years. Historically its use has largely been confined to property speculators, and smaller builders and their associates who often built “spec homes”. Some share market investors who made frequent share trades could also have fallen into the capital gains tax regime.

There have been plenty of arguments for an updated capital gains tax regime. No one in New Zealand has been able to come out with a capital gains tax proposal that is actually workable and with quantifiable results.

Countries such as Australia and Great Britain do have capital gains tax regimes in place. Anecdotal evidence suggests that most of the revenue that could possibly be attributed to a new capital gains tax regime would come from the increased taxable earnings of the compliance providers; i.e. accountants, registered valuers, financial advisers and lawyers.

Over the past few years, there have been changes in the taxation treatment of mixed use assets, such as holiday homes (from 2013/14), yachts and aircraft (from 2014/15). It is not uncommon for holiday homes (or indeed primary residential homes) to be rented out especially in peak holiday periods.

Historically obtaining a little holiday home revenue opened the possibility of tax deductions for mortgages, rates, and repairs and maintenance amongst others. Now this has been cut back dramatically, so effectively for a property that was rented out as a holiday home for 14 nights and used by the owners for 14 nights, only around 50 percent of the apportioned expenses would be claimable against taxable income. If the owners increased their use of the property to 42 nights the claimable expenses reduces to 25 percent.

The other dramatic tax change over recent years has been the introduction of PIE Tax, and a revised foreign investment fund tax. PIE tax is particularly important for the two million or so people who are KiwiSaver members. When it comes to the investment in most New Zealand publicly listed companies and most of the ASX 200 companies in Australia, there is no tax on the capital gains of those companies whose share price increases.

Add in a capital gains tax that encompasses those shares, there is likely to be a dramatic reduction in investment returns. This would impact on the standard of living for those people who have saved for their retirement through KiwiSaver.

If a capital gains tax were to be applied to rental properties, rents would need to be increased in order to provide a similar long term return on the property to what it would have been without a capital gains tax. Another unintended consequence could be a reduction in the number of rental properties, which would increase the need for more social housing.

New Zealand is a country where small businesses employ a large percentage of the non-public sector working population. Many of the owners of these businesses work for considerably less income than if they were working for a larger business. They often do this for lifestyle purposes. At some stage they will either sell or close the business. Currently if they sell, the proceeds are effectively a non-taxable capital gain.

If a new capital gains tax were to be introduced, it looks like there would be a massive number of exemptions, especially around primary residential property, which may or may not include properties owned by family trusts. This would account for a significantly high proportion of residential property sales.

If we take this into account, the two areas that most of the capital gains tax revenue would come from, would be KiwiSaver and the sale of businesses including farms. Between these two, well over half the population would directly be negatively worse off. We believe a far better way to raise taxation revenues would be a tax regime where overseas investors paid tax in New Zealand on their investments, rather than continuing to enjoy their favourable tax treatment.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.