The Tax Working Group (“TWG”) has published its final recommendations on the future of New Zealand’s tax system, which include a recommendation that New Zealand should introduce a broad capital gains tax.
The TWG’s capital gains tax recommendation would, if implemented, represent the biggest change to New Zealand’s tax system since the 1980s. This article covers the background to the report (published on February 21, 2019), the key aspects of the proposed capital gains tax regime, and our view on the likelihood that the proposal will survive the political process (including the next election).
Background to the Report
The TWG was established by the government after the 2017 election with a mandate to examine the “structure, fairness and balance of the tax system” and consider whether any changes could be made to improve New Zealand’s tax settings.
Unsurprisingly, the “national conversation” since the TWG’s establishment has focused on the contentious issue of capital gains taxation. New Zealand does not currently have a general capital gains tax. Over the years New Zealand’s income tax legislation has been extended to tax an increasing range of gains, but only on certain forms of investment in real or personal property. Importantly, under the current tax settings gains on residential rental properties are not typically subject to tax in New Zealand.
Purist Ambitions: Key Aspects of Proposed Capital Gains Tax
Following nine months of nationwide consultation, the TWG recommended a broad capital gains tax for New Zealand, which it justified on the grounds that:
“The inconsistent treatment of capital gains [under New Zealand’s current tax settings] reduces the fairness of the tax system. It is also regressive, because it benefits the wealthiest members of our society. Both effects weigh against the sense that New Zealanders are all making a fair contribution, and risk undermining the social capital that sustains public acceptance of the tax system and so our shared prosperity in the long term.”
The TWG spent a considerable amount of time considering what this capital gains tax should look like and has ultimately recommended that:
- the new tax would apply to gains that are not currently taxed, including gains from shares, property investments (excluding the family home and the land beneath it), business assets (including goodwill), and intangible property;
- the new tax should not apply to personal use items, including jewelry, artwork and vehicles. Complex rules are needed for mixed use assets;
- only gains arising after the proposed April 1, 2021 implementation date (the Valuation Day) should be subject to the new tax. This approach would require taxpayers to establish a value for their assets as at the Valuation Day. The TWG has suggested a variety of proxies that could be used to establish an appropriate value (e.g. rating valuations in the case of land), and has recommended that taxpayers should have the right to apply a professional valuation should they choose to;
- the new tax should generally be payable when the relevant asset is disposed of, although “rollover relief” would apply in certain circumstances so that certain disposals are ignored (for example, disposals on death, under relationship property settlements, and under certain transactions within wholly owned groups would not be treated as disposals for the purposes of the capital gains tax rules). A special accruals-based tax regime would be required for portfolio investment entities, including KiwiSaver retirement savings schemes;
- the new tax should be assessed at the ordinary rates of income tax (i.e. there would be no tax rate discount for capital gains) and no adjustment for inflation;
- while capital losses should generally be able to be offset against other forms of income, certain losses, including from assets held on the proposed April 1, 2021 Valuation Day, should be “ring fenced” to capital gains only; and
- tax treaty relief for investors in certain jurisdictions (including Australia, the U.S., and the U.K.) should continue to apply, so that they are not taxed on gains they make on shares in New Zealand companies (unless the company is “land rich”).
Importantly, a minority of the TWG rejected this broad proposal. The minority favored a more limited capital gains tax covering gains from residential rental properties only, which could be incrementally extended over time on a case-by-case basis.
Political Reality: Responses to the Report
The government is expected to release its full response to the report in April. So far, the government has reiterated that any capital gains tax would only take effect after the next election in 2020. But the government has not committed to much else. On the day of the report’s release, Revenue Minister Stuart Nash said:
“The overall findings confirm that there is no need for a major overhaul of the system…Our response will preserve the key principles of our existing broad-based low-rate tax system. In the words of the Prime Minister, we will not throw the baby out with the bathwater.”
Prime Minister Jacinda Ardern has since sought to reassure concerned small business owners and farmers, saying they are “top of my mind assessing options.”
The government’s muted response to the Report is in stark contrast to comments made by National Party leader (the de facto leader of the opposition) Simon Bridges, who says the report is a “declaration of war”, and an attack on “hard-working New Zealanders” and the “Kiwi way of life.” The report has also been heavily criticized in the mainstream media, with negative opinion pieces appearing on an almost daily basis.
The report’s purist capital gains tax recommendations have proven deeply unpopular with sections of the voting public.
We expect the Labour-led government is now considering whether it is prepared to risk the 2020 election on the capital gains tax issue. We will have to wait until April to know the answer to this, but in our view it is now very likely that:
- the government will not proceed with the TWG’s broad capital gains tax regime; and
- the government will seek to salvage something from the report by implementing the more limited capital gains tax focused on residential property recommended by the minority of the TWG. This could be simple to implement, for example, by removing the five-year requirement from the existing “bright line” test for residential land.
We recommend that anyone who may be affected by capital gains taxation should keep a close eye on developments over the next couple of months.
Simon Akozu is a Senior Associate and Charlotte Agnew-Harington is a Solicitor at MinterEllisonRuddWatts, New Zealand.