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Is CGT a four letter word?

Even the government is not immune from the effects of the global economic recession, as evidenced by the Budget 2009. We have always been told that it would be political suicide for a party to introduce capital gains tax, but one has to wonder if there was ever a more convenient time for it to be introduced by the ruling party.

The tax base is pretty comprehensive in New Zealand but there is a glaring omission when you compare it with other OECD countries and particularly Australia – the lack of a capital gains tax on real property.

Now before you gasp with horror and call me a tax heretic, let’s analyse some of the options:

What form could such a capital gains tax take?

The traditional type where on the sale of property a tax is imposed on the gain made by the vendor? Or could it be more akin to local government rates?

We are already accustomed to an annual or monthly tax on the value of our property. Would this perhaps be an easier concept to “sell” to the public? This form of CGT would also give the IRD a more regular, immediate source of tax revenue. This would avoid the IRD having to wait for years for a vendor to sell a property as it would not rely on a disposition event.

If the more conventional approach were adopted then one would expect there to be many carve-outs available to alleviate the taxpayer’s liability. For example, a full exemption for a primary residence and extensive allowable deductions for second and subsequent properties that enable a taxpayer to reduce the realised gain on which they would be taxed.

If a detailed analysis is made of other jurisdictions which have introduced a CGT I think it might reveal that the effective CGT paid is not as high as most people assume.

Overlay all of the above with the state of the New Zealand property market currently. Prices are incredibly high when compared to annual salaries. Is this not a classic case of supply and demand? Limited housing supply but the demand is not limited to the domestic market. The demand is global! The prices are not determined entirely by local demand (which means no matter how hard Kiwis save or alter their spending habits it may not have the desired effect for local purchasers with local income).

This raises the possibility of CGT being imposed on a basis of residency of the vendor? This would fit seamlessly into the concept of entitlement to tax based on residency or source. Tax on real property in New Zealand is the entitlement of the IRD. If this aspect was incorporated into the construction of the model for CGT, then non-residents would be taxed on their capital gains derived from the sale of real estate situated in New Zealand. What effect would this have on the property market? Would it impact the house prices? Do we want to discourage investment in real property in New Zealand? Considering that CGT is common in many jurisdictions around the world, would this really impact on a non-resident purchaser’s decision to invest in New Zealand?

It is also rather interesting that lately the media have started to report more readily on the topic of CGT. Could this be a way of gently getting the taxpayers used to the idea? Is a capital gains tax inevitable? I think perhaps it might be.

2 Responses

Australian on August 28, 2009 at 10:18 pm

Hi Carla, I enjoyed reading this article, and I think there are many other angles to consider on the CGT.
We already have a de facto CGT for many types of transactions. For example the land transactions. I say, bring in a proper CGT and let’s do away with the crazy associated persons rules. I mostly look at the associated persons rules in relation to land transactions, and a comprehensive CGT should do away with working out whether or not someone is associated with my wife’s cousin’s aunt’s sister-in-law to work out whether they should pay tax on their house that they bought 9 and a half years ago (you may sense some frustration here).
The second thing is that bringing in a CGT will bring our tax system more into line with Australia, and I think that is a good thing. The end game should be harmonisation with Australia to do away with complexity across borders. Oh yes, and not to mention the 56% tax that we pay on investments into Aussie companies.
The CGT may not bring in much by way of tax revenue, but it does not matter. Money is like water, and the tax system like a bucket. As long as there is a little leak, everything will try to make it’s way through the hole, and that causes friction.
There may be a thousand reasons not to bring in the CGT, but I think on balance it is better than what we have. I might be on my own on this one I think.

Carla on August 31, 2009 at 9:26 am

Thanks for the input.
I think you are quite correct! Your comments about already having a form of tax on capital gains in respect of land are spot on. The difference is that many taxpayers don’t know they fall into the net until it’s too late (assuming they have had no advice from a tax adviser).
The average person in the street might think that CGT will apply to them when in fact most CGT legislation has generous carve outs for primary residence. In addition, the numerous deductions allowed also mitigate the CGT liability.
It will be most interesting to watch the developments on this topic over the next few months.

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