Category Archives: Capital Gains Tax

Any political party wanting a fairer, more productive New Zealand needs to address the issue of the taxation of capital – Terry Baucher.

Is a capital gains tax ever possible?

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Earlier this week Gareth Vaughan asked me whether a New Zealand political party could ever sell the idea of a capital gains tax (CGT) to the public and if so, how? Always up for a challenge, I believe the answer is yes.

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Firstly, a quick definition: we’re discussing a realisation-based CGT, i.e. the gains are determined when an asset is sold or otherwise disposed of. This is the “standard” CGT in use around the world. All assets would be revalued prior to implementation so any gains which have arisen prior to the start of a CGT would never be taxed.

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To begin with, it’s vitally important to recognise the scale of the challenge. As Bernard Hickey pointed out, Jacinda Ardern’s “Captain’s Call” was effectively a $520 billion gamble.

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Viewed like this, Labour’s initial approach was a bit like Custer’s charge into the Little Big Horn, a bold cavalry raid relying on shock and awe to overwhelm the enemy before it can organise. Like Custer, Labour underestimated the scale of the opposition but unlike the hapless 7th Cavalry, managed to extract itself and is still in with a chance even if a bit battered by the experience. Jacinda Ardern and Grant Robertson will now appreciate that introducing a CGT will not be a swiftly won skirmish but full on trench warfare.

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Into the breach

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The arguments in favour of a CGT can be summarised as follows:
  • Raising taxes is not politically impossible;
  • We already tax a large number of capital gains;
  • Broadening the base of taxation to include capital gains is consistent with current policy settings;
  • Broadening the base would produce a fairer tax system and should enable tax rates to be lowered;
  • CGT would simplify the tax system; and
  • It could help address New Zealand’s poor productivity record.

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Let the difficulties argue for themselves

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In 1943, facing opposition to his proposal for floating harbours to be used in the D-Day landings, Winston Churchill growled “Don’t argue the matter. The difficulties will argue for themselves.”

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What’s remarkable about the CGT debate is that proponents of a CGT regularly fall into the trap of arguing the difficulties. Even when the Labour Party ran on introducing a CGT in 2011 and 2014 it started from a circumscribed position of exempting the family home.

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Opponents therefore didn’t even have to address the question of whether it was fair that someone owning a multimillion-dollar property and receiving non means-tested New Zealand Superannuation (hello Winston!), shouldn’t be taxed on any capital gains from the sale of their property.

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Taking so much off the table without question just puts those advocating change on the defensive. Better to follow Nelson’s last signal at Trafalgar and “engage the enemy more closely”. It’s going to be trench warfare so don’t surrender ground willingly.

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The base line for a CGT should be to put everything, including the family home, up for debate. If a CGT was introduced my preference would be to give a generous exemption for the family home, maybe $250,000 per person as is the case in the United States. Remember gains arising prior to commencement will NOT be taxed.

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“But the politics”

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Recent history shows that parties can raise taxes and still win elections. In the last thirty years three New Zealand governments have either introduced or raised taxes and all were subsequently re-elected. David Lange’s Labour Government introduced GST, a completely new tax, in 1986. Helen Clark campaigned and won in 1999 with a promise to increase the top rate of income tax to 39%. Finally, in 2010, John Key’s National Government raised the rate of GST to 15%. All three governments were comfortably re-elected after their tax increases. Raising taxes or introducing a new tax is therefore not politically impossible.

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There is no CGT in New Zealand, there are no sheep on our farms

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New Zealand remains virtually unique among the OECD’s 35 nations in not having a CGT that is generally applicable regardless of intent. The principle behind taxing capital gains is not revolutionary. As Inland Revenue advised then Minister of Revenue Todd McClay in February 2014:

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“Increases in asset values, just like regular income, increase a person’s net wealth and ability to consume. A capital gain is income…

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“There is no obvious reason why a person who derives $100,000 in interest income should be taxed differently to a person who derives $100,000 in capital gains.”

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In fact, we already tax a LOT of capital transactions. There are presently over thirty provisions within the Income Tax Act which tax capital gains. These rules were described as “an incoherent mix of taxation based on accruals, realisation, and imputed return” in a paper prepared by Leonard Burman and David White for the 2010 Tax Working Group (“the TWG”).

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Capital gains already taxable include the financial arrangements and foreign investment regimes, foreign superannuation scheme transfers and certain property transactions including the “bright-line” test introduced in 2015.

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Against this backdrop the CGT argument really should be framed as “why aren’t we taxing X or Y?”

