Terry Baucher says the lack of a capital gains tax makes tax policy illogical, and unfair to those priced out of the housing market

Terry Baucher says the lack of a capital gains tax makes tax policy illogical, and unfair to those priced out of the housing market

By Terry Baucher*

Are the opponents of a comprehensive capital gains tax (CGT) really just NIMBYs in another guise?

At times it’s hard to escape the suspicion that the vociferous opposition to CGT from the likes of the New Zealand Property Investors Federation appears to be more motivated by the self-interest of protecting untaxed capital gains than any concerns about introducing a complex new tax.

The current tax rules around capital gains are a mess.

As the IRD’s Policy Advice Division advised the 2009 VUW Tax Working Group (TWG), the tax treatment of capital gains is “inconsistent… lacks an overall coherence and creates uncertainty”.

This might be great for tax consultants, but hardly fair for taxpayers in general.

In theory, the existing rules tax sales of any asset or property acquired with a purpose or intent of sale.

This, as opponents of a CGT have been quick to argue, means a change in law isn’t needed.

However, defining “intent” gives plenty of wriggle room for well organised and advised persons.

By contrast, there are several major asset classes where capital gains are automatically subject to taxation regardless of the investor’s intent. 

One such case is the Financial Arrangements regime (also known as the Accrual Rules). The Accrual Rules have been around since 1986 and like the Foreign Investment Fund (FIF) rules are another part of the Income Tax Act best approached with a stiff drink in hand. 

The Accrual Rules cover financial instruments such as bonds (both in New Zealand and overseas), bank deposits and mortgages.

The rules tax all income and any gains, including foreign exchange gains, arising from the investment over the period the financial arrangement is held. 

The Accrual Rules regularly spring unpleasant surprises on the unknowing.

I will elaborate on just how unpleasant these can be in my next column.  For the moment the following example will serve as a taste.

A couple selling their former family home in the UK which was rented out after they migrated to New Zealand, should not be taxed on any capital gain. However, if the mortgage over the property was Sterling denominated, then the Accrual Rules would tax any exchange gain.

Conceivably, the taxable foreign exchange gain on the mortgage could exceed the non-taxable capital gain on the property.

The end result is that one class of gain is taxed, but another is not even though both gains relate to the same asset. It is a clear example of the current tax system’s “incoherence”. 

I have written previously about the FIF regime which applies to shares and other investments such as foreign superannuation schemes and life insurance policies in countries outside Australia and New Zealand.

As most people are probably aware, under the FIF regime the lesser of a 5% “fair dividend rate” of the investment’s market value at the start of the tax year, or the actual income and gains for the year is deemed to be income. This applies even if the FIF income is more than the actual cash return.

The current FIF rules are intended to “levy a reasonable level of tax on offshore share investments”.

Officials argued that investors were choosing to invest in lower yielding equities outside Australia and New Zealand. By doing so they minimised their taxable dividend income but still derived the same overall economic gain through share price appreciation. The new FIF rules countered this practice by expecting a return similar to the typical dividend yield of Australian and New Zealand shares.

The TWG estimated the total value of residential property investment at $200 billion. If the FIF regime 5% fair dividend rate was applied to residential property investment this should result in approximately $10 billion of taxable income per annum.  In fact, according to figures supplied by the IRD to the New Zealand Property Investors Federation the net taxable income from residential property for the year ended 31st March 2013 was $1.5 billion.

This is barely 1% of the estimated value of residential property.

This immediately begs the question that If investing in low yielding but capital appreciating foreign shares is considered unacceptable, why doesn’t the same logic apply to residential property?

Are residential property investors really paying their fair share of tax?

Viewed in this context the arguments against CGT appear to be a form of NIMBYism – don’t tax my capital gains. That's understandable from the viewpoint of those currently enjoying tax free capital gains, but illogical as a basis for a coherent tax policy. 

Ultimately, introducing a CGT boils down to two issues of fairness: firstly, from a tax policy perspective it is neither fair nor logical to exclude from comprehensive taxation such a significant asset class as residential investment property. 

The other issue about fairness relates to the current housing affordability issue. As one participant at a recent conference on the design of a CGT remarked, when people feel they have been priced out of the housing market they cannot be expected to also accept as fair that the capital gains of those who own property should be tax free. That is a long term recipe for social stress.

