CGT would hit middle hardest

February 22, 2019

It there’s such a thing as a fair tax, it’s not one based on misplaced envy as the Tax Working Group’s capital gains tax appears to be.

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Fairness is desirable but not at any cost and  it’s best achieved by helping the poor up not pulling the better-off down, especially when those who will be hit hardest are those with modest investments, not the really wealthy, and worse still, they’d be hit by one of the most penal CGTs in the world:

The Tax Working Group’s report released today proposes a broad-based top rate of 33% capital gains tax (CGT).

The New Zealand Initiative argues in a new policy note, The Pitfalls of CGT, that headline rate would immediately push New Zealand to the top of the international CGT rankings among industrialised economies, just behind Denmark and Finland.

“The proposal is conspicuous by a lack of exemptions and concessions around business investment, so a full rate would arguably qualify New Zealand’s CGT regime as one of the harshest in the world,” said Dr Patrick Carvalho, Research Fellow and author of the note.

“Worse, given New Zealand’s recognisably low-income tax thresholds by international standards, a new CGT would disproportionately hit middle-income earners already struggling to invest for retirement.”

“New Zealand should be cautious about siren calls for a top-ranking CGT. Trying to punch above our weight can sometimes place us in the wrong fight category,” concludes Dr Carvalho.

A good tax would foster investment that would help businesses grow, produce more and employ more.

A good tax would encourage and reward thrift and delayed gratification.

A good tax would improve productivity and promote growth.

The CTG as proposed would do the opposite.

New Zealand needs foreign investment because we don’t have enough of our own capital. The CGT would aggravate that by making investing overseas more attractive than investing domestically:

The Tax Working Group (TWG) proposals released this morning would skew New Zealand investors away from local assets, distort the KiwiSaver market and mangle the portfolio investment entity (PIE) regime if introduced, according to the founder of the country’s largest direct-to-consumer managed fund platform.

Anthony Edmonds, InvestNow founder, said while the TWG final report includes some welcome reforms, overall the capital gains tax (CGT) recommendations would add cost, complexity and confusion to New Zealand’s relatively efficient managed funds market.

“For example, the TWG’s plan to increase tax on New Zealand shares by applying CGT while leaving the fair dividend rate (FDR) tax for offshore shares unchanged would naturally drag capital offshore at the expense of local assets – at a time when New Zealand needs to fund major infrastructure projects,” Edmonds said. “In trying to discourage people from investing in residential property, the TWG has created a tax disincentive for Kiwi shares, which can only distort investment allocation decisions.”

Essentially, the TWG recommendation to tax unrealised capital gains on PIE funds marks a return to the ‘bad old days’ when Kiwis paid more tax on managed funds than direct share investments. . .

Concern over the housing shortage is one of the motivating factors for a CGT but It won’t improve home affordability in the long term:

Bindi Norwell, Chief Executive at REINZ says: “In the short-term there may be some initial relief in house price affordability as investors look to sell their property to avoid paying CGT. This may create opportunities for first home buyers.

“However, in the long term it’s likely to push house prices up as people look to invest more money in the family home, as there will be less incentive to invest in rental properties or other forms of investment e.g. equities.

“This will also have a flow on effect for the rental market with fewer rental properties available for tenants, thereby further pushing up weekly rental prices when they are already at an all-time high.

“The report even recognises that any impact on housing affordability could be small, therefore, we question whether all of the administrative burden and cost to implement GCT is worth it? Especially as CGT coming at the end of a raft of legislative changes the housing market has faced recently including the foreign buyer ban, ban on letting fees, insulation, healthy homes and ring fencing. . .

A tax that results in fewer and more costly rentals and more expensive homes is not a good one.

Nor is a tax that is fatally flawed:

Today’s Tax Working Group report recommendation for a new capital gains tax will not address residential housing affordability but it will penalise business owners and create costly complexity in our tax system, meaning it is fatally flawed, according to Business Central.

“New Zealand’s tax system is envied worldwide. The proposed capital gains tax increases compliance costs without boosting productivity,” says Business Central Chief Executive John Milford.

“Business Central agrees with the conclusions of the minority view on the Tax Working Group.

“A capital gains tax is just another cost on business, nothing more. . .

It would hit small and medium businesses hardest:

Key areas of the Tax Working Group Final Report released today were disappointing, says Canterbury Employers’ Chamber of Commerce Chief Executive Leeann Watson. . . 

Ms Watson says the proposed capital gains rules should not be implemented because of the significant impact on small and medium-sized enterprises (SMEs).

“We support the Government’s review to ensure that our tax system is fit for purpose for a changing business environment. However, there is very real concern that taxing both shares and business assets under a comprehensive capital gains tax regime would create double taxation.

