Labour Party leader Jacinda Ardern is not ruling out a capital gains tax being implemented if her party wins the election on September 23.
Crowe Horwath managing tax partner ScottMason looks at the implications.
AS another election looms, once again the spectre of capital gains tax (CGT) arises, initially in the form of Labour announcing it would extend the Brightline rules from two years to five years (for residential property).
Now, a comprehensive CGT is a probable key policy plank for Jacinda Ardern, suggesting such would probably be introduced in the next term by a Labour-led Government — but with no details available.So, is a CGT a good or bad thing for the economy, and for NZ Inc? There are, in fact, some good reasons for it and some good reasons to avoid it. In my mind, it all comes down to the desired outcomes, the detailed design, including how comprehensive it is, and the way it is transitioned into effect.
Let’s start at the beginning. We could all agree there are currently inequities created across the tax system by having a capital/revenue distinction, not least around favouring some forms of investment, which drives economic imbalances for the allocation of capital towards such.
Accordingly, gains from selling certain investments, such as long-term property (residential and commercial), New Zealand shares, business goodwill, and non-business appreciating assets such as artwork, vintage vehicles and the like, can be tax free.
Every KiwiSaver participant also receives special treatment via concessionary taxing regimes for portfolio investment entities (PIEs).
Some would argue that not only do these certain asset classes attain a benefit, but that likely holders of those assets are themselves a subset of society, thus potentially discriminating against the less well off.
However, it is important to note that New Zealand has a number of pseudo-CGT regimes already.
For example, there are specific regimes in place that generally tax any gains from land that is developed or bought for resale, from residential land (outside your main home) held less than two years via the Brightline test, from foreign shares via the FIF rules, from financial arrangements, and from any other assets acquired with an intent of resale. Therefore, not all gains from capital are created equal, and exempted from tax.
There are arguments that CGT opens up the flow of capital by not favouring certain asset classes such as land, and counter arguments that it can lock up capital inter-generationally because assets are not sold when they really should be, so as to avoid the tax leakage.
Legislated holding periods can address this latter point to a limited degree.
The most likely political rationale for promoting a CGT in New Zealand is around perceived fairness, where certain transactions beyond the reach of ‘‘ordinary’’ New Zealanders, whomever they may be, fall outside the tax net, and around addressing the popular view that the wealthy are favoured by the tax system.
However, CGT should not be sold as an envy tax to snag those rich so-and-sos who we think don’t pay their way.
It should be seen as a way to create absolute fairness to all while removing barriers/preferences from the economy, eliminating the difference between income from effort (wages/profits) and income from certain kinds of investments.
I get the frustration of the salary earner who can only save after-tax dollars and gets taxed on the interest earned in the future, and therefore ends up with less than the person who generated the exact same amount of pre-tax wealth from their land (say, a farm) and sold it for a tax-free gain.
So that could support the application of CGT to business assets to produce a fair outcome.
However, what if I choose to invest every dollar I earn in my business, compared with you who invests in your house, and at year 30, we have the same amount of value to sell. Is it fair that I get taxed on the sale proceeds of my business under CGT, but you get to retain 100% of your house sale proceeds? I would suggest not.
If we were to move to a CGT environment, a critical questions is: should it apply to every asset class equally, including all houses, rather than exclude family homes, as the Greens and Labour will probably suggest in the form of political expediency?
This home exclusion would create an even greater investment bias, and likely over-weighting, towards non-productive, high-value family homes, which ties up valuable capital within the economy.
Will holiday homes be in or out? Further, if landlords are treated differently from home-owners, won’t rents have to go up as they try to achieve the same return, or will supply tighten again, driving up rents? Would this also drive greater demand in ‘‘growing regions’’ like Auckland and negatively affect the regions?
Should a hybrid approach be taken to homes whereby ’’average’’ annual proportional increases in value are ‘‘protected’’ but anything above that indexed increase in value is subject to CGT?
Then there are flow-on questions to be answered. Are there other assets we want to specifically capture, or exclude, for wider reasons? Should your KiwiSaver scheme be taxed the same way as the person who chooses to invest directly?
On what basis would CGT be introduced? Will we have ‘‘valuation day’’ for every asset in the economy, which is a massive undertaking, and apply CGT to every asset sale from then?
How will the markets react when previous investment decisions under one set of rules are no longer economically valid, and could, say, the NZX collapse as a result?
These key decisions affect nearly everyone, directly or indirectly, so we all have a stake in this.
Furthermore, if a material and fair CGT system were introduced, how would the proceeds be spent and would this allow for marginal income tax rates to be reduced?
Imagine a tax system in which all income, irrespective of source and nature, was taxed at the same low 15-20% rate, assuming our welfare system would continue to support those on lower incomes; in which there were few exclusions (if any); and in which tax advisers were pretty much unneeded.
In essence, if there is a possibility we are going to have CGT foisted on us, and current polling suggests that this outcome hangs in the balance, the big issue very quickly becomes around design, and don’t we need to understand and debate that while we still have the chance to influence it via our votes?
When have we, as voters, ever been willing to take that blind leap of faith on such an important matter?
What we have seen around the world, especially in minority-government political systems like ours, is that new tax regimes become politicised post-election. The downside of this is, generally, complexity and thus compliance costs and unfairness.
Without question, most countries have CGT in one form or another, but almost every one of them has struggled to settle on a system that works without hugely distorting the economy, mostly because housing is wholly or partially excluded.
CGT has often been introduced as a ‘‘plus’’ tax, rather than as part of an overall review and reform of the tax system, which brings its own issues.
If you are interested, use the UK as a case in point. CGT has been a political football since inception, resulting in continual changes, especially around the vexed issue of how to deal with inflation.
Huge uncertainty, demonstrated by the degree of case law, has driven an undue focus on mitigating CGT, which in itself is not healthy for an economy — just for tax accountants.
So it is incumbent on the voting public of New Zealand to question the Labour and Green proposals, to seek the detail, and to challenge the ‘‘political-ness’’ of design drivers of any proposed CGT.
It is not good enough to have a discussion simply about yes/no at a sound-bite level. It is critical that the quality of debate digs deep into the detail so we can all make an informed decision come election day and, if we do have a change of government that results in a CGT system, that system must be the best, fairest and most investment-neutral that we can get.
Because once it is in, it is in forever and will affect everyone.
●Scott Mason is the managing principal of tax advisory for Crowe Horwath.
