Designing a Capital Gains Tax for New Zealand: Key Issues


New Zealand currently does not have a capital gains tax (CGT) but it is nonetheless subject to debate with an upcoming election. As New Zealand has a traditionally low tax approach, introducing a CGT would perhaps run counter to current policy. The following is an excerpt from an article featured in Tax Planning International Asia-Pacific Focus, written by Stewart McCulloch, partner, Elizabeth Elvy and Sean Yang, senior associates, at PwC, New Zealand. 

New Zealand is known globally for its broad base, low rate system, which allows substantial amounts of tax to be collected at modest tax rates. These settings are designed to reduce the cost of taxation. If New Zealand does introduce a comprehensive CGT regime, we need to ensure its design and implementation supports our international reputation for having a world class tax system.

Introducing a new tax in New Zealand for the first time in twenty years is a political challenge. Consequently, all CGT policies released by current opposition parties contain a raft of exemptions. The voting public's current expectations suggest that a family home exemption is inevitable. Other exemptions may apply to small businesses, personal assets and collectibles. While exemptions allow a new CGT to be more acceptable to voters, exemptions will create additional inequities and inefficiencies in the tax base. It is also counter to New Zealand's general broad base, low tax approach to taxation.

Differential treatment of taxpayers such as individuals, trusts and companies will also lead to distortions as those with capital gains may seek arbitrage opportunities to minimise tax.

Another issue New Zealand cannot ignore in designing a CGT is the effects of globalisation. The designers will need to consider the extent to which New Zealand should be taxing non-residents. There is a need to balance the desire to tax non-residents on their New Zealand gains with the need to encourage foreign investment. Most overseas jurisdictions tax all capital gains derived locally but the UK regime stands out as being particularly generous to non-residents as it allows most of their capital gains to be treated as exempt for tax purposes.

It will also be necessary to review New Zealand's double tax treaties to ensure New Zealand's taxing rights with respect to capital gains are consistent across the board. At the moment, this is not the case.

Calculating the capital gains tax payable will be challenging and possibly subjective. If a CGT regime is introduced in New Zealand, demand for asset valuations will undoubtedly increase. The building industry may also be asked to fast-track capital works on real estate as taxpayers attempt to boost asset values ahead of the regime coming into effect.

Finally, consideration will need to be given to the compliance burden on taxpayers. The introduction of a CGT could result in many non-filing taxpayers having to file personal tax returns.

Observations from CGT Regimes Overseas

Jurisdiction

Key observations

UK

• CGT regime introduced in 1965 but has been subject to constant change by different governments. • Separate legislation on the treatment of capital gains for individuals and corporates. • Significant rate differentials between ordinary income and capital gains for both individuals and corporates, providing incentives for tax arbitrage. • Indexation, taper relief and rate differentials with ordinary income have all been adopted over time as measures to counteract inflationary pressures. • Significant number of exemptions adds complexity and inefficiencies. • Very narrow tax base for non-residents, such that the regime is almost exclusively targeted at UK tax residents only. • Significant number of avoidance cases relating to capital gains matters due to the complexity of the regime.

US

• CGT revenue is primarily derived from the sale of share equities. • Differential treatment between individual and corporate taxpayers with no adjustments made for inflation. • Relatively narrow tax base for non-residents - non-residents are generally only taxed if the gain has been made from US real estate or equity in US real estate-rich companies. • Up to US$0.5 million of the capital gains made from sale of a personal residence is exempt. • As there are no deemed disposals on the death of a property holder, heirs receive a step-up to an asset's cost base when the asset is inherited. This has contributed to significant lock-in effects.

Canada

• Capital gains are taxed under the income tax regime but only half of the gain is treated as taxable. This has resulted in difficulties distinguishing between ordinary income and capital gains. • Trusts are taxed as individuals with deemed disposition of real property every 21 years to prevent deferral of capital gains. • Deemed disposition on death, gifting or ceasing to be Canadian resident. • Broad tax base includes capital gains made by non-residents on Canadian property. • Lifetime exemption applies to capital gains made from farm and fishing properties, and shares in small businesses.

Australia

• Capital gains are taxed under the income tax regime but the taxable gain could be discounted by up to 50 percent. • Assets are very broadly defined to include any kind of property, and legal or equitable rights. • Differential treatment of different taxpayers, coupled with a significant number of exemptions and prescribed capital gains tax events have results in a high level of inequity and inefficiency.• Broad tax base includes capital gains made by non-residents on Australian property, or by an Australian permanent establishment.• Indexation of cost base values were initially introduced but frozen in 1999 and replaced with discounts for individuals, trust and super funds if the relevant assets have been held for 12 months or more.• Exemptions apply to gains made on assets acquired before the introduction of the CGT regime — this results in significant lock-in effects by discouraging owners from disposing of such assets.

South Africa

• Introduced in 2001, the CGT legislation is accompanied by a very thorough and comprehensive guide on different scenarios. • Differential treatment of taxpayers with some exemptions. • No major tax disputes to date regarding a capital gains issue. • No adjustment for inflation or de minimis exclusions means illusionary gains continue to be taxed.• Broad tax base includes capital gains made by non-residents on South African property, or by a South African permanent establishment.

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