“This could disadvantage New Zealanders owning shares in New Zealand and create inconsistencies around overall taxation on investment.”

Ms Watson says a capital gains tax would be unlikely to achieve the desired outcome for business.

“There is concern around the effect for capital markets in a capital constrained economy with a long-term savings deficit. Adding further tax on the savings and investment of those New Zealanders in the middle-income bracket won’t drive the deepening and broadening of the capital base that we need for business investment, which is higher productivity and wages.

“While the impetus behind the changes are aspirational, there is little to indicate they would significantly reduce overinvestment in housing or increase ‘tax fairness’. In addition, there is concern that additional administration costs and investment distortions could outweigh any benefits and potentially discourage much-needed investment and innovation by locking businesses into current asset holdings.

“It is vitally important that we remain competitive as a country and are not continuing to add further compliance for business and in particular small business, who represent 97% of all businesses in our economy.”

Ms Watson says there needs to be a viable business case for any changes to the current tax system.

“There seems to be a real focus on ‘fairness’ in the system design, as opposed to revenue-building, so we need to be careful that any tax changes are for the right reasons and are backed by a clear, practical and sustainable business case. We currently have a fairly simple and efficient tax system that should be kept and better enforced, with changes to specific rules where needed.” . . 

The costs of a good tax would not outweigh the benefits:

The Employers and Manufacturers Association (EMA) says the key issue in the Tax Working Group’s proposal released today is that the cost of its capital gains tax rules will outweigh any benefits.

Chief executive Brett O’Riley says any gains from such a broad-based capital gains tax would be eaten up by administration and other costs, leaving little revenue.

“Fundamentally the proposed capital gains rules don’t address the Tax Working Group’s objectives of reducing over-investment in housing and increasing tax fairness,” he says.

Mr O’Riley is also concerned that capital gains tax on business assets could discourage investment and innovation, locking businesses into their current asset holdings. He says there are other policy settings that could be changed to increase investment in different asset classes, away from property.

“I also fail to see how taxing growth on the value of assets from the proposed commencement date of 1 April 2021 would work, because it would be open to conflicting valuations,” he says. “It could also act as a further disincentive to growth when New Zealand already has issues with business not growing from SME’s into larger scale operations and a CGT may also limit the availability of capital to reinvest in businesses as smaller businesses face an additional tax bill.

“It’s difficult to see any benefits for the business community from implementing the proposed capital gains tax rules, as taxing both shares and business assets appears to be double taxation,” says Mr O’Riley.

It is relevant to note that a number of the Tax Working Group do not favour its recommendations on capital gains tax. The minority view summary is available here

One reason for dissension was compliance costs:

Former IRD Deputy Commissioner Robin Oliver was one of the 11 in the Tax Working Group.

Along with two others from the group, he believes the costs and bureaucratic red tape involved in adopting all the capital gains options outweigh the benefits.  

“We didn’t agree that this was in the best interest of the country to go the full extent, particularly in the business area, taxing share gains which result in double taxation,” he said.

“To get a valuation for all business assets in all parts business and all business will easily cost over a billion dollars in compliance costs. The amount of revenue you’ll get is relatively minor.”

As for taxing shares, Mr Oliver said it would result in New Zealanders who invest in New Zealand companies paying more tax when foreigners investing in New Zealand companies will pay no more tax. Furthermore, New Zealanders investing in foreign companies will pay no more tax.

“The obvious conclusion is New Zealanders will own less New Zealand companies and more foreign companies, and foreigners will own our companies,” he said. . . 

The proposed tax is no panacea for fairness:

Deloitte tax partner Patrick McCalman warns that a CGT is not a panacea for tax fairness.

“At one level, there is an attractiveness in the argument that a ‘buck is a buck’ and everyone should bear the same tax burden on every dollar earned. However, when one delves into the detail of the design, other issues of fairness emerge,” says Mr McCalman.

“For example, is it fair that property could pass on death without an immediate CGT cost, while gifts made during one’s life would be taxed? For family businesses, wouldn’t it be more productive to be able to pass assets from generation to generation before death,” he says.

“Accordingly, we need to be cautious as to how much ‘fairness’ a CGT will introduce. It may simply change where the ‘unfairness’ is perceived to sit within the tax system, creating new tax exemptions that would distort where investments are made.”

Complicating matters further is the political dimension. And MMP only exacerbates the political difficulty and increases the likelihood of whatever ultimately sees the light of day being less coherent from a policy perspective. . . 

