Welcome to 2021. So what lies ahead in the tax world this year? Well, firstly, housing will remain an issue and I expect we will see steady calls for radical action on this front, including a demands for a capital gains tax. I actually think it's gone beyond the point at which a CGT would have an impact.
In terms of tax measures, as I've said previously, restricting interest deductions including applying the existing thin capitalisation rules to investment properties might help to even the playing field between investors and first-time buyers, a group to which the Government appears to be paying particular attention.
Susan St. John has called for the Risk-Free Rate of Return (which is similar to the Foreign Investment Fund fair dividend rate rules) to apply to investment property. And her suggestion was recently echoed by Professor Craig Elliffe, who was a member of the Tax Working Group.
The Tax Working Group looked seriously at the question of applying a Risk-Free Rate of Return to investment property. It estimated the revenue from applying a rate of 3.5% would be approximately $1 billion in the first year and was expected to rise to $2 billion per annum within 10 years. The expectation would be that such a move would,
“tax a currently undertaxed asset class more adequately and act as a curb to burgeoning house prices. Westpac economist, Dominick Stephens calculates that a 10 per cent CGT would reduce house prices by nearly 11 per cent. It is unclear what effect the RFRM, but it should stem the increase. But it's not clear what effect a Risk Free Rate of Return method would have, but it should stem the increase.”
Now, tied to the question of housing is the issue of wealth inequality, and I expect we will continue to see calls for a wealth tax. Over in the UK just before Christmas, their Wealth Tax Commission released a report recommending a one off wealth tax for the UK, which it estimated could raise about £260 billion over five years. What was particularly interesting about this commission is the depth of the research into the topic.
Quite apart from the final report, the Commission produced a series of other working papers on the design and operation of wealth taxes around the world. And these, in the commission's own words,
“represents the largest repository of evidence on wealth taxes globally. To date, it comprises half a million words across more than 30 papers covering all aspects of wealth, tax design and both in principle and practice.”
Just to put that in context, I estimate the Tax Working Group’s consideration of wealth taxes amounted to perhaps 10000 words in total. So we are looking at a very significant amount of research.
Now, one other thing to keep in mind about the British Wealth Tax Commission was that it called for a wealth tax, even though the United Kingdom has a capital gains tax and an inheritance tax. Instead, it recommended a thorough review of those existing taxes. The Commission also went for a one-off tax rather than an annual wealth tax, which is the common type of wealth tax currently and what the Greens propose. The Commission saw that there were quite a few practical issues around the operation and an ongoing wealth tax. These issues together with political pressure, has meant that the use of wealth taxes has declined throughout the OECD.
The Tax Working Group also concluded that an annual wealth tax would have enormous practical issues in implementation, which is why it did not recommend it.
But what the Wealth Tax Commission’s research makes clear is just how unique New Zealand's approach to the taxation of capital is. It's well known that New Zealand does not have a comprehensive capital gains tax, but that's not entirely unique within the OECD. Switzerland, for one, does not have a capital gains tax.
Where New Zealand is unique, is that it does not have comprehensive taxation of capital in any form. Switzerland has a comprehensive wealth tax. In fact, the tax it raises from wealth taxes represents one per cent of GDP, which is the highest of any country with a wealth tax. Wealth tax revenue amounts to 4% of the Swiss tax take so it's an important part of the Swiss tax system,
Wealth taxes in the OECD do not raise significant amounts of revenue and that's one of the reasons they've been declining in use. The Wealth Tax Commission's papers are well worth reading. A particularly interesting one is about the political economy of the abolition of wealth taxes in the OECD, which those who want to promote taxation changes would do well to read closely.
I think pressure will continue to mount on the Government on the taxation of wealth because of this ongoing anomalous position where we don't tax capital on transfers by way of an inheritance tax or even a stamp duty, and not tax increases in value generally will feed into the debate around inequality.
And there's an interesting point a client made to me on this topic. It’s been a long-standing New Zealand policy to attract high net worth individuals to come to New Zealand. Such immigrants may well qualify for a four-year tax holiday on their non-New Zealand investment income. These people being wealthier tend to have very diverse investment portfolios.
But as the client pointed out to me, it seems wrong that their investments would be taxed on their capital growth under the Foreign Investment Fund regime whereas property investors who are not taxed on that growth at all. My client thought that was an anomaly that sooner or later would start to act as a disincentive for high-net-worth migrants to New Zealand. This may lead to growing political pressure to level the playing field, so to speak.
So anyway, the taxation of wealth, whether through a capital gains tax and or a wealth tax or some other mechanism, is going to remain on the agenda.
A week before the British Wealth Tax Commission issued its report, our Government declared a climate change emergency and joining 32 other nations who have made such a declaration.
Now in my first podcast of last year, I said that the role of environmental taxes as one of the tools in the meeting our emissions targets will become ever more important. And that remains the case.
But we now have a new American president, and one of the first actions of President Biden after his inauguration was an executive order confirming the United States would re-join the 2015 Paris agreement. Now, several people have pointed out this may well act as an indirect trigger for the government to take further action on reducing emissions.
More than a few columns have pointed out that there is a discrepancy between the government's declared intentions and the actual steps being taken to reduce emissions and meet our commitments under the Paris agreement. One estimate is that New Zealand exceeded its national share of consumption-based emissions by more than a factor of 6.5.
So this year I expect we should start to see some movement on taxing emissions more thoroughly and a place they might well start because the transport sector is the biggest source of emissions is to change the taxation of motor vehicles, maybe by following the UK's example of applying FBT on the basis of emissions.
The government should also look at eliminating anomalies in the tax system, which effectively penalise low carbon activities such as employers paying FBT on providing free public transport. Another would be as a paper prepared for the NZTA suggested was maybe applying FBT to employer provided parking.
Biden's inauguration could mean swifter resolution to the issue of international taxation. I think this is one where we will have to wait and see because there will be fierce lobbying in the US by the so-called GAFA Google, Apple, Facebook and Amazon. I think progress will be made, but it will be slower than people expected.
And finally, the third trend I think we'll see this year is Inland Revenue coming out from its rather inward-looking attitude in recent years as it completes the final stage of its controversial Business Transformation programme. With the immediate impact of responding immediate requirement to respond to the COVID pandemic now over, (please people remember to scan) Inland Revenue can get back to its more regular work.
Already before Christmas we started to see a number of new initiatives including one in relation to following up on the information Inland Revenue received under the Common Reporting Standards on the Automatic Exchange of Information.
Another is reviewing all transactions potentially within the bright line test. You may recall that Inland Revenue fired out emails to tax agents advising “These clients appear to have made transactions within the bright-line test” which caused quite a stir. I expect we'll see more work going into that space, which coming back to the start of the podcast ties into the taxation of property.
And finally, I think we'll also see more activity going after the so-called cash economy. I think we'll see Inland Revenue start following up on cash transactions, such as tradies offering a discount for cash.
So we're going to have a busy year ahead, as always, and I will bring you the news as it develops. Next week, I’ll take a closer look at Inland Revenue, and its annual report which was released just before Christmas.
In the meantime, that's it for today. I'm Terry Baucher and you can find my podcast on website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients until next week, Ka kite āno.