Terry Baucher says the current ad-hoc approach to taxing capital gains leads to a lack of transparency and needless complexity

By Terry Baucher*

Is this a capital gains tax which I see before me.. .I have thee not, and yet I see thee still” (Macbeth, with apologies to William Shakespeare)

First things first, the property taxation proposals announced yesterday are NOT a comprehensive capital gains tax; they are an extension of the existing law.

What the proposals also are is further evidence of why the Tax Working Group’s final report in early 2010 described the current tax treatment of capital gains as:

“… an incoherent mix of taxation and this mix includes differences in bases for calculating capital gains. This is unsatisfactory.”

Reaction to yesterday’s announcement has focussed on the  so called “bright line” test under which most gains from residential property sold within two years of purchase will be taxable from 1 October this year.  (“Bright line” test is tax nerd speak for when a specific taxing point is triggered).

What the new “bright line” test does is introduce some certainty into the rules by making it clear in which circumstances sales of residential property will be taxable regardless of intent.  But at the same time it leaves the general uncertainty around property disposals in place.

In fact it introduces more confusion: if a property is sold two years and a day after purchase will that be fine?

Or does the rule around “intent” still apply?  (Yes, according to the Prime Minister).

What are the rules for properties held in trusts or companies?

What about losses?

Some of the issues will become clearer after the relevant consultation process has finished but for the moment the position is unclear.  Which might actually be useful in making investors hesitate therefore allowing some of the current heat in the Auckland property market to dissipate.  We shall see.

A key buttress of the “bright line” test is the additional $29 million of funding for Inland Revenue’s property tax compliance activities. This means Inland Revenue’s Property Compliance Programme’s (“the PCP”) total funding over the next five years will be $62 million, a near doubling in resources.  With an expected return of nearly $7 per dollar invested the PCP is expected to collect $420 million in tax over the next five years.  Based on the PCP’s past results about half of this amount would be from speculative activities, the specific target of the bright line measures.   

But in some ways the most interesting proposals are those aimed at non-resident buyers. As Revenue Minister Todd McClay remarked the new rules “will allow Inland Revenue to share information about non-residents with overseas tax authorities.”  This is a further demonstration of the Brave New World of tax co-operation between tax authorities. 

Although some double tax agreements contain a clause agreeing to provide assistance in collecting taxes (a good example being the agreement with Australia), the collection of tax from non-residents is problematic. This difficulty is often cited as an argument against a comprehensive capital gains tax. 

The proposed withholding tax measure addresses this issue. How exactly the withholding tax will work will only become clear when the proposed issues papers are released and its implementation is not likely to happen until mid-2016.  Lawyers acting for overseas owners will watch this with interest.

Finally, the requirement for non-residents to obtain an IRD number before opening a bank account underlines the increasing importance of anti-money laundering legislation. Combined with recent changes to Companies Office disclosure requirements for directors, the measures are part of a trend towards greater regulation of cross-border transactions to counter possible illegal activities.

Viewed individually, the measures make sense but at the same time they underline a continuing weakness in the New Zealand tax system; the ad-hoc approach to taxing capital gains.

This leads to a lack of transparency and, quite ironically, needless complexity, the supposed Achilles Heel of capital gains tax.

This is not likely to change soon. 

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