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What’s in it for me? Broadening the base

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Following the example of the introduction of GST in 1986 and its 20% rate increase in 2010, any CGT introduced should be promoted as a revenue-neutral measure and accompanied by compensatory income tax and/or GST reductions. Such a step would be entirely consistent with the “broad base, low rate” approach to tax policy both Labour and National have supported for the past 30 years.

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This is also the view of Treasury which in a September 2012 report stated;

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“Treasury continues to see merit in a general capital gains tax or a land tax as possible revenue-raising reforms, and considers that a capital gains tax offers the best way of improving allocative efficiency by reducing economic distortions caused by gaps in the tax base.”

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The debate on CGT has tended to paint its application as a loss for those affected. The better question is what is the opportunity cost of NOT taxing capital gains?

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Inland Revenue advised the TWG in 2010 that a comprehensive CGT including the family home could raise $9 billion annually. That was more than the projected $8.3 billion corporate income tax take for the June 2010 year, or just under 25% of the combined GST and individual income tax take of $36.1 billion. If the family home was excluded, the projected CGT revenue was $4.5 billion, still a substantial sum. Excluding the family home would come at a cost which should be made clear.

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Based on the available evidence (and unlike Australia, Canada, the UK and the US, Inland Revenue doesn’t release very detailed tax statistics), the evidence is that capital is under taxed especially relative to salary and wages. Furthermore, non-taxation of capital tends to favour the wealthy.

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A joint Treasury/Inland Revenue report prepared for the TWG in 2009 examined the composition of taxpayers paying tax on capital gains in Australia and the United States.

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In Australia, 1,148,440 taxpayers reported taxable gains for the year ended 30th June 2007. And 48.4% of all gains for the year was returned by the 90,202 taxpayers (7.8%) with taxable income in excess of $150,000. There were similar findings for US taxpayers.

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The report concluded “If New Zealand is similar, this would suggest that omitting to tax capital gains is likely to favour the rich.”

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A subsidy from the general taxpayer to property owners

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A further issue arises not just in the potentially higher income tax rates for taxpayers in general but also through the ability for negatively geared investors to offset their losses against other income. This offset often results in substantial tax refunds. For example, according to information supplied to me by Inland Revenue, the rental losses reported by the top three income deciles for the year ended 31st March 2016 totalled $339 million (about 60% of the total losses for the year). At 33% that represents about $112 million in tax. This is effectively a subsidy from the general taxpayer to property owners.

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This leads on to the question whether it is fair that someone who may have enjoyed perhaps hundreds of thousands of dollars of tax refunds through negative gearing, also gets the capital gains on their investments tax free? This is perhaps one of the biggest anomalies of the present system.

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According to Statistics New Zealand, the number of New Zealanders living in their own home has fallen from a peak of 73.8% in the March 1991 quarter to 63.2% in the December 2016 quarter.

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Statistics New Zealand now estimates 33% of New Zealanders, over 1.5 million people, live in rental property. Increasingly, it seems the benefits of residential property are going to fewer people. Does the present tax treatment of property effectively result in an unseen subsidy in the form of higher taxes paid by non-property owners? The trade-off proposed is that the revenue from a more comprehensive CGT could be used to lower income and/or GST rates for everyone. This is not being debated at the moment.

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Complicated compared with what?

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The Burman and White paper for the TWG acknowledged that a CGT would be “relatively challenging to administer” but then asked the question “compared to what?” Anyone arguing a CGT would be more complex than the financial arrangements and foreign investment fund regimes clearly hasn’t spent much time navigating these minefields of complexity. CGT should enable both regimes to be consigned to somewhere near the bottom of the Kermadec Trench.

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For many transactions, a realisation-based CGT would be conceptually clearer than the current law and therefore more comprehensible to the layperson. This is particularly true of land transactions, where tax advice is often little more than a variation of ‘It depends’. The introduction of the ‘bright-line test’ in 2015 highlighted how unsustainable the existing approach to taxing land transactions based on intent at the time of purchase had become.

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Critically, a CGT would also be more enforceable, as intent would no longer need to be determined. It would also be fairer: given the subjectivity of measuring ‘intent’, taxpayers in identical circumstances could currently finish up with differing tax bills. (What may be acceptable proof of intent to one Inland Revenue auditor may be insufficient for another.)

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What productivity growth?

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In any case how are the present rules really working out for us? Ex-Reserve Bank economist Michael Reddell pointed out this week that New Zealand’s productivity has gone nowhere in the past five years, part of a near 70-year relative decline.

