Capital Gains Tax: What we know thus far…
Will a CGT redistribute wealth or just fill the Government coffers?
It seems that the discussion regarding New Zealand having a capital gains tax (CGT) is one that will last the test of time. Every election, every housing crisis, and of course every time a tax working group is formed, CGT is the hot topic. The question we have to ask is why?
What would a CGT look like?
For the purposes of this article we will look at what the Tax Working Group’s interim report has suggested as their vision of a CGT.
What could be subject to CGT?
Business assets including farms, land and buildings i.e. both residential and commercial property, shares and other forms of investments.
What is unlikely to be subject to CGT?
Family home, with strict guidelines on what constitutes the family home, and personal assets, i.e. cars, boats, jewellery, artwork etc.
How will it be taxed?
There are two methods proposed for calculating the capital “income” that will be taxed.
Actual Gains, the logical approach for most is to simply tax the realised gain, being the sale price less the original cost and any other additions/improvements.
Risk-free return, this method is not a new concept. Effectively a set percentage being the risk-free rate (often similar to the 2 year government bond rate, currently 1.8%) would be applied to an asset’s equity. This notional income would replace all other forms of taxable income from that asset.
For example, a rental property is valued at $1,000,000 with bank debt of $800,000, leaving $200,000 of equity. If we use the 1.8% as an example, this would result in taxable income for the year of $3,600. This amount would replace the rental profit or loss actually incurred. As you can imagine this method would have many winners and losers, those with a high yielding asset would have less tax to pay under this approach whilst those making rental losses would be worse off as they would be paying tax even though they received no income. As mentioned this is not a new concept and is already currently being used under the guise of the Fair Dividend Rate (FDR) method applied to foreign shares.
What tax rate would apply to the capital gains?
This has not been particularly clear, and recommendations for various tax rates will be made in the final report, however it is clear that the risk-free return method would likely be taxed based on the standard income tax rates i.e. marginal rate for individuals.
What will happen to the capital gains generated before a CGT was introduced?
It would be unlikely that any CGT would act retrospectively, and the report has suggested two ways that might address this issue. Firstly and most likely would be a national valuation day, think council valuations done all at the same time. This valuation would form a new cost for the asset and therefore would only look to tax gains generated after the national valuation date. The second method would be for CGT to apply to any assets purchased after legislation was introduced. The latter is less likely as it would be difficult to keep track of the purchase date of all forms of asset, and would also take the collection of tax longer as many would choose to retain assets acquired before legislation came into effect over purchasing new assets.
The effectiveness of a CGT may come down to whether the Government chooses to play Robin Hood, using CGT to increase the household net income, or the Sheriff of Nottingham. When faced with the artificial attempts to decrease property prices via foreign buyer bans, ring fencing of losses and reserve bank restrictions, I have to wonder whether CGT would be the lesser of two evils.
Want to keep up with the changing landscape of property investment? Then contact the team at Withers Tsang.