By Terry Baucher*
“This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” Winston Churchill, November 1942
The Election is over and those parties actively proposing a capital gains tax (CGT) have lost, badly.
So does that mean the debate about CGT is over?
No, for two reasons.
Firstly, the issues about equity in the tax treatment of all asset classes and for those who are either locked out or struggling to get into the housing market won’t go away until, and unless, housing affordability improves.
Secondly, the debate about the merits of a CGT has shifted quite markedly in the past three years from “Why?” to “Perhaps”.
One of the more striking illustrations of this shift was the 54% of the CEOs surveyed for the New Zealand Herald’s Mood of the Boardroom survey who saw merit in a CGT.
There was a lively debate on CGT following my last column and my thanks to all the participants.
Looking at the comments most supporters of a CGT back it on grounds of fairness and intergenerational equity.
Opponents countered with concerns about complexity, particularly around any exemptions, whether in fact a CGT could meet the objective of putting a brake on rising house prices, or that the existing rules are sufficient.
Complexity is a fact of life in tax, and as I noted last time, the foreign investment fund and financial arrangements regimes are hardly simple.
Ironically, complexity often creeps into tax systems as a by-product of fairness.
Overall, complexity should not be seen as a king-hit against CGT.
With regard to the objective of CGT I share the doubts of those who are sceptical about the ability of CGT alone to slow down rising house prices. CGT should be seen as part of the available tools to tackle house price inflation, not a magic bullet in itself. Many of the countries who have also experienced rapid house price inflation already have a CGT which does suggest it’s no magic bullet.
The third group of opponents argue the existing tax rules are sufficient and what is really needed is better enforcement.
Critically, this is the view of John Key, Bill English and the re-appointed Minister of Revenue, Todd McClay.
We can therefore expect the IRD to follow their lead. Enthusiastically.
Practically speaking how will the IRD achieve greater enforcement?
I believe there will be three mutually reinforcing strands to its approach. Over time the collective effect will see a broadening of the scope of capital taxation.
First, and most obviously, there will be greater investigative work by the IRD’s auditors, particularly those in the Property Compliance Programme (PCP).
The PCP merits a separate column in itself but briefly, since its creation in 2007 it has generated a return of $6 for every dollar invested. In the year to 30 June 2014 investigations by the PCP resulted in additional tax of over $53 million, $26 million of which stemmed from property sales deemed not to be capital in nature. I expect to see more resources given to the PCP with the aim of building on the work already done.
Secondly, and stemming from this greater audit focus, expect the IRD to start considering in detail a person’s rationale for investing. For example, could the purchase of a low-yielding and heavily leveraged rental property be interpreted as meaning the property was acquired with a purpose or intent of re-sale? Does the investment make sense without a capital gain?
Lest this sounds fanciful, the general view amongst tax advisors is that gains arising from the sale of gold or other precious metals are almost certainly taxable. This is on the basis that only by sale can any investment return be realised. Accordingly, the intention to sell must have existed at the time of purchase.
As part of the same trend the IRD will issue public “clarifications” or reinterpretation of existing rules.
These clarifications will just happen to have the effect of increasing the incidence of taxation.
A good example of this approach would be the Interpretation Statement on Tax Residency issued earlier this year. The draft Interpretation Statement issued in December 2012 caused a huge stir amongst tax advisers with what was seen as a dramatic broadening of the definition of a “permanent place of abode”. The finalised Interpretation Statement somewhat dialled back this widening, but there is no doubt that the scope of residency has been widened.
Finally, “technical” amendments which eliminate “anomalous” exemptions in the tax system. The new rules taxing foreign superannuation schemes are one (particularly egregious) example. Another recent example is 2013 legislation which changed the tax treatment of lease inducement and lease surrender payments. According to the IRD this was because the capital-revenue boundary, “became problematic in the context of certain land-related lease payments.” (That’s IRD-speak for “We don’t like it”).
The combination of these three strands of more audit activity, clarification and reinterpretation and amending legislation has proved very effective over the past few years and should continue to do so.
Basil Liddell-Hart the British military historian and Winston Churchill confidante, was a champion of the theory of the indirect approach.
Expect to see the Government and IRD adopt a similar strategy over the next few years as they look to expand the taxation of capital gains without drawing too much attention to their actions.