The Tax Working Group's interim report shows taxation of income from capital is ripe for reform & environmental taxation is central to the agenda, EY's David Snell says

By David Snell*

The Tax Working Group’s interim report leans towards extending income from capital, a bigger role for tax in sustaining our natural environment and a mild nudge towards boosting national savings.

They’re the main messages I took from Thursday’s launch lock-up with Sir Michael Cullen in downtown Wellington.

Sir Michael promised the Tax Working Group would take a “fair, large and liberal” interpretation of its terms of reference. It would kick start a national conversation on tax.

I’ll give them a pass mark on both topics. For me, today’s interim report recommendations boil down to two issues.

1. Taxation of income from capital is ripe for reform.

What would a capital gains tax – under another name – look like if the Government decides to follow Sir Michael’s heavy hints in favour of reform?

The group has put forward two options; it’s clear that reform is favoured, despite recent speculation to the contrary. Those options are:

 An extended tax on realised gains, which looks to have wide potential scope. Interests in land, intangible property, goodwill, business assets, shares and certain choses in action are all included, or

 A risk- free rate of return method, deeming a notional return from assets.

The report contains initial options and findings, along with some “roughly right” costings from which Sir Michael was at pains to distance himself.

Importantly, Finance Minister Grant Robertson has invited the group to choose between these methods in its final report. His words falls short of an instruction to recommend a tax. There is reference only to a potential capital gains tax. But Robertson’s words can be read as showing a focus on how, rather than whether, extended tax is a good idea in the first place.

2. Environmental taxation is central to the group’s sustainability agenda.

It’s pleasing to see the weight placed on setting a long-term direction for environment taxes. This is an opportunity not to be missed. Tax Working Groups do not come along very often. The Government has committed to a target of a net zero emissions economy by 2050 under a Zero Carbon Act, a Green Investment Fund, a Provincial Growth Fund and an independent Climate Change Commission.

The mass of scientific evidence shows our climate is changing, with carbon emissions the single biggest cause.

Primary sector industries are crucial to New Zealand’s future and to our national identity, with sustainability important across the sector. Sir Michael argues that even tourism is a land-based issue. It’s clear that the group sees sustainability as crucial to New Zealand’s long-term future.

Today’s interim report from the Tax Working Group argues the benefits from a tax approach to our natural capital are potentially largest when those taxed will change their behaviour: they have some low cost abatement responses.

EY’s own submission to the Tax Working Group highlighted that our taxes are poorly aligned with the environmental and climate costs of our economic footprint.

While statistics vary, according to the OECD, at 1.3% of GDP New Zealand’s revenue from environmentally related taxes is among the lowest of its members.

Environmental taxes are by no means the only way for government to respond to environmental issues, nor should they be the only response. However, I’d agree environmental taxes are an essential part of the Government’s toolkit, and can play a key role in delivering positive environmental and ecological outcomes in both the medium and long term.

What’s underplayed?

There is a sense of how the constraints in the terms of reference – no changes to tax rates, don’t cover tax’s impact on the transfer system and don’t tax the family home – have influenced the group’s thinking.

Taxing the self-employed under today’s changing gig economy needs a rethink. Re-examining the current employee/contractor boundary should have been examined.

Inland Revenue research shows the self-employed under-report income by about 20%, often in error rather than deliberately. It would have been great to see the group explore emerging opportunities to use technology and smart withholding techniques.

Tax conversation under threat

Sir Michael has narrowed down the national conversation. Feedback is actively sought from selected groups and specialists only. The report’s executive summary reads as if that conversation is in the past. For me, that’s a shame. Accessible language and innovative use of social media were crucial in delivering a record number of submissions, many of which were thoughtful and high in quality.

The debate will run for days.


*David Snell is EY’s New Zealand Tax Policy Leader.

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34 Comments

Well, if low yields, costs to meet increasing healthy home requirements, LVRs, and new rental legislation currently makes rental property not particularity great, it looks like the outlook it is going to get a whole lot worse.

What is Plan B for investing for a great retirement?

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11

Plan A still applies, save as much of your income as you can and invest in a diverse portfolio (which does not mean 'make sure your rental houses are on different streets')

RE: "Sir Michael has narrowed down the national conversation. Feedback is actively sought from selected groups and specialists only."
While my comment above regarding landlords being hit may seem a little flippant, I think that there are significant issues to comment on and which should be part of a wider debate.

As regards housing; home ownership is part of our culture and values (it is not the case for example in some European countries) as private mum and dad ownership of rental property(ies) which is critical, not only related to supply, but also traditionally a means of investment. I do not want to see a situation in future where our rental houses are largely owned by large investment groups or the extremely wealthy such as in European countries as it is not in the interests of both tenants and potential mum and dad investors. Such an event would be a significant social and culture shift.

