By Terry Baucher*
“New Zealand’s current approach to taxing income from capital is inconsistent....New Zealand is one of the few OECD countries that do not have a separate capital gains tax. Nevertheless, the [Income Tax] Act does tax specific capital receipts. Although there is often a policy rationale for each instance in which capital gains are taxed, this incremental approach lacks an overall coherence and creates uncertainty.” (IRD Policy Advice Division and Treasury “The taxation of capital gains”, September 2009)
“It’s a ****ing omnishambles.” (Malcolm Tucker, “The Thick of It”, frequently).
Putting aside Malcolm Tucker’s inventive profanities, I find it hard to escape the conclusion that “omnishambles” best summarises the current approach to the taxation of capital gains in New Zealand.
In my last column I highlighted the unequal treatment of foreign superannuation schemes relative to residential investment property.
Income and capital gains of foreign superannuation schemes are taxable, whether it’s under the new regime applying from 1 April 2014, or the foreign investment fund rules prior to that date.
By contrast, capital gains from disposals of investment properties are usually not taxed.
But, as the IRD quote at the start of this article indicates, capital gains ARE taxable in certain circumstances.
In fact, there are nine sections within the Income Tax Act 2007 which specify when disposals of land represent income. Thanks to the IRD’s Property Compliance Programme, a considerable number of “investors” in South Auckland are currently becoming intimately acquainted with these provisions, and paying mightily for the introduction.
So that’s all good then?
The problem is that several of these charging provisions contain words and phrases such as “purpose”, “intentions”, “undertaking or scheme”, “not minor”, or “significant expenditure”.
With the Inland Revenue and the Courts not willing to set empirical definitions, the result is haphazard to say the least.
$50,000 might be considered “not minor” and the resulting gain taxable in one case, but $100,000 in broadly similar circumstances might be deemed “minor” and tax free in another.
Each situation is different and often the final call may come down to a crucial bit of evidence about a person’s “intention” or how long and hard they are prepared to argue the point.
As a consequence advising on the tax treatment of land transactions is difficult. “It depends”, is not really the advice someone wants to hear (or pay for), but often it is the only possible answer.
Back to foreign superannuation schemes. Last week the Finance and Expenditure Committee reported back to Parliament on the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill. Very little has changed from the original proposals.
The changes to the taxation of foreign superannuation scheme transfers have broadly been accepted by tax advisors as a pragmatic solution to a difficult issue even if the issue has been made more problematic in the absence of a capital gains tax (“CGT”).
I’m possibly an outlier on this matter but in my view there are a number of difficulties with the changes.
Firstly, the proposed schedule method, under which the amount taxed rises with the length of time the scheme has been held. At first sight this appears to be a quasi-CGT.
However, the schedule method incorporates a deemed interest factor which, according to the IRD, is required “to account for the use-of-money benefit that a person receives by not paying tax annually.”
The result is that for long term holders 100% of any amount transferred is taxed. Such an outcome is neither a tax on income nor a CGT, but a capital transfer tax.
There is an alternative “Formula Method” which taxes the person based on the actual gains while they were resident in New Zealand. But this method is complicated and also incorporates an interest charge.
Secondly, as I highlighted in my last column, the proposals results in unequal treatment for New Zealanders
A person transferring from an Australian superannuation scheme to a KiwiSaver scheme may do so without penalty.
However, anyone transferring from a non-Australian superannuation scheme will trigger a tax charge even if the transfer is also made to a KiwiSaver scheme. It’s perhaps understandable (though not logical) if the tax treatment of a migrant differs from someone born in New Zealand.
However, it’s absurd if a brother and sister both born in New Zealand and both with the same amount of foreign superannuation accumulated during an OE, incur differing tax treatments on transfer because of the origin of that foreign superannuation.
Yet this is a deliberate outcome of the proposals.
Finally, these changes will prompt holders of foreign superannuation schemes to consider transferring their schemes to New Zealand. However, taking such a potentially significant step seems to me a case of allowing tax considerations to override investment matters.
Ultimately, the proposed treatment of foreign superannuation schemes is another example of how the present “incremental approach lacks an overall coherence and creates uncertainty”.
In my view this is no way to run a tax system.
Unless we are to adopt a completely different approach to taxation (such as that proposed by Gareth Morgan), I consider a formal CGT applying across the board to be the best way to avoid the inconsistencies noted above.
It would also be fairer by removing the uncertainties around when a transaction may be taxable.
Yes, there will be complexities involved, but the majority of OECD countries have a CGT in some form, so New Zealand can draw on their experiences when designing its own.
Tolerating the present situation is simply allowing an omnishambles to continue.
It’s time for a comprehensive capital gains tax.