The Tax Working Group’s final report has been issued, and I give a quick assessment of the main points below. However, bear in mind that what the TWG have recommended and what Labour actually implement, are likely to be completely different.
Capital Gains Tax (CGT): Unsurprisingly, the TWG has recommended that a capital gains tax be implemented. Although there was disagreement amongst the members of the group, the majority are advocating that CGT apply to land (except the family home), shares, business assets and intangible property. The minority have argued it should apply to residential property only.
Tax liability: The tax liability will arise when the asset is sold.
Basis for taxable gain: The gain is based on the difference between the price at which the asset is sold and the price at which it is bought, with the exception of assets that are held at the time that the new law is enacted.
Valuation day: For assets that are already owned at the time of enactment, there will be a so-called “valuation day”. In other words, all assets within the CGT net will have a value attributed to them on that day and gains from that point forward will be taxable when the relevant asset is sold. Taxpayers will have 5 years to establish value at valuation day (although if the asset is sold prior to this, the valuation will have to be established at that point).
Rollover relief: There is limited so-called “rollover relief”. For example, assets held at the time of death and passed to beneficiaries are not treated as being sold. Eventually, though, when the beneficiary sells the asset there will be taxable gain equivalent to the difference between their sale price and the original cost price of the deceased. There is also supposed to be rollover relief where assets change hands during relationship separations. Additionally, there are targeted rollover relief proposals for small businesses with turnover of less than $5m where assets are sold and the proceeds reinvested in replacement assets.
Tax rate for capital gains: The gain that is realised on selling a capital asset is to be treated as ordinary income. This is a significant point which means that there is no specific capital gains tax rate nor any concessions, as there are in Australia, for holding onto assets for a period of time or to reflect inflation. Gains will be taxed according to the applicable tax rate of the seller in the year of sale. For most this will likely be 33%.
Under the Hood
While the above are the headline grabbing proposals, if one looks further “under the hood”, there are some other interesting points of a more technical nature as follows.
Depreciation: The TWG has suggested that depreciation deductions should be reinstated – but not for standalone residential rental properties. Depreciation deductions would be available if this proposal were accepted in respect of commercial properties, for example, or so-called multi-unit residential properties.
Offsetting of losses: Losses realised on selling a capital asset should be able to be offset against all other forms of income subject to specific carve outs. In other words, capital losses will not be ring-fenced. The exceptions to this rule (i.e. where losses will be ring-fenced) are where there is a loss realised on a transfer of an asset between associated parties, or where the asset being sold was held at the date of enactment and therefore the calculation of the gain is based on its value at the valuation day. Another way to look at this is losses realised on selling an asset bought after the enactment of the law will not be ring-fenced.
Implementation of recommendations: The TWG has acknowledged that the government can choose to implement all, some or none of its recommendations. In the context of CGT, it has specifically noted that there is a spectrum of measures that the government could choose to adopt. For example, at one end of the spectrum they could employ the approach advocated by three members of the committee and focus the CGT on residential rental property only. They then mention a middle ground whereby residential rental property, listed shares, land-based business and commercial properties are subject to CGT. At the other end of the spectrum is the approach favoured by the majority of the members, being that CGT applies broadly to all assets excluding the home and private use assets (i.e. the likes of vehicles, art, jewellery etc.).
Home exemption: In terms of the home exemption, the suggestion is that the home and the land that it sits on be exempt, but the land is only exempt up to a limit of 4,500m² unless a larger area of land can be justified as the home. This means that there is no proposed exemption for farmland, for example.
Homes owned by trusts or companies: The home exemption proposed is intended to be available not only to individuals but also trust owners. The TWG even goes further to say that companies should qualify for the home exemption from CGT if the property owned by the company is used by the shareholder or shareholders as their residence.
Homes partly used for business/producing income: The home exemption comes with qualifiers if part of the home is used for business or income producing purposes. Provided the majority of the home is used for private purposes, you get the benefit of the exemption. However, you cannot claim any deductions on the business/income use – while still having to return the income as taxable. Alternatively, you can choose to claim deductions, but then the business/income part of the property falls within the CGT net. For example, if part of the home is used as a home office, you face the choice of ceasing to claim expenses and getting the benefit of the full exemption, or continuing to claim expenses and losing the exemption for the business proportion of the home.
Lower CGT tax rate for retiring business owners: The TWG proposes that the tax rate applicable for gains on sale of businesses by owners moving into retirement is lowered. They suggest that the first, say $500,000 of a gain realised on selling a closely held active business by an owner aged 60 or older should be taxed at a rate 5% lower than the actual marginal rate.
Possible repeal of loss ring-fencing rules: The TWG has suggested that the government consider repealing the soon to be enacted residential rental ring-fencing rules. The TWG notes that the case for ring-fencing of residential rental losses is reduced if capital gains are taxed. They also note that to the extent that the taxation of capital gains on residential rental properties may put upward pressure on rents, the removal of the ring-fencing of losses may dampen such pressure.
Taxation of companies/small businesses: Outside the context of CGT there are recommendations in respect of taxation of companies and small businesses. Specifically, the TWG suggests that the government explore options for implementing robust rules for taxing close companies that would prevent tax avoidance in the event that there is a larger gap between the higher personal marginal tax rates and the company tax rates. In other words, the TWG is seemingly foreshadowing an increase to the top personal marginal tax rates, which was something beyond its remit to suggest in this report.
Non-payment of GST and PAYE: The TWG also recommends that the IRD have greater ability to pursue directors of companies where there is deliberate or persistent non-payment of GST and PAYE.
Tax on vacant land: The TWG has recommended that there be consideration of a tax or levy applying to vacant land or uninhabited residential properties. They have suggested that this be considered as a local government measure rather than a national tax.
Don’t rely on any of the TWG’s proposals, as Winston Peters is unlikely to agree to them. There would be such a backlash that Labour would be crazy to implement the report in its current form. We are more likely to see a cutdown version with lower tax rates and perhaps businesses and farms exempted. Or something different again.