The current cry for capital gains tax is a (over?)reaction and has been clouded by a unique period of sustained house price increases over the past decade. I believe (despite claims by some on this site who look to 2020 for the next take-off) we are unlikely to see a similar sustained period of increases in the medium term at least due not only to the market being over-priced, but through the use of LVRs for economic stability purposes.

And remember, a capital gain on shares or that on a business, means that in a crash or a business going bankrupt, losses will be underwritten by tax credits. While it will be argued, that capital gains on shares or increase of a business, or painting, should be taxed, there is outcry when in crashes or businesses going bust, governments need to cough up for losses.

Could be an outcry when they tax Kiwisaver capital gains

They already do, which is entirely the point.

No land tax or wealth tax, nor gift or death duties is a surprise to me given some of the talk. CGT is no surprise at all, but they haven't nominated the rate or said what will happen to the brightline test... hmmm

We already have a CGT, it's called the Brightline Test and was introduced under National

Exactly. Did anyone tell Doctor CULLen?

There is simply no hard scientific evidence that the globe - as distinct from smaller high density industrialised regions is warming due to anthropogenic emissions.

Pollution by way of what the IPPC terms carbon black in the scientific report to the policy advisers is indisputably warming areas where this pollution has settled - eg Greenland - but this is not caused by CO2.

The climate has always been changing driven by natural variability.

Global temperatures today are very similar to where they were in the 1300 -1400's.

We do not know what drives natural variability such a the little ice age of the 1600's. There is strong evidence that sunspot activity is important as shown by the very well documented Dalton minimum.

While it is correct to say global temperatures have risen ~ 1º since the pre-industrial period - it is a gross distortion to omit the preceding phrase " having fallen by ~ 1º from the preceding medieval warm period"

Global average temperatures as measured by a number of satellites show today's temperatures equal to the average of the last 20 years. http://www.drroyspencer.com/latest-global-temperatures/

Given the ever increasing CO2 emissions over that period - why are we not seeing any global warming ?

Record wheat harvests 3 times in recent years in the wheat belt of WA show more rainfall and moderate temperatures. Not less and higher temperatures as the IPPC models predict

It makes no sense whatsoever to make these very expensive commitments when the science reports from those who's jobs do not depend upon a man driven warming world simply have not seen evidence of anthropogenic global warming.

Nor do the basic laws of thermodynamics, radiation and gas laws allow for this to occur in an environment with an infinite cold sink above our atmosphere that simply absorbs, then rises with convection and radiates any rise in temperatures away to restore an equilibrium driven solely by the mass of our atmosphere, the force of gravity, the temperature of the sun, our distance from the sun and the albedo or reflectivity of earth.

Pollution - or a darker earth's surface will increase heat absorption without doubt - but it is not driven by CO2 a colourless gas.

What is the ideal temperature for our globe ?

Why do we keep returning to a pre-industrial benchmark when we know that was a particularly cold period with very poor growing conditions world wide ?

Time will eventually prove one way or the other the doomsayers right or not. In the meantime it makes not sense to impoverish ourselves for no good scientific reason. The very significant growth component of farming in this am's GDP release show just how dependent we are upon our traditional farming industries which we must maintain at all costs.

Given that temperature is a measure of the energy stored in any substance, and that weather systems are a way of the atmosphere to expend excess energy. Would you not agree that the current weather systems, the extreme hurricanes/typhoons, rainfalls, and localised temperatures are unusual? Did they occur in those other warm periods you refer to?

There is no evidence of increases in extreme weather. Hurricanes in particular are declining:
http://wx.graphics/tropical/global_major_freq.png

And the IPCC had this to say in their last assessment:
"The current assessment concludes that there is not enough evidence at present to suggest more than low confidence in a global-scale observed trend in drought or dryness (lack of rainfall) since the middle of the 20th century"

Media will always promote scares, even when they aren't backed by data.

They need to encourage people to invest in the economy not put them off.
Capital gains tax is a pretty stupid tax. I would prefer a stamp duty to be applied.

Far more efficient to collect rather than creating yet more income for accountants.

My suspicion is that whatever reductions are made to income tax to compensate for whatever capital or wealth taxes that are imposed, will not last. This happened with GST which the Lange government introduced and increased. That the Bolger and Clark governments retained. But the Clark government as well, spiked up income tax as if GST no longer existed. Key’s government did little to change the status quo. Income tax is just too much of an easy go to for politicians to resist and they don’t. There it is.

