Opinion: The design of capital gains taxes

by NZ Lawyer14 Jul 2014
There has recently been much debate as to whether New Zealand should have a capital gains tax.

Much less has been said, however, about 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?

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 has 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 houses worth less than a prescribed amount – in which case, how much? Or should the prescribed amount relate to the size of the gain, rather than the value of the house? 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?
On 18 July, the University of Auckland Law School and Business School will host a conference canvassing the options as to how these and other related questions might be answered.

Experts from around the world (the UK, the US, Australia, Canada and South Africa) will explain how their countries have dealt with the design problems capital gains taxes present – and whether their countries’ solutions are optimal.

The idea is 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 particularly challenging.

The conference will therefore attempt also to give some indication as to the practical implications of capital gains taxes. The conference is supported by the University of Auckland, the Hood Fellowship, the Lion Foundation, the New Zealand Law Foundation, NZICA, Ernst and Young and Russell McVeagh.

Professor Michael Littlewood, University of Auckland Law School