SPOTLIGHT – Capital Gains Tax – How would it affect you? Tax Working Group’s Final Report.

SPOTLIGHT – Capital Gains Tax – How would it affect you? Tax Working Group’s Final Report.

It’s been a big day today with the Tax Working Group (TWG) releasing their proposal on a comprehensive capital gains tax.

Before we all get carried away, a TWG back in 2009 also recommended a capital gains tax reform on which the previous National government chose not to implement. The proposals need to be implemented and passed into law by Parliament to be in place.

Summary of their recommendations can be found in the link below:

Video from TWG has been created to explain a few simple examples on how it could apply:

They’ve suggested a broad capital gains tax that covers all productive assets (rental properties, business assets, Kiwisaver, shares, intangible property (e.g. Patents & goodwill). Exemptions have been applied for unproductive assets such as a family home (less than 4500m2 in land), personal items & vehicles. The proposal was designed to be tax neutral over a 5 year period yet will bring in $8.3b over these next 5 years which will need to be re-distributed. TWG have acknowledged that the majority of the tax take will be after 5 years so despite the crown’s promises it being tax neutral the net proceeds to the crown will likely well exceed the $8.3b.

Some of the members of TWG did not agree with the proposal and instead suggest a targeted extension of existing rules such as the Brightline test for property investors.

Ideology aside, good tax reform should encourage a productive allocation of capital to increase wealth for the entire nation.

Here is my summary of those who may lose out from the capital gains tax proposal.

There are well over 2 million Kiwisavers who will be impacted by the proposal. The proposal suggests that the fund manager to pay the Crown the tax on the increase in overall capital gain from any investment gains. Losses would then incur a tax rebate. The tragedy here is that Kiwisaver is the jewel in the retirement piece for many young kiwis. It will ease the burden of the NZ Super in the decades to come and is a productive use of capital. Taxing these gains/losses and deducting the money in the same year will not only lose in an absolute sense but also would have lost on the opportunity for those dollars to compound over the decades to come. Kiwisavers would end up with a generally smaller balance come retirement than they would have otherwise.

Property Investors

The Brightline test has been a simple and effective tool to capture those who are intending to actually trade these properties. The broad stroke effect from the TWG proposal is that investors may be holding onto properties that are unproductive and after accounting for inflation would incur a loss which isn’t rebated. For example, if a property is bought for $500,000 and inflation runs at 2% p.a. in nominal terms after 10 years the $500,000 property would now be $609,500. Investor would then need to pay a marginal tax on the $109,500 difference. Assuming they are on a 33% tax rate they will incur a bill of $36,135. Over the 10-year period the investor would have actually lost money and would not be able to re-invest back into the market with an identical property at an identical price.

In our opinion any capital gains tax on property investors must have an allowance for inflation. Given the incentive to buy unproductive assets we’d expect less houses ‘adequate’ to a family’s needs, and more bespoke, larger homes as there is an incentive to park the majority of capital into a tax efficient asset such as a family home.

We would expect overall house turnover to decrease and there is an incentive to hold onto non-performing properties. It’s hard to say how this will impact house prices, but with a lower quantity of houses on the market the market would become more volatile as there would be less records to evidence an average price.

It would also incur cashflow issues to investors in a cross -guarantee scenario. Bear in mind, this below scenario is applicable without CGT in place either.

Let’s consider an example; I’d like to introduce you to Bill & Jane, a couple in their early 30’s on a modest salary.

They bought a house in the town they grew up in 10 years ago for $200,000 and took out a loan with ABC Bank for $160,000. 10 years later, their mortgage was $50,000 and there were job opportunities in a nearby town and they bought a house for $450,000 via a cross guarantee at ABC bank as their new family home. This was 100% financed with the equity from their rental property.

Life was good, not long later they had the confidence to start their own business and they just found out they were expecting their first child. Their rental was now worth $400,000 so they decided to sell, with the idea to repay the original ($50,000), pay down enough of their new loan to get to 80% ($90,000), pay for the capital gains tax ($60,000* based on 30% tax rate) and the rest will be reinvested into their business ($200,000).

On settlement day what will the bank do? There isn’t any income (based on the fact the business is brand new) to pay for the remaining $360,000 loan so the bank will take 100% of the proceeds. Bill & Jane end up with a mortgage of $100,000 and their current family home of $450,000. There is no money aside to pay for the capital gains tax bill and no money to invest into their business.

They do have options and provided an appropriate loan structure when they bought their next property could have avoided this situation. However, many kiwis would end up precisely in this predicament.

Property Developers

Minimal direct impact. Property developers already undertake a taxable activity.

Business Owners

In our opinion we’d expect businesses to carry on as normal. The businesses most impacted by the proposal are those who invest in research & development and those selling their businesses. Smaller businesses would not bother going through the expensive sales process and will simply liquidate.

Share Investors

It would only encourage divestment from this already lacking investment class in New Zealand.

Hon. Grant Robinson, Labour’s Finance minister has clarified they do not intend to implement all of the proposals. The report had made some allowances for income earners with less than $48,000 p.a. such as removing the ESCT that employers pay on their Kiwisaver contributions. The winners would be the accountants, lawyers and bureaucrats who will be kept busy with this proposal as well as anyone impacted by the $8.3b in tax dollars over the first 5 years.

I challenge us all to put ideology aside and open this conversation for debate with each other.

Comments 3

  • JasonFebruary 21, 2019 at 6:11 am

    Well put. After reading the proposal I also fail to see how any of the recommendations benefit anyone other than bureaucrats and accountants. The tax reduction for low income earners is so little it’s almost pointless. Middle income earners are disincentivised from saving, investing, and getting ahead. And the wealthy will simply adapt and restructure their affairs in more tax efficient ways. Here’s hoping that if this comes into effect that significant wealth isn’t moved offshore.

  • Alan WilloughbyFebruary 22, 2019 at 9:05 am

    It has been said that you will never make the poor richer by making the rich poorer.
    CGT is largely a tax on inflation, as was pointed out. There are numerous difficulties with the concept. If you owned a piece of bare land and sold it, you would not pay tax on the difference between valuation when CGT comes into being and the sale price if it was less that 4500sqm. But what if the owners had built a house on the land and then sold it? Would they be liable for CGT on the total sale price, on the sale price less the value of land on CGT date, on the value of the house only (even though the money paid to the builder would have included tax)? If you have a house and add value to it by extending, then sell it, do you pay tax on the total increase in value, do you pay tax on the increase in the original house until it is valued when the additions start plus the increase in value from when additions are completed until sale date? If the latter, a minimum of three valuations are required – do we have enough valuers to cope with the added valuation load? How many valuers will be required on 1/4/21 to value every rental house, business and commercial building in NZ? Who will pay for the valuers? It is of benefit to the govt, but I’ll bet they won’t be the ones paying.
    Frankly, like Tony Alexander, I’ll believe it when I see it.

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