4 Sep 2014

Q & A - Capital Gains Tax explained

5:11 pm on 4 September 2014

Labour plans to introduce a capital gains tax, or CGT, has hit the headlines. Radio New Zealand's economics correspondent Patrick O'Meara explains what a CGT is and what Labour is proposing.


What does a Capital Gains Tax mean for you? Photo: Photo NZ

What is a CGT?

It's a tax on the capital gain of assets like shares, bonds, and property.

Don't we already tax these things?

No, New Zealand is one of three countries in the OECD without a CGT of some kind.

But under the Income Tax Act capital gains can be taxed as income in certain situations. For example, speculators who buy a house with the purpose of selling can be liable.

Both National and the previous Labour government have encouraged Inland Revenue to ensure speculators in property hot spots didn't escape the net. But there's no doubt the current regime is ad hoc.

Ok, how much could I be taxed?

Labour's proposing a flat rate of 15 percent that will apply to any gain. But it won't be comprehensive. The family home is exempt, as it is in most other countries.

The CGT will apply once the asset is "realised" i.e. when it's sold. For example, if a person buys a house for $300,000 and later sells it for $400,000 then tax would be payable on the gain.

Is that all? Only the family home is exempt?

No, not quite. Personal assets such as furniture and boats, collectables like art and jewellery, and gambling winnings are also exempt.

Nothing else?

Well, small business owners who sell their assets, up to a maximum of $250,000, for retirement are exempt too. As are payouts from retirement savings schemes, including KiwiSaver.

What if you own a farm?

A CGT doesn't apply to the farmhouse, but the surrounding land that makes up a working farm will be liable.

So, the whole $100,000 in the above example is liable?

It gets a bit tricky here. The answer is not necessarily. It depends on when you bought the asset and when the proposed CGT is brought in.

Under Labour's plan, the CGT will only apply to gains realised once the tax is implemented, so past gains will not be affected.

When the tax is introduced, assets will be valued. This "valuation day" will determine the date after which gains will be subject to tax. This approach was taken in Canada, Britain and recently South Africa.

In the above example, if $90,000 of the $100,000 gain is made before the valuation, then the 15 percent CGT will apply only on the $10,000 gain after the valuation. That means the tax payable would be $1,500.

What happens if the asset loses value? How are losses treated?

Losses can be carried forward and offset against future capital gains, but not other forms of income. Labour say further limits on capital losses may be introduced.

Back to family assets - Do I pay a CGT if my house is in a trust?

You heard the Prime Minister, John Key in the leaders debate with Labour's David Cunliffe didn't you?

Labour's finance spokesperson, David Parker, says no, if it's your principal family home. But other assets in the trust may be subject to tax.

The family bach?

If it remains in family hands, then it won't. But if it's sold, then it will.

What about my parents house once they die?

Labour says there will be a grace period (the details of which have yet to be worked out) where the sale of the house won't be liable. After that a CGT will apply.

How much revenue will a CGT raise?

The gains are modest initially - $25 million in the June 2016 financial year - rising to $1 billion a year in June 2021.

But the forecasts are highly dependent on asset prices rising and the impact of a CGT on people's behaviour.

How many people will be affected?

Labour expects fewer than 10 percent, or 267,000 of New Zealanders will pay the CGT in any one year, based on Australia's experience.

And it says evidence from other countries show high income earners usually pay the most.

In Australia, those earning more than $180,000 paid 60 percent of the CGT. In Canada and the US the top 1 percent of taxpayers generated approximately 60 percent of the CGT.

The CGT will also catch non-residents as well. That would set apart from Australia, which doesn't tax them except in specific cases.

Labour Party finance spokesman David Parker (left) and party leader David Cunliffe outline the revised alternative budget..

Labour Party finance spokesman David Parker (left) and party leader David Cunliffe. Photo: RNZ / Diego Opatowski

It sounds complicated.

Well, most other countries have one and Labour argues New Zealand can learn from their past mistakes.

But tax lawyers warn a CGT will be complex.

For example, defining the principal family home could be difficult.

What happens if people inherit a second home or buy an inner city apartment to cut down commuting times, and then "flip" their principle family home from one to the next and claim a tax exemption if they sell?

Or where is the line drawn when selling the family farm where the farmhouse itself is exempt but the surrounding land is not?

Lifestyle blocks could also get tricky.

And what about homes that are also used for business purposes? And what if that changes over time?

Labour argues this will be sorted out by an expert panel, which will be established to deal with technical issues before any final decisions are reached.

And of course, the panel can draw upon the international experience to help set the rules. But there appears a lot of areas that will need to be thought out.

So why is Labour doing this then?

Labour argues that it's about fairness. Under a broad-based tax system, capital gains should be taxed alongside income. While some is captured under current tax rules, Labour says the system favours some taxpayers, mainly higher earners, over others.

Labour also claims CGT will also reduce investment in housing and encourage more into the productive sector, which in turn, should create jobs and growth.

And a spin off from that be of benefit to first home buyers. NZIER says investors accounts for 45 percent of annual transactions in the property market.

Hasn't a CGT been looked at before?

Yes, three tax reviews have looked at this issue in New Zealand over the last 20 years. And the OECD has urged successive New Zealand governments to adopt one.

But, it's never gone further than that.

Why's that?

Well, while the OECD has supported its implementation, it wants a comprehensive CGT.

That means one that includes the family home, and one that is based on a accrual basis not a realised basis.

That means tax would be payable on the annual increase in value of a capital asset and paid each year.

For example, if a house increases in value by $10,000 a year over five years, then a $1,500 CGT would be payable each year. Most countries reject this approach.

In New Zealand, the three tax reviews have not recommended a CGT.

The 2010 Tax Working Group acknowledged a CGT would be the most comprehensive option for base broadening, but like the OECD, it favoured a CGT that included the family home and was done on an accrual basis.

It noted a partial CGT, which Labour is advocating, would be complex and encourage people to re-arrange their affairs to avoid the tax, thereby limiting the revenue the government would collect.

It concluded the costs of implementing such a tax would outweigh the benefits.

It favoured a land tax instead.

The Tax Working Group's arguments centred mainly on efficiency arguments.

The Council of Trade Unions' economist Bill Rosenberg argues fairness shouldn't be easily dismissed. And he says greater fairness has an efficiency component.

He cites IMF research which found there is more danger to economic growth from high inequality than redistributive tax policies.

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