Recently, the Tax Working Group (the Group) released its final report, setting out its recommendations and the design of the proposed broad taxation on capital gains (TCG) – aimed at addressing the structure, fairness and balance of our tax system.
Exactly what form will the TCG take and what will it mean for you, if introduced? Below we discuss a few scenarios that highlight how the recommended TCG could work and whether a TCG would indeed be fair.
The most anticipated (and controversial) new recommendation and the one likely to elicit the most passionate debate, not to mention political jostling in the months and years to come, is the extension of TCG from residential rental investment properties. There was a consensus amongst the Group TCG should at least be extended to residential rental properties – ostensibly to halt the regressive effect of benefiting the wealthy.
The Labour government has indicated any TCG would be tested in the 2020 general election, and (if successful) would be implemented on 1 April 2021 – an ambitious timeframe that would require the introduction of draft legislation by the end of this year. The National Party has already stated that it would not implement any TCG if it is elected in 2020.
In proceeding, it will be crucial that the Inland Revenue is fully resourced and has the capability to develop and implement the new tax.
There is a very real risk the implementation of a rushed, poorly designed TCG would cost taxpayers heavily in compliance and undermine the fairness it is striving to achieve.
What remains to be seen over time of course is whether the fiscal take from a TCG, compared with the record-keeping, compliance and efficiency costs of implementation and administration, is worthwhile. It may be a risky approach – a rapid downturn in our market could see the forecast $8.3 billion take, intended to fund tax cuts to the more needy, replaced by capital losses that could be offset against other or future forms of income.
Whilst rental prices are likely to increase, it remains to be seen whether introduction of any of these measures will dampen the housing market which is affected by other factors such as immigration policy and consent approval bottle necks at local government level.
Further comment on the TWG report is expected from the Government this month.
What did the Group say about taxing capital gains?
The Group has recommended a broad TCG will apply to:
shares (listed and unlisted)
intangible property such as goodwill, intellectual property (patents, trademarks and copyrights), debt instruments, contractual rights and software
land and improvements excluding the family home and personal assets but including holiday homes, farms, commercial and industrial properties and other investment properties (including land owned overseas).
Specifically excluded assets are proposed to include:
the family home
personal use assets such as a car or boat, jewellery and fine art
certain shares in foreign companies.
The TCG is proposed to be levied on “realisation” – which could include transfers within a family (aside for on death) or to a family trust – at the person or entity’s marginal tax rates, with no allowance for inflation. The gain would be measured from the implementation date – “Valuation Day”, which could be as early as 1 April 2021.
Not all gains would be taxable as the Group has recommended some “rollover relief” which will defer the taxation of capital gains until a later disposal in circumstances including:
transfer of assets on death, but no relief on gifting while the donor is alive (apart from to spouse, civil union or de facto partner);
business restructures that result in disposal of assets but no change in ownership in substance;
small businesses with less than $5m in turnover that sells business assets if the amount is reinvested in the business;
a one-off concession to be designed to provide relief for the first $500,000 capital gain made by business owner on sale once reaching retirement age; and
specific measures to deal with Maori collectively-owned assets.
So what could we expect from a TCG and what could it mean for you, based on the Group’s recommendations?
What if my personal home and other properties currently occupied by family members are owned by a discretionary trust?
Your home may be excluded from TCG if you are the settlor of your trust, or you are a beneficiary who becomes irrevocably entitled to the property or the proceeds of the property. This could have wide-reaching implications for family discretionary trusts that hold properties, not occupied by the settlor of those trusts – a common feature in NZ. To qualify under the home exclusions the trustees of your discretionary trust would need to resolve to distribute the properties or the sale proceeds relating to those properties, currently occupied by your family members, to those family members in order to qualify.
I am 70 and in good health. I own three properties and would like to gift one to each of my children given they are struggling to enter the New Zealand property market. My will leaves a house to each of them but I don’t want to wait until I die for them to take over these properties. What are the implications for me?
Unfortunately the recommendation is to provide “roll-over” relief where your children inherit the properties on your death. They would also acquire the value of the properties on Valuation Day of cost to you and would need to pay TCG if and when they sell the properties. If you gift the properties to your children while you are alive, the difference between your cost base and the property values at date of transfer will be subject to TCG. This is a cash cost that you will need to be able to fund. If you don’t have other cash or assets you could liquidate to fund this cost this could be a real problem.
What if I own a house in New Zealand, which I used to live in as my main home, but have relocated to Australia for work with my family? I still use my New Zealand home when visiting New Zealand, but am treated under the double tax agreement with Australia as being tax resident only in Australia.
It is proposed your home will not be eligible for the excluded home exemption as the exemption only applies to New Zealand tax residents.
My wife and I met and married for a second time each. We still live in our respective homes with our respective children who attend different schools at the opposite ends of Auckland and don’t want to live as a “blended family”. What will happen when either one of us sells our home?
