By Gina Gatchell, Director
With enough rumblings to cause a volcanic eruption, the capital gains tax debate is currently raging in New Zealand.
The bonfire was ignited after the Tax Working Group’s Final Report[1] was released last week, in it recommending capital gains tax be introduced from 1 April 2021 (Valuation Day, or ‘V-Day’).
Debate is revolving around principles which other countries have addressed, refined and enacted decades ago; the fairness and equity of the proposal, issues around what should be and shouldn’t be taxed on disposal, the lack of any accounting for inflation, and the rate at which the ‘tax’ will apply[2] being the highest in the world.
More fuel to the fire was added today, with a proposal to value property ‘en mass’.[3]
History of capital gains taxation in New Zealand
The creep towards a formal capital gains tax started back in 2011 when Prime Minister at the time John Key suggested the idea of a tax on gains made on property to Inland Revenue.
It took Inland Revenue over four years to consider the idea, and the match was lit when the tax was introduced to close a loophole that had long existed in New Zealand’s grey area of taxing gains on the disposal of property.
Prior to the introduction the disposer of property was only subject to tax on gains under less stringent provisions, including under the Land Transaction rules.
The loophole allowed investors to make gains which, in New Zealand’s white-hot real estate market at the time, attracted overseas investors in droves. These investors, as well as New Zealand resident property investors had identified an opportunity to make non-taxable gains from real estate in a very short period of time – sometimes buying and selling on the same day for large gains.
The Brightline Test all but brought a stop to this with the inside two years of purchase[4] requirement to pay tax on the gain on sale.
Like other countries, the family home is excluded from the Brightline Test and thus is not taxable on disposal.
It is interesting to observe the way in which capital gains tax is applied in Australia and the United States, both countries having had capital gains tax regimes in place for decades.
Australia
Australia’s capital gains tax regime has been in place since 1985[5]. Referred to as ‘CGT’, there has to be a CGT event in order for taxation to arise. A ‘CGT event’ is a well-defined term under Australian Income tax legislation, as are loss ringfencing, loss carry-forward and rollover rules.
Taxpayers are taxed on their net capital gains at ordinary income tax rates; no separate rates exist.
Net capital gains are taxable as statutory income[6], at marginal income tax rates applicable to the taxpayer’s residence status, that is, resident, or non-resident of Australia.[7]
There are 12 major categories of CGT event as follows (with section references to the Income Tax Act of Australia 1997):
104-A – Disposals – the most frequent type of capital gain event.
104-B- Use and enjoyment before title passes
104-C – End of a CGT asset
104-D-Bringing into existence a CGT asset
104-E Trusts
104-F Leases
104-G Shares
104-H-Special Capital Receipts
104-I-Australian Residency Ends
104-J CGT event relating to rollovers
104-K – Other CGT events
104-L Consolidated Groups and MEC groups.
Australia uses discounting, which is a step in the process of arriving at a taxable capital gain, but does not index for inflation.
United States
United States’ capital gains tax regime dates back to 1913. Up until 1921, capital gains were taxed at ordinary rates with the maximum applicable rate 7%.[8] From 1942, gains could be discounted by 50% , or an election to use a 25% alternative tax rate was available if the taxpayer’s main tax rate was more than 50%.
Major changes to capital gains tax occurred in 1986 with the Tax Reform Act of 1986. This legislation brought to account previously excludable long term capital gains, raising the top capital gains tax rate to 28%, which applies today for certain gains[9].
Capital gains tax rates fluctuated during subsequent years, settling at 15% for most types of gain. The top rate of 20% for most gains was introduced in The American Taxpayer Relief Act of 2012, which also made qualified dividends tax rate of 15% permanent.
Generally, the United States taxes gains from the disposal of capital property at 0%-20% dependent on the marginal income tax bracket of the person or entity disposing of the property. However, gains from certain transactions including §1245 property and §1250 property have a 25% rate and their own set of loss offset rules. Collectibles are at 28%. Passive Foreign Investment Companies also have separate tax rules for gains in which case these are taxed at ordinary income tax rates of up to 37%.
The section 121 Exclusion of gain on sale of a principle residence is a well-known and universally accepted way that American citizens are used to using to exempt their residence from US capital gains tax (provided they meet the qualifying criteria[10] to use the exception).
Once the criteria are met, up to US $250,0000 for single filers, US $500,000 for joint filers is excludable on the gain.[11]
Today, the United States capital gains tax regime does not account for inflation or discounting. There are well-defined rollover provisions including the like-kind exchange provisions.
Conclusion
New Zealand has been slow to adopt a formal capital gains tax, and is a long way behind other countries in developing its regime. New Zealand society is a long way further east along the continuum than its OECD cousins, which probably indicates that there will need to be a major shift in societal attitudes towards acceptance of capital gains tax. It seems that the Shakey Isles just got shakier, and like the probability of a Ruapehu eruption, we just don’t know what’s around the corner.
Read The Tax Working Group’s ‘Future of Tax: Final Report.
Disclaimer: the views in this
article do not necessarily represent the view of the author. The contents of
this article are not tax advice and NZ US Tax Specialists accepts no responsibility
for any position taken on the contents of this article. Specific advice should
be sought.
[1] To read more please visit https://www.nzustax.com/tax-reform-in-new-zealand-the-future-of-income-tax-in-new-zealand-new-zealand-issues-comprehensive-report/
[2] The Tax Working Group’s Final Report proposes that gains be taxable at marginal income tax rates; for individuals, this is currently 33%.
[3] ‘Automated mass valuations could be used to value Kiwi properties ahead of a capital gains tax’ NZ Herald Business Section 26 Feb, 2019.
[4] Extended to five years for property purchased after 29 March 2018; property purchased between 1 October 2015 & 28 March 2018 is subject to tax on any gain if purchased and sold within two years.
[5] Prior to 1 September 1985 in Australia capital gains were generally exempt from CGT.
[6] In Australia income falls broadly under two categories; Statutory Income; if income is not classed as Statutory Income then it falls into the category of Ordinary Income and subject to the rules for taxing Ordinary Income.
[7] Other countries, such as and including the United States have separate rates of taxation for capital gains as opposed to taxing all income whether from capital gains or otherwise at the same rates.
[8] Sourced from Wikipedia, History of Capital Gains Tax in the United States. https://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States#History
[9] Gains from collectibles are taxable today at 28%.
[10] To qualify, the residence needs to be owned by the taxpayer or the spouse, and lived in for at least two out of the five years prior to the sale of the residence. Exclusions to the 2-year live-in rule do apply. The exclusion can be taken no more than two years apart. Apportionment and depreciation recapture rules apply should the residence have been rented out at any point prior to sale.
[11] The gain is calculated as the net sale proceeds minus the adjusted basis.