CGT comes at a cost, may not deliver much
By Mathew McKay and Hayden Roberts
“Pure and tough” was how one former member of the Tax Working Group described the group’s capital gains tax recommendations to a Bell Gully event.
That description may do little to allay concerns about the results of the working group’s 12 months of deliberation, which saw the majority (with an 8:3 split) recommend a broad extension of the taxation of capital gains in New Zealand.
“It’s tougher and purer than the capital gains tax the Labour Party campaigned on for two elections and lost. Much tougher and purer,” former Deputy Commissioner of the IRD Robin Oliver said at the event. At pains to point out that they no longer speak on behalf of the Tax Working Group, Oliver and former Bell Gully tax partner Joanne Hodge gave some insight into its recommended outcome, which many already anticipate will not result in a tax as pure or as tough once the Government responds to lobby groups and selects from among the group’s recommended reform packages.
The capital gains tax recommended by the working group would become effective on April 1, 2021. It would apply only to gains made on assets after that implementation date (with a valuation of assets required as at the implementation date), apply at ordinary marginal tax rates on the full amount of the gain, and operate under a traditional realisation-based model.
Although international comparisons are difficult, New Zealand’s lack of a comprehensive capital gains tax makes it stand out. But we will continue to stand out on the international scene should the recommendations be adopted in full. “It’s hard to see any other capital gains tax in the world that taxes at full (marginal) tax rates – it makes sense in theory, but it’s a tough result,” said Oliver.
He said the group faced very little political constraint beyond the exclusion of the family home and any kind of “death tax”. That resulted in relatively “pure” and comprehensive proposals by the standards of international regimes. In contrast, other countries have implemented capital gains taxes that are more politically driven – and subsequently not as tough. They tax capital gains at much lower rates than for labour and with many exemptions. “So when you say all these other countries around the world have a capital gains tax you are not talking about the same thing,” he said.
Politics may yet play a part. There is every indication the Government is keeping its options open. It has signalled a measured approach will be adopted, with options to pick and choose aspects of the Tax Working Group's recommendations. Ministers have indicated it is highly unlikely all recommendations would need to be implemented.
But if the tax is watered down significantly, a different question arises: Is it worth it?
Hodge said the “minority report”, from the three members of the working group who did not support a comprehensive approach to extending the taxation of capital gains, reflected a number of concerns. They included a negative effect on productivity, a lock-in effect where people hold on to assets in order not to pay tax, the potential for double taxation from taxing business asset gains and share gains, the significant complexity added to the tax system, and the “immense, mind-bogglingly difficult” proposition of valuing all the affected assets in the economy. “A lot of the CGT litigation in Australia relates to disputes over valuations,” she pointed out.
The forecast revenue over five years, from the CGT rules as proposed, amounted to less than would be raised by adding one percent to GST, she said. If the Government decided to water down these rules by imposing a lower CGT rate, introducing more exemptions and broader rollover, then a half a percent increase to GST would be a more relevant comparison. Under both scenarios the increased complexity of the rules would have a huge impact on New Zealand’s ‘simple tax system’ operating neutrally in the background.
Meanwhile there are risks around the timeframe: a government response to the recommendations this month, detailed design to be consulted on and completed by August, a bill introduced between October and December, then legislation passed and enacted by July 2020 ahead of implementation in 2021.
“The timeline is completely infeasible,” said Hodge. “If faulty legislation is enacted it will lead to lack of confidence in the tax system and taxpayers will take full advantage of any loopholes. Subsequent amendments will be needed and these just add to already heavy compliance costs.” All five of the tax experts were of the view the proposed timeframe for enactment would produce risk to the tax base and a later implementation date was required.
The extent to which the tax experts in the group weighed such concerns differently to the broader group is revealing.
While the broader group had an 8:3 majority for a capital gains tax, only five of the 11 members of the group are tax experts. Of the “tax five”, while there was still a majority in favour of a capital gains tax, it is by a narrow margin.
Oliver and Hodge, with Kirk Hope of BusinessNZ, produced the minority view paper and did not recommend the introduction of the proposed CGT rules
While Hodge said extending the taxation of capital gains had perceived advantages, which included improving the fairness and integrity of the tax system and levelling the playing field between different types of investments, in the end the minority could not support a comprehensive capital gains tax approach. Ultimately, the case for taxing more gains from residential rental property was the clearest, and that was where they favoured action.
“The minority view is: keep plugging the gaps, as we have been doing over time, and enforce our existing rules better,” she said.
Bell Gully partner Mathew McKay leads the firm’s tax practice and is a specialist in tax disputes and litigation. Hayden Roberts is a specialist income tax lawyer, and is a senior associate at Bell Gully, a Foundation Supporter of Newsroom.