After tomorrow New Zealand may have decided to follow the majority of the OECD by electing a government which will introduce a comprehensive CGT.

Regardless of the Election result, it is a debate which will continue.

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*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here » 

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...nicely stated.  If one follows the logic of it, we need a deemed rate of return on all investments, maybe on all assets so we avoid an argument over whether it is an investment or not.  Then the case for exemptions will flow...farmers Maori land, Charities and so on....sort of see why no one gets any traction on the issue.

CGT on houses is dead in the water in NZ. Watch National come back to power only on the basis of this.
Those who aspire to buy homes have this untaxed gain in view, so they are ready to pay higher than usual prices, when they get in.

No they won,t ; the brightest will just pack up and go , probably Australia and beyond. New Zealand houses are among the most "unaffordable" in the world compared to people's incomes thats why rents cannot rise even if landlords try to pass on interest and rates increases. Its a joke really and cant go on forever.

Terry , NZ Labour are not proposing a comprehensive CGT !
 
... there's exemptions galore ....
 
Even Cunny , the principle architect of their CGT , doesn't know the ins and outs of it ...
 
... if it was truely comprehensive ( i.e. included the family home , bach , Aunt Ednas' Norwegian Blue Parrot ) .... even the Gummster would vote for it ....
 
But it is so far from being " comprehensive " that it'll be the tax planners and accountants who get rich on it , not the IRD !

 
Exceptions will be diluted over time. So even if there are exceptions initially to make it palatable , when you have a new tax like that, it becomes a slippery slope as it gets milked for more and more over time. It is very easy for them to add it to more an more stuff over time, as people aren’t so outraged by changes, when they are drip fed the changes over time.
Look at GST for an example. In order to make it palatable, they said it was just going to be 10%. But what is it now? 15%, and it may go up to 17.5% as no party has ruled that out as far as I am aware.  It’s what the parties don’t say that you have to watch out for
 
 
 

"After tomorrow New Zealand may have decided to follow the majority of the OECD by electing a government which will introduce a comprehensive CGT."
 
It's not because no NZ poltical party is offering a compfrehensive CGT.

I think the Greens do.
3. Capital Gains Tax
In order to help reduce distortions created by the tax system, the Green Party will:

  1. Support the introduction of a comprehensive capital gains tax on inflation- adjusted capital gains at the time of realisation. Any capital gains tax must apply to assets in New Zealand that are purchased and sold by corporations or people living overseas as well as assets sold or purchased by residents.
  2. Support an exemption for the family home from any capital gains tax.
  3. Support treating taxable real capital gains as income for tax rate purposes and investigate mechanisms to allow the income from capital gains to be spread over several years for New Zealand residents.

https://home.greens.org.nz/policy/green-taxation-and-monetary-policy

So tell me this. Why do the Greens think it fair that if I choose to rent and invest my capital in the markets, I be taxed on the capital gain, whilst my neighbour, who chooses to invest in his home, won't have a capital gains tax?
Greens need to go back to being Green.
 
 

I'm not sure, you'll have to ask a Green.
Mostly, though, family homes are used to live in, not used as "another stream of income". If it's not sold, the gain in't realised, anyway.
NZ is very lucky not to have any inheritance tax - a lot of other countries do. So when a family home is inherited, provided it isn't converted into an income/investment property, the heirs will not be liable for CGT when they sell it.
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I think the fairer question is,why should some income not be taxed, and some be taxed at a very high rate? All income streams should be taxed - the fact that real estate gains aren't, is why there is such a demand from small time investors who have 1 to 5 investment properties.....and that is distorting the market.

I think the fairer question is,why should some income not be taxed, and some be taxed at a very high rate?
Exactly my point.  if i rent you wil tax my capital gain on my alternate use of money, if I buy a house you won't. 
Can't you see the conflict? 

In a perfect world both should be taxed equally, however such a policy isnt possible with the voter so there is a compromise around the family home, it is ring fenced, no biggee.
regards
 

No,ot really, but I may not be understanding what you're trying to say.
when you say "if I rent", do you mean "if I rent out, i.e. if I have invested in a renatl property'?
The rental income will be considered income, an wuill be taxed. Usually the cost of a property can be offset agains the income generated. The yield will therefore not be enormous, so your tax burden will be small (especially as the CGT of 15% has been proposed).
The house (family home) will not be taxed, as it is not an income. It is not a luxury, it is a necessity. No physical income is generatedwhile you live in it. In fact, it could be argued what with rates due on a property, it's actually a cost.
When a house is sold, he gain, indexed, should be taxed. There are mitigating circumstances for example when a family home is inherited, or when a family home is sold in order to fund the purchase of a unit in a retirement facility.

