By Aaron Quintal*
Another election has come and gone, with the most heated debate being whether we should tax capital gains. An important point that got lost in the discussion is that New Zealand already taxes a lot of capital gains under specific regimes in our income tax.
The most pervasive of these regimes is the financial arrangement rules, covering the taxation of everything from debt instruments to deferred property settlements to currency contracts and derivatives.
In short, any gain made on a financial arrangement, such as selling a corporate bond for more than you paid for it, is currently taxable under New Zealand law regardless of whether you are in business or not and regardless of why you purchased the financial arrangement.
These would usually be treated as a capital gain in most other jurisdictions and often subject to preferential rates of tax under their CGT. Not so in New Zealand, where the full amount of the gain is taxable at the taxpayer’s marginal tax rate.
Many gains from selling real property (houses) are taxable in New Zealand. Despite the common misconception, you do not need to be “in the business” of buying and selling houses in order to be taxable on the gain.
If you buy a house to do-up with the dominant purpose of selling it for a profit, you are taxable on the gain you make (subject to certain exclusions where the house is your family home and you don’t engage in “regular pattern” of do-ups).
Even if you don’t have the purpose of selling at a profit when you buy the property, if the project involves a subdivision of the land or substantial earthworks, drainage or roading, any gain you make will likely be taxable as ordinary income if the work is begun within 10 years of acquiring the land.
To the people who rang talkback radio in the lead-up to the election supporting a capital gains tax, saying they had done up three houses in the last couple of years and, in the interests of fairness, they should be taxable on that gain – you probably already are.
In situations where there has been pressure on the income tax base from people trying to convert income payments into otherwise tax free capital gains, Parliament has reacted swiftly to amend the law. Restrictive covenant payments, lease inducements and proceeds from the sale of patents, all of which are generally capital gains overseas, are taxed in New Zealand as ordinary income. There are not, quite simply, vast swathes of capital gains waiting to be earned tax-free.
The big gap in the New Zealand tax base, and the one that rightly gets the most attention, is gains made on the sale of owner-occupied housing. However, these gains are not something any political party planned to include in the scope of their CGT at the last election and almost all overseas CGTs completely exclude or preferentially tax owner-occupied housing.
Although international comparisons are always difficult, the available data show New Zealand has a higher tax to GDP ratio than countries like Australia, the US and Canada even though they have capital gains taxes and higher tax rates than New Zealand.
This tells us their exemptions, carve-outs and gaping holes in their tax system mean New Zealand has a broader and more comprehensive tax system than many of our competitors, even though we don’t have a separate “capital gains tax”.
OECD warnings that the New Zealand tax system is narrowed by the lack of a comprehensive capital gains tax need to be taken with a substantial handful of salt.
*Aaron Quintal is a tax partner at EY.