The Tax Working Group (“TWG”) released its final report to the Government on Thursday 21st February 2019 with close to 100 recommendations.
The Government established the TWG to examine further improvements in the tax structure, fairness and balance of the tax system. Although the much-anticipated report has now been released, the changes recommended are substantially the same as those publicised in its interim report.
The key recommendation by the TWG is to introduce a comprehensive capital gains tax (CGT) regime. The general outline of the recommended regime is as follows:
What Assets are caught?
- A broad-extension of CGT will apply to all asset types - land and improvements, shares, intangible property and business assets. The family home however and “personal-use assets” such as cars, boats, jewellery, fine art, collectibles (rare coins, vintage cars etc.) and other household durables will be exempt. Holiday homes and other family-owned real estate (excluding the family home) will be captured and will not be exempt as a “personal-use asset”.
- Personal-use assets will include intangible property not owned or created for business purposes. For example rights to benefit under a trust or will, personal insurance policies and occupation rights relating to a retirement village would be considered personal-use assets.
- Under the existing tax regime, a New Zealand resident is taxed on their worldwide income. Similarly, a New Zealand resident will be taxed on their worldwide assets. Where a New Zealand resident taxpayer sells foreign land, any gain will attract CGT in New Zealand. However where CGT is also payable in the foreign jurisdiction, such as Australia, a foreign tax credit would be available to mitigate the impact of double taxation.
- The current rules on the taxation of foreign shares under the foreign investment fund “FIF” rules will continue to apply. CGT will however be imposed on foreign shares which are not currently subject to the FIF regime. For example Australian resident listed company shares and shares with a cost of less than $50,000 will be captured.
How will Assets be taxed?
- Capital gains will be on a realisation basis and taxed at a person’s marginal rates.
- Unfortunately there will be no discount for capital gains and no adjustment for inflation. The discount was initially considered as a means to address the ‘bunching effect’ situation, whereby a person is pushed into higher tax brackets as a result of realising a capital gain. For example where a retiree on a tax rate of 17.5% derives a capital gain from the sale of assets to assist in funding their retirement that gain may well be taxed at 30% or even 33% depending on the size of the gain.
- There are a number of exclusions/concessions which will provide “rollover relief”. This relief will apply to all inherited assets, donated assets (charities) and certain events beyond a person’s control such as investment in replacement assets as a result of a natural event or disaster. There will also be relief for a business restructure where there is no change in the substance of the ownership, and a small business concession.
When will CGT arise?
- The tax applies to gains made only after the implementation date also known as the “Valuation Day” expected to be 1 April 2021. The TWG does not propose that assets need to be valued on Valuation Day as this would be an unreasonable burden on both valuers and taxpayers. It is recommended that taxpayers have five years from Valuation Day to determine a value for their inclusion. A default rule will apply where this is not achieved.
- It is recommended various valuation methods be available for taxpayers to determine the “cost base” of the asset. A “median rule” is proposed to smooth out gains on assets held prior to Valuation Day. This means valuation will be based on the middle value of actual cost (including improvements), valuation date value (including improvements), and sale price.
- As capital gains are proposed to be taxed in the same way as other income, any disposal resulting in a capital loss will be treated the same as other tax losses generally. This means a taxpayer would be able to offset losses arising from the disposal of capital assets against ordinary taxable income (not just against capital gains).
- Capital losses will only be ring-fenced for portfolio investments in listed shares, associated party transactions and losses from Valuation Day assets.
- Subject to fiscal constraints, the TWG recommend that the Government reinstate building depreciation deductions, at least on a partial basis.
Although the taxation of capital gains makes up a significant portion of the TWG report, there were other recommendations made by the TWG. A snapshot of some of these recommendations is set out below:
- Refunding Employer Superannuation Contribution Tax for KiwiSaver members earning up to $48,000 a year and ensuring members on parental leave would receive the maximum member tax credit regardless of their level of contributions.
- Increasing the member tax credit to $0.75 per $1 of contribution (although retaining the contribution cap at current levels).
- Changes to the loss-continuity rules that would support the growth of start-up firms. Currently at least 49% of the shareholders must continue until such losses are utilised. Where start-up firms require an injection of equity, this can be a disadavantage given start-ups are generally loss-making at inception.
- An increase in the bottom personal tax rate threshold as opposed to a tax-free bracket. Currently the bottom tax rate is 10.5% for incomes up to $14,000. Approximately 20.9% of people are in this bracket. The TWG reviewed the potential for increase the bottom tax bracket $20,000, $22,500, or $30,000 for the Government’s consideration.
- The TWG suggests that the Government consider whether to remove the loss ring-fencing rule on residential rental property given the taxation of capital gains is extended under the above recommendations.
- With regard to Charities, The TWG recommends that the Government consider whether there needs to be a distinction between rules for privately-controlled charitable foundations and trusts and other charitable entities. The TWG suggest that concessions for such foundations could be removed as they do not have the same arm’s length governance and distribution policies as other charitable organisations.
There are a number of other recommendations made. We are expecting the Government’s full response to the TWG report in April. Assuming the Government adopts the recommendation to introduce a CGT, passing legislation prior to the next election is ambitious given the complexities involved and the need to consult with taxpayers. As we have seen in the past (as with the recently enacted legislation on the ring-fencing of losses), where timeframes are compressed, the quality of legislation suffers.