A risk- free rate of return method sounds like political suicide. Lets say it was 6% assumed return, that would be 60k on the average Auckland home. I assume you would then pay 33% tax on that, or 20k a year.
Either house prices would drop significantly, or rent would increase significantly.

Risk free rate of return is usually based on short term govt bonds. so more like 2% at present.

The similar tax currently raised on non-exempt foreign shareholdings over $50k is based on an expected 5% return. Would seem reasonable for housing to assume the same.

https://www.ird.govt.nz/toii/fif/calc-methods/calc-method-fdr/

"If you use this method you will generally be taxed on 5% of the opening market value of all your attributing interests in offshore investments"

I agree. The problem will be to find a reasonable and easy way to set the opening market value...For sure QV valuation/rates which are set every 3 years and not representative of the real value of individual properties will be difficult to manage without thousands of objections every year.

Agree with you on some of your points, although I feel the risk free rate of return would be much lower than 6% currently. What other alternatives are there to reduce house prices?

Also, the amount of tax on it would be reduced if the value of the house was dropping consistently.

Re: "EY’s own submission to the Tax Working Group highlighted that our taxes are poorly aligned with the environmental and climate costs of our economic footprint". Another angle to take is that environmental and natural resources unsustainability impose economic costs. E.g. Water pollution reduces the usability of water for human use and soil erosion reduces agricultural productivity. Tourists come to NZ mainly to enjoy our amazing scenic beauty and facilities related to that, so if we don't manage our environment sustainably, we'll have fewer tourists and reduced economic benefits. And, as the EU moves towards higher environmental standards, including for their farmers, they are likely to apply those standards as part of any enhanced trade deal we negotiate with them. Additionally, in the wider Pacific context, sustainability is a stability issue - e.g. apart from climate change the unsustainable management of fisheries stocks around our Pacific cousins islands will have harsh long term economic impacts. So I'd say that environmental taxes aimed at the sustainable management of environment (e.g. reducing water and air pollution) and of our natural resources (e.g. sustainable fisheries) make economic sense, if they maintain or increase the economic benefits we generate from them.

"An extended tax on realised gains, which looks to have wide potential scope. Interests in land, intangible property, goodwill, business assets, shares and certain choses in action are all included"

I wonder why business confidence is tanking…? Anyone?

The Livestock issue in the report will be an Interesting one to watch. It's clear that herd vs national standard valuation methods - the latter is revenue account, the former capital - is completely unresolved. The relevant section is tucked away in Appendix B: reproduced in full below.

Appendix B
XVIII Livestock and other assets
237. An essential part of the detailed design of the rules for extending the taxation of capital gains will be integration with existing regimes. The integration will depend on the more material design issues referred to in this Appendix. For example, the bloodstock tax regime might be unaffected as bloodstock are already either held on revenue account (taxable) or exempt from tax, depending on the activities of the owner.
238. Farmers can apply various regimes for valuing livestock for tax purposes, including national standard costs or by applying the herd scheme. National standard cost in effect treats livestock as trading stock of the farmer. Because national standard cost livestock is explicitly on revenue account the rules extending the taxation of capital gains would not apply.
239. However, under the herd scheme livestock is valued each year at the national average market value. Changes in national average market value from year to year are treated as being on capital account and not subject to tax. The Group understand that a significant number of farmers use the herd scheme to value all or most of their livestock. Careful consideration of the issues associated with herd scheme livestock and the proposed rules will be necessary.

The overall report is quite well-balanced IMHO - it does not shy away from quoting the issues around, for example, differential GST rates or valuation/realisation issues around any CGT regime. It's actually a good read.

Thanks for the recommendation! I was going to give it a miss but sounds worth the time.

Why does this tax working group only look at increasing taxes and not offsetting some increases with tax DECREASES in other areas? If taxes are out-of-kilter or unfair, would it not be better to take and give some tax breaks? As it stands the tax working group is simply saying: PAY MORE, this, in my experience, leads to higher prices, not lower ones

The group has been asked to present a final report which is revenue neutral.

https://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=121...

"Finance Minister Grant Robertson has indicated he wants final recommendations from the Tax Working Group (due February) to be revenue neutral.

In his letter of response to the report, Robertson has asked the Working Group to now recommend and consider "an overall package of measures".

"This should include measures that result in an overall revenue-neutral package.""

Thanks mfd, shame nothing is mentioned in this article

One of the biggest issues is making the family home exempt - which will no doubt extend to the family farm.

This provides a huge incentive to invest in one's own home vs another property which is likely to be caught in one form of CGT net.

A great example of unintended consequences as the last thing we need right now is a huge financial inventive to make everyone's home bigger vs investment in a productive enterprise.