What I am trying to ask is where is the logic/fairness re an exemption for the family home  and not an amount foregone from having to rent instead?   It is fast getting to a point (In Auck anyway) where only the  wealthy will have a family home.
 So Joe struggler who can't afford one and has to rent, invests his savings which under these proposed rules will not only be taxed on income, but taxed on capital gain.
To be fair, a non home owner (renter) should be allowed to invest an equivalent amount to a home value as a tax free capital gain.
A CGT is only an improvement if it hits everything.
 
 
 
 

No you are not trying to ask that, IMHO you are trying to ask to make the left un-electable.
It depends on where you invest, Investing in say a deposit account is taxed.  Investing in shares isnt normally unless its overt speculation I believe.
The CGT as it would stand is an improvement. It hits the one man band, say a plumber or farmer whos tax accountant advised them to buy rental properties purely as a tax avoidance scheme for retirement who would otherwise pay business and income tax.  It hits the foreign investor who is land banking with an exit tax. So really it broadens the tax base. 
Now in fairness I think that the CGT like GST sould be 15% on everything over time as that is simple and far harder to avoid.  In balance that should then mean that the PAYE or business tax rate should be dropped to make the effect on most ppl neutral.
But like same sex marriages the civil union bill was a stepping stone, hence this first stagre could also be a stepping stone to a flatter, simpler system.
regards
 

Wrong assumption re the left.  I'm neither left nor right, rather I would love to see a fairer tax system but remain sceptical about CGT.  From all the reading i have done, including speaking with tax specialists (who will love it), CGT does not or has not delivered anywhere in the World what the proponents here suggest. 
For that reason I see the debate as a waste of enery...arguing for a tax to be introduced to do something which, evidence based, it will not achieve.
The proponenst of this tax need to present hard dat that show it will achieve what they say it will.  Have you seen any such data?  if so, please share it with us.
 
 

Oh right, a National supporter trying to Pee on the Greens, just note the % increases every election.
a) I dont think you are taxed on capital gains on shares, today, you should be IMHO.
b) You may or may not make a capital gain on your house. Anyway you cannot realise it unless you sell up and by something cheaper. So its mostly an un-realisable gain. 
c) Greens are green, but there is such a thing as being a broad based party not some fringe one shot job like say ban1080.
So the Greens dont need to do anything different. Their vote % is climbing, they are now the 3rd substantial party with a significant support in the 12~15% range.
regards
 
 
 

Line 1; comprehensive
Line 2; exemption
 
So they do not have have a comprehensive CGT at all.

Do you think it would be a good idea to tax the gain on the sale of a family home? I think it would have to depend on the reason why it was sold. If it's part of an inheritance I don't think it should be, because NZ does not have an inheritance tax.
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If it's a family upgrading and by selling the home, realising a gain they will use to purchase a bigger home, I suppose it could be argued that that could be taxed, as well.

The article is arguing that a CGT will only work if it is comprehensive.  You are pleading a case that one group should be exmept, property investors are arguing a different group should be exempt.
 
Your concerns about inheritance are easy to deal with, make the CGT on an accruals basis the same as FIF.  If it's good enough for shares, why not houses?

Emotive issue, I suppose.
 
What if you had to sell the home your mom lived in, in order to generate some cash so you could purchase a unit in a retirement home for her? Would you want that gain to be taxed?
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I think the CGT favouring parties are taking the softly softly approach. Only excluding the family home is a small price to pay to get the tax going? Not sure.
 

They are excluing the family home because the whole concept of the CGT is that it is a tax that 'other' people pay.  Labour's advertising on this reflected that., one their adds stated that "You and your mothers house won't be taxed, but the speculator up the road with four houses will be taxed".
 
Quite what the difference between two houses and four houses is lost on me, but capital gains tax on people's owner occupied houses is politically toxic.

NOT having a CGT creates distortions because people see the gain as 100% profit, which makes it more appealing to invest in a 2nd property. This drives up the price, and gives us an unrealistic price/income ratio we have now.