It is proposed if you genuinely have two homes you can each have an excluded home. However, this can only be the case for three years, after which only one property will be your and your wife’s excluded property. This result may require reconsideration of relationship property agreements and an allocation of the benefit of this exemption. Also when does the three year measurement start and how does one determine, when living in separate homes, when a “couple” relationship begins? The report addresses married couples in its examples, but makes no mention of “de facto” couples. These rules could start to drive personal and family decisions based on whether these rules can be circumvented.
When I separated from my partner I took over the family home that had a substantial mortgage. To enable me to meet the mortgage payments I have a boarder who shares the common living areas in my house – will this impact my ability to claim the exclusion for my home on sale?
The recommendations propose where you use more than 50% of your property as your residence you could treat the whole property as your excluded home. However if you are deducting expenses, such as a portion of your mortgage interest, against your rental income, when you sell your home you will need to pay tax on the portion of the property that was used for income-earning purposes. The proposal is an apportionment of sale proceeds across the floor area devoted to income earning – common areas could be 50% private and 50% related to income-earning. This could result in a significant portion of the capital gain, say 40% being taxable. Alternatively, you may elect to not take any deductions against the income you receive from your boarder. Either way this is going to make your efforts to manage your mortgage outgoings more expensive for you – a cost that will invariably be passed on to students or boarders looking to rent a room to manage their own living costs, which is not a fair outcome.
I recently sold my home and put half the proceeds into a commercial property and the other half into a downsized apartment. I run a car mechanic service business from the commercial property. What happens if I sell the business?
You will be taxed on any increase in the value of your business assets, including the business premises, from Valuation Day – you might have been better off to retain your home and rent your business premises.
I hold the shares in my family business. We have been growing steadily to the point where our turnover has just exceeded $5 million per annum. We are now in a position to sell some plant (which has increased in value) and upgrade to larger more productive plant as part of our business expansion strategy. The new machinery will also enable us to employ 5 additional staff members. Will the business be taxed on the gain on sale of our equipment?
Yes, any gain on the value of your plant post Valuation Day will be a taxable gain as your company will no longer qualify for the relief to businesses with turnover up to $5 million. So, despite your company’s contribution to the economy by employing 5 additional people your company will be required to pay tax on the sale of your equipment.
If I sell my shares in that company will I be taxed again on the gain in share value that was created in part by the sale of equipment and investment in more expensive plant?
Yes you will be taxed again on the increase in share value if you have not distributed profits by way of imputed dividend or taxable bonus issue. Some tax planning would be required to manage this.
I have a Kiwisaver fund – what will happen when I redeem my interests in this fund?
The Group has recommended sales or redemptions of interests in portfolio investment entities (PIEs) including Kiwisaver remain exempt, therefore this redemption should not be subject to TCG.
I have bought some shares – over the time I have held them they have only increased in value at the same rate as inflation. Will I be taxed on the increase in value?
Your shares will need to be valued on the Valuation Day (which could be 1 April 2021). Any increase in value from that date, even if it only matches an inflationary increase in value, will be subject to TCG. You are actually no better off than when you bought the shares, in fact you would be worse off than you were before you bought the shares – an unappealing proposition. Consideration of these implications will need to be taken in to account to guard against a disincentive to invest in the NZ market, particularly given the recommendation that the current level of taxation of foreign shares under the fair dividend rate method is left unchanged.
As can be seen many of these outcomes do not appear fair, but are they perhaps less unfair than the current position?
What else is included in the recommendations?
In brief, aside from the TCG recommendations, the following key recommendations were made:
Taxation of business:
- no changes to company tax rates nor imputation credit regime;
- various changes to the loss-continuity rules (primarily aimed at start-up businesses);
- expansion of deductions for black-hole expenditure;
- raising the threshold for provisional tax, increasing the closing stock adjustment, increasing the automatic deduction for legal fees (which may also expand to other types of professional fees), and reducing the number and complexity of depreciation rates; and
- a suggestion the Government could look at reintroducing depreciation deductions for buildings if a tax on capital gains is introduced.
Various recommendations have been made to fund and support a faster transition to a more sustainable economy and offset the impact of such taxes on modest-income households. These behaviour modification recommendations include
- expanding coverage and rate of the Waste Disposal Levy;
- strengthening the Emissions Trading Scheme (ETS); and
- advancing the use of congestion charging, similar to cities like London.
Also discussed are measures that address water pollution and the extraction of water from rivers, streams and aquifers.
A recommendation of welfare transfers by
- raising the threshold for the lowest income tax rate from $14,000 to $20,000 or $30,000; and
- possibly increasing the second tax rate from 17.5% to 21%.
No reduction of the top marginal rate was recommended due to it being recognised as low by international standards.
- Incentivise participation in Kiwisaver for low income-earners through various measures.
Recommendations were also made on a raft of other matters requiring significant government attention in relation to the future of tax in New Zealand.
What may not be apparent from this summary but what is clear from the report is there are myriad issues and legislative amendments that would require in depth consideration before introducing any form of TCG. Our current tax system, according the report, works well. Any TCG changes will have wide reaching implications and will need to be carefully managed.
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Bridget is an experienced tax advisor with over 20 years’ experience. She has worked for both large accountancy and law firms and her experience across both disciplines enables her to fully comprehend the tax-related issues affecting business owners and individuals alike.
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