Conference on key issues in the design of Capital Gains Taxes

04 August 2014

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Full house at the Capital Gains Taxes conference.

By Michael Littlewood

On 18 July 2014 the Law School, together with the Business School, hosted a Conference on the design of capital gains taxes. The Conference was organised and chaired by Professor Michael Littlewood (of the Law School) and Professor Craig Elliffe (of the Business School). It did not address the question: should New Zealand introduce a capital gains tax? On that score, as everyone knows, much has been said and opinions differ. In particular, the National Party is opposed and Labour and the Greens are in favour. Rather, the Conference attempted to answer the question: if New Zealand were to adopt a capital gains tax, what shape should it take? In particular, if capital gains are to be taxed at all, what, exactly, should be taxed? And at what rate?

To shed light on these questions, we were lucky to attract to Auckland distinguished visitors from countries whose capital gains taxes might be viewed as helpful models, namely Reuven Avi-Yonah (Irwin I Cohn Professor of Law at the University of Michigan, brought to Auckland as a Hood Fellow), Philip Baker QC (one of the UK’s most eminent tax scholars, brought to Auckland under the University’s Distinguished Visitor Programme), Professor David Duff (of the University of British Columbia, brought to Auckland as a New Zealand Law Foundation Visitor), Professor Ann O’Connell (of Melbourne University) and Professor Jennifer Roeleveld (of the University of Cape Town).

The speakers also included a number of New Zealanders, namely Dr David White (of Victoria University), Shelley Griffith (Otago), Professor Craig Elliffe (University of Auckland), Peter Vial (Chartered Accountants Australia and New Zealand), Shaun Connolly (Russell McVeagh) and Aaron Quintal (Ernst and Young).

The basic idea of capital gains taxes is, of course, to tax capital gains and the basic scope of the tax is as indicated by its name. Most importantly, tax would be charged on gains made on sales of investment property and shares in listed companies. But capital gains taxes typically extend also to gains made on the disposal of other sorts of property – for example, unlisted shares, securities other than shares, unincorporated businesses and collectible chattels. Such gains are already chargeable to income tax in some circumstances – in particular, where the taxpayer is engaged in a business of dealing or otherwise acquires the property in question with the intention of selling it. The point of a capital gains tax is thus to tax gains made where the taxpayer is not engaged in business and acquired the property as an investment, rather than with a view to selling it. The line is not always easy to draw, but short-term profits are typically counted as income and longer-term gains as of a capital nature.

Beyond those basic parameters, however, the design of a capital gains tax presents a number of difficult questions. The best known of these is, what should be done about the family home? One view is that all economically significant gains should be taxed; and that there is no reason for providing for any preferential treatment for family homes. In other words, according to this school of thought, gains made on the sale of a family home should be taxed in the same way as any other capital gain. But whatever arguments might be marshalled in support of this idea, it seems unlikely to happen because any political party proposing it seems unlikely to be elected. The question, then, is, should family homes be categorically exempt? Or should the exemption be subject to some limitation? For instance, perhaps each family should be limited to only one tax-exempt family home – in which case the gain made on the sale of a bach would be taxable (unless it was the family’s only home). Or perhaps the exemption should be limited to gains of less than a prescribed amount – in which case, how much? What should be done where the taxpayer buys a house, lives in it for a few years, moves out and lets it for a few more years – and then sells it at a profit?

Other design issues include the following. First, should the capital gains tax (if there is to be one) be a separate tax or part of the income tax? Should liability be based on residence? Or on the situs of the property on which the gain is made? In other words, should persons resident in New Zealand be taxed on their worldwide capital gains? Or only on gains made on property situated in New Zealand? Should capital gains be taxed at the same rates as income tax? Or some other rate? For instance, the Labour Party’s proposal is for the tax to be charged at a flat rate of 15 per cent. That would make the introduction of the tax more palatable (or at least, less unpalatable) and it could also be seen as making a rough and ready allowance for inflation.

Some countries’ capital gains taxes provide for what is called roll-over relief. That is, if you sell an asset and buy another of the same class, liability is deferred (for example, if you sell one investment property and buy another). In other words, you are not required to pay the tax until you sell the replacement asset (and at that point, liability is again deferred, if you again buy another asset of the same class). The point of this is that it largely overcomes the “lock in” effect. If people are taxed on gains made on the sale of capital assets, they are likely to defer liability by simply retaining their assets – which is inefficient and tends to clog up the economy (in that the tax incentivises people to retain assets that they would otherwise sell).

Roll-over relief is thus one way of mitigating the lock-in effect. Another is to tax capital gains not when they are realised, but as they accrue. In other words, instead of paying tax on the whole of your capital gain when you sell your asset, you could be required to pay the tax annually on the basis of the gain accrued over the previous 12 months. Most people seem unenthusiastic about this idea but it cannot be dismissed entirely, because some of its keenest supporters work for the New Zealand Treasury.

The basic aim of the Conference was to canvass the options as to how these and other related questions might be answered. The idea was not to promote the introduction of a capital gains tax but merely to help inform the debate. After all, those opposed perhaps have an even greater interest in the detail than those in favour. But whatever else might be said either for or against it, the introduction of a capital gains tax would entail change for lawyers, accountants, valuers, businesspeople and investors generally; and the transition period – from the government’s announcement of the tax until several years after its introduction – would be likely to be particularly challenging. The Conference therefore attempted also to give some indication as to the practical implications of capital gains taxes.