The Deloitte paper raises several questions about fairness:

At one level there is an attractiveness in the argument that a “buck is a buck” and everyone should therefore bear the same tax burden on every dollar earned. However, when one delves into the detail, other issues of fairness emerge including new tax exemptions which would distort where investments are made – in effect, in seeking to create fairness, the proposal creates a number of layers of unfairness. For example:

    • With a CGT applying at full rates with no inflation indexation, is it fair that someone who buys an asset is taxed on the full amount of any gain when part of that gain is simply inflation? How will they be able to re-invest in a new asset if the inflation element is taxed?
    • Is it fair that the family home and artwork are excluded but most other property is not? Consider a plumber who has a $500,000 house and a $500,000 commercial building who would be taxed on the disposal of the commercial building. Should they have instead bought a $1,000,000 house, rented a business premise and enjoyed a tax free capital gain?
    • Is it fair that that investors in New Zealand shares would pay tax on capital gains but investors in foreign shares would continue to be subject (as they are presently) to the 5% FDR rate (even if gains are less or more)?
    • Is it fair that small business (turnover less than $5 million) could sell assets and defer the CGT bill if they reinvest the proceeds, while medium and larger size business cannot?
    • Is it fair that property could pass on death without an immediate CGT cost but gifts made to children during one’s life would be taxed?
    • Is it fair that there are proposed tax reductions for KiwiSaver to compensate for CGT but not for other forms of investment?

At one level, true fairness can only exist if all asset classes and forms of remuneration are subject to the same tax rate. But even then, anomalies will always arise. . . 

The proposed tax would be especially bad for farming and farmers:

Federated Farmers has said from the outset that a capital gains tax is a mangy dog, that will add unacceptably high costs and complexity.

“There is nothing in the Tax Working Group’s final report, released today, that persuades us otherwise,” Feds Vice-President and Commerce spokesperson Andrew Hoggard says.

“A CGT would make our well-regarded tax system more complex, it will impose hefty costs, both in compliance for taxpayers and in administration for Inland Revenue, and it will do little or nothing to ease the housing crisis.”

It is notable that even the members of the working group could not agree on the best way forward, with three deciding a tax on capital gains should only apply to the sale of residential rental properties and the other eight recommending it should be broadened to also include land and buildings, assets, intangible property and shares.

“Federated Farmers believes that the majority on the tax working group have badly under-estimated the complexity and compliance costs of what they’re proposing, and over-estimated the returns.”

The recommended ‘valuation day’ approach to establishing the value of assets, even with a five-year window, will be a feeding frenzy for valuers and tax advisors, “and just the start of the compliance headaches for farmers and other operators of small businesses that are the driving force of the New Zealand society and economy. . .

Farm succession is difficult enough as it is.

A CTG would make it harder still and encourage older farmers to hold on to their farms. That would lead to more absentee ownership and leasing with less investment in improvements as happens in other countries.

New Zealand doesn’t have a lot of many wealthy people and while those relatively few would pay more with the CGT as proposed, if their accountants and lawyers didn’t help them find ways to minimise their liability, they’d still be wealthy.

The many small business owners and more modest investors would not. They’d have the reward for their hard work and thrift cut back and lose enough of the value of their investments to hurt – unless they’d invested in art, cars or yachts which would be exempt.

That sends the message that such luxuries are good while investing in businesses and productive assets is not.

Where’s the fairness in that?


Development welcomed and not

April 17, 2014

In Dunedin: Hotel project terminated.

Plans for a $100 million waterfront hotel in Dunedin have been scrapped and the developers’ partnership with the Dunedin City Council has descended into acrimony.

Hotel developer Jing Song yesterday confirmed she had torn up a memorandum of understanding with the council, signed just last month, which had aimed to find ways to progress the project. . . .

In Auckland: New luxury hotel to boost Auckland economy:

A new five-star hotel development on Auckland’s waterfront will strengthen the region’s visitor economy says Auckland Tourism, Events and Economic Development (ATEED).

Waterfront Auckland and Beijing based developer Fu Wah International Group have formed a partnership to build a 200 room hotel on the western edge of the Viaduct Harbour by 2017.

ATEED Chief Executive Brett O’Riley says the new hotel will be excellent for Auckland and help contribute to growing the visitor economy, in line with the targets in the Auckland Visitor Plan.
“The hotel – in its amazing location on the water’s edge in the heart of Auckland’s innovation precinct – will enhance our premium accommodation offering. As part of our strategy to attract more high-net wealth individuals to holiday and do business here, we’ve been working with the Fu Wah Group to help them identify the advantages of doing business in Auckland,” he says.
“We are focussed on positioning Auckland as a premium destination and having a globally recognised luxury hotel will add to the tourism offering.” . . .

This looks like two cities with two difference approaches to development.

One welcomes it the other does not.

Whether or not that is fair, is moot, but that’s the perception and anyone contemplating investment will be aware of it.


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