There is already CGT on people who are buying properties as investments. The fact that many people aren't paying it is more of a problem with enforcement. So if more money was put into that , then it would solve the problem.

Correct. It's enforcement of the existing tax regime.
Makes one wonder how much smarts our leaders and would-be leaders have upstairs, particularly one who is prepared to risk running an election campaign based on introducing a toxic (new, kiss-of-death tax?) that already exists. Almost like they want to fail. What sort of advisors do they have. What sort of understanding of the current regime don't they have. So dumb

no, because the double down is encouraged by a willingness to hold.  
CGT is just cost of doing business in that scenairo.

Make the CGT on an annual basis the same as FIF then.  That way you have no disincentive to selling.

No, it reduces distortons. Having a CGT removes the tax incentive reason to buy a property as a secondary item that otherwise would not be purely used to dodge tax.
tax consulatants already advise on buying property as a way to earn thier $s so at worst, no change.
regards

not so much the builders.  We don't really need a megacorp rolling out the tiki-tiki's.

It's that the builders and connected professions are up against a mountain of red-tape.  Very expensive slow moving red-tape.  this makes it expensive for customers to build, and the system in NZ makes it expensive for build professionals to hire/hold staff - the low margin means than any staff have to be guaranteed income and perks(sick days, holidays, temp replacements)  and risks covered, out of each job; it's not viable to hold sort term skilled-staff in the industry (so they rely on subbies).
 They can do the work...but the economy has to be able to pay them...and the bureaucracy has to be able to rubber stamp the consents and RMA fast enough to make it happen.

There is another way around it
 
It is generally accepted a CGT already exists. It's application revolves around the word "intent"
 
Approximately 100,000 properties change hands every year
IRD to Employ 2000 additional staff
Monitor and audit every single property transaction
Every single one. Both sides of the transaction. The seller and the buyer
Maintain a data-base recording the intent of every transaction

If the intent is to provide a rental property into the rental stock, then quarantine the net profit or loss from rental income. If it is negatively geared then any rental loss is carried forward and not available to be deducted from other income. That way the investment has to stand on its own merits. If it truly is an "investment". Any rental income that is subsidised by Rent Assistance should also be recorded and clawed back if and when the property is sold. Rent Assistance is simply a state loan to the property owner.

Exactly, intent is the word a lot of investors avoid.
To me, if an investment does not stack up with a good ROI without capital gain then it is clearly looking for a capital gain so should be taxed with 'intent'.
I find it hard to see anyone argue they invested with negative gearing (losing money) and expect IRD to accept they did not buy for capital gain. Why invest to lose money?

Of course an old person would think up the idea to start taxing rentals. They themselves have enjoyed all the royalties of increasing property values and had a chance to "get in" and "get out" now these pesky young people are coming in - TIME TO TAX THEM!!!!! Then when “we” complain about not being able to get ahead (look at the older generation and with their spending habits they would be nowhere without their property going up 10 fold in price) – we are told to stop being so lazy and eyes are rolled, because they had it soooo much harder than “us”
/Sour grapes

head scratch...  But rental income is already taxable like any other business activity

Exactly. Cunnliffe and his rich mates have bought up all their rentals now want to tax the younger generation. Typical baby boomer selfish attitude.
If your going to implement CGT make it 10% across everything and retrospective.

No the baby boomers are being selfish by not implementing CGT

There will be no CGT under the next 6 years of National majority government so let's not waste any more time discussing it here! 

3 years, 6 maybe sure.
CGT, that I think is a dead duck. If the left cant figure out Mr and Mrs Joe Mainstream dont want a thing to do with it (whatever the quality of the argument for or against it) , yes Im sure it will help National to a 4th term.
Lets see what is what after the blood letting.
regards

I think the Nats just realise how little benefit it would be.  large costs, lots of accounting rules, little return, and the impact on economy significantly high.  CG only tends to look good in Auckland, or over long periods of time.

Thanks Terry for bringing the subject of FIF into the debate about CGT.   I need more than a stiff drink as I dutifully write my annual check to the IRD for FIF tax on the "unrealized" gains of my overseas portfolio.   The property investors who are indignant over the possibility of having to pay CGT on an *actual* gain simply come across as a bunch of whingers.  
I look forward to your next column.