Why should it extend to the family farm? A Farm is a business unit, generating income, a family home is not. While a family home on a farm may be exempt from a CGT while the owner is living in it, the farm itself should not be. The presence of the house on the farm will of course, add to the capital value of the farm, so any investment in the home will add to the capital value of the farm.

Question; in the discussion on CGT does the report talk about "realisation" of any capital gain? Otherwise any change in capital value may be on paper only, and may even result in increased costs to the owner without any change in actual income. From a taxation perspective i would think this to be an important aspect of any CGT.

JB I believe making the family home exempt is foolish. If a CGT was across all asset classes it would be set a very low rate and achieve enormous extra revenue for the Government. Including the family homes makes it much more inclusive ie everyone has skin in the game as people generally that want new taxes are not captured by that tax. The downsize or upsize depending on one's posostion is unintended consquences.Look no further than Sydney since CGT was applied there in mid 80's with the family home exemption massive amounts of money has gone into the family home it was the birth of really expensive suburbs. Classic results went like this - if one had 10 houses pre CGT on average 5 were sold and put into the family home and the other 5 were never sold basically removed out of the available housing pool for ever so as not to be effected by the CGT.I personally will benefit by millions extra over time if this happens as I only own good homes in the top ten suburbs in Auckland. If we are going to have real change rather than change to appear to be doing the right thing to get re-elected 'lets do it now' I hope this makes sense to readers if the family home is not included in the CGT the rich will get richer and inequality will worsen.

Agree totally - I have observed this happening exactly as you state on our very regular visits to Australia over a 30 year period.

The worst part of this is that is a self fulfilling prophecy - invest more in a new or larger or upgraded home - the value goes up - I feel a strategy coming on - and away we all go !

End result is the wildly over priced homes in large parts - not all - of NZ & Australia.

Forget all the debt to income ratios you read about - they are all calculated on total debt and total households including those with no debt - I believe about 33 % of all houses.

For those with debt then - the ratios are 50 % worse than the published figures !

Now we are seeing the many interest only mortgages becoming due and banks switching them to I+P - but of course now having all aged - borrowers are finding they can't afford to repay in the limited time they have till 65 say when incomes are very likely to come to an end.

The Australian reports this am that some 11 % of borrowers don't even know what an interest only mortgage is.

This whole housing debt issue cannot end well I fear - neither here or across the Tasman.

A few observations. One, taking capital gains on KiwiSaver will be hard to sell. Two, what about tax credits when losses occur, ie 1987, 2008, with a few in between on both property and shares? Three, hardly surprising that accountants are enthusiastic as they will be swamped with new clients. Four, taxing capital gains on shares will radically affect, ie distort, investment intentions, driving mum and dads (hate that phrase) towards fixed interest rather than face complex tax returns each year. Five, exempting the family bach will drive mum and dad investors to buy one rather than a rental property, thus driving prices and locking up capital. Six, our taxes on high income earners are quite low. Is the plan to hit just about everyone (KiwiSaver) to cut that group's taxes? Seven, legislation exists to tax speculation, where investments are made solely for capital gain. Why not simply enforce this? Finally, the family home will be exempt as to do otherwise would result in political oblivion. But people will double down here, putting cash into their home rather than something which will be taxed, especially if the chosen method is deemed rate of return.

I agree with several points. I think the Government should rectify a tax system which is based on intentions which create uncertainty and increase compliance work for all. The Accoutants/Tax lawyer are obviously very happy.
Currently if you buy shares/properties and your ""intention"" is not to get a capital gain "???" than you are not taxed....
It would be much easier to have a basic tax for all based on facts such as:
- Family Property: If you sell within 2 years capital gain is taxed, otherwise not irrespective of the intentions.
- Family investments: if you sell within 5 years capital gain is taxed, otherwise not irrespective of the intentions.
And similar for the other categories of investments, establishing a clear time reference for the taxation of capital gains.
Kiwi saver contributions should be exempted and made compulsory for all with improved tax incentives.

I understand the reasons behind the motivation to diversify sources of tax income (e.g. the expected diminish in PAYE). The issue is if something like an environmental tax on consumption of resources is introduced, the tax will be passed on to the last consumers. That is likely to be a regressive tax as the impact will be stronger for lower income groups. There is also the potential of negative impact for NZ export industries that have additional costs compared to their overseas competition.

The snowballing of taxes until everyone's ruined equally.

New taxes may initially be offset by other tax reductions but this is often the politically expedient way to introduce a tax. Once it's in, all taxes will be ratcheted up. As an example you could look at how GST was introduced and then ramped up and up.