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What part has the present tax rules played in that decline? The Burman and White paper for the TWG raised this issue, arguing:

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“That is why geniuses who might otherwise do productive work have been drawn to financial engineering or into fields that can earn income in the form of capital gains rather than income. With such huge tax incentives, the investments that produce capital gains do not even have to be particularly productive. Thus, many resources invested in such underperforming assets may be wasted.

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Eliminating that waste would be good for productivity. It would also bolster support for the income tax. A tax system riddled with loopholes, where billionaires can pay lower average tax rates than their secretaries, invites disrespect and undermines voluntary compliance.”

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Apart from having a CGT, something else Australia, Canada, the UK and the US all have in common is superior productivity to New Zealand. This lends weight to Burman and White’s argument that the lack of a CGT may have resulted in lower productivity here. Maybe those opposed to CGT should answer that question when defending the present treatment. (And Bill English, simply saying it’s not true about no productivity growth in the past five years doesn’t count).

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If not a capital gains tax, what?

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What might also emerge from a debate could be that CGT isn’t the answer, but maybe the alternative suggested by The Opportunities Party of a deemed rate of return on all productive assets would be worth pursuing.

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Ponder this: a one percent levy on the $1.38 trillion net financial wealth currently held by households would yield $13.8 billion a year. To put that in context the Government expects to collect an estimated $20.6 billion in GST, and $34.3 billion in income tax from individuals in the year to 30 June 2018. A levy should provide a substantial amount for redistribution to cushion the cashflow impact of an asset tax.

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A fairer, more comprehensible and productive tax system

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Whether it’s through a CGT or an asset tax, taxing capital more comprehensively would achieve the goal of a broad-base, low rate tax system. It should be sold on this basis and introduced alongside a potentially quite substantial reduction/re-alignment of income tax and GST.

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CGT is not without complexities but it would be far more comprehensible than the present “incoherent mix”. Eliminating the bias towards tax-free gains would mean a fairer tax system as Burman and White pointed out. It should also free up capital to be deployed more productively raising productivity and wages. That’s a lot of positives for those proposing change to deploy.

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Any party wanting a fairer, more productive New Zealand, and as far as I can tell, that’s all of them, needs to address the issue of the taxation of capital. Because whatever we’re doing now isn’t working.

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Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting.

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The new American Dream: rent your home from a hedge fund – Simon Black. 

About a month ago I joined the Board of Directors of a publicly-traded company that invests in US real estate.

The position brings a lot of insight into what’s happening in the US housing market. And from what I’m seeing, the transformation that’s taking place today is extraordinary.

Buying and renting out single-family homes has long been the mainstay investment of small, individual investors.

The big banks and hedge funds pretty much monopolize everything else. They own the stock market. They own the bond market. They own all the commercial real estate. They even own the farmland.

Single-family homes were one of the last bastions of investment freedom for the little guy.

But all that’s changing now.

Last week a huge merger was announced between Invitation Homes (owned by private equity giant Blackstone Group) and Starwood Waypoint Homes (owned by real estate giant Starwood Capital).

If the deal goes through, the combined entity would be the largest owner of single-family homes in the United States with a portfolio worth over $20 billion.

And this is only the latest merger in an ongoing trend.

Three years ago, for example, American Homes 4 Rent bought Beazer Pre-Owned Rental Homes, creating another enormous player. A few months later, Starwood Waypoint bought Colony American Homes.

And of course, Blackstone was one of the first institutional investors to start buying distressed homes, forking over around $10 billion on houses since the Great Financial Crisis.

At one point, Blackstone was reportedly spending $150 million a week on houses.

There are some medium-tier players coming into the market as well. A friend of mine runs a fund that owns about 2,000 rental homes in Texas, and he’s buying every property he can find.

I called him for his perspective on what’s happening in the housing market. Here’s what he told me:

There are lots of little guys assembling portfolios of 10-100 homes. And I like to buy these guys out because they have much higher funding costs than us.

And, eventually, as we get larger, medium-sized funds like mine will get bought out by Blackstone and the other mega players.

In short, medium-sized funds are buying up all the little guys. And mega-funds like Blackstone are buying up all the medium-sized funds.

This means there’s essentially an ‘arms race’ building among the world’s biggest funds to control the market, squeezing small, individual investors out of the housing market.

Then there’s the situation for renters.

US Census Bureau statistics show that, over the past decade, the number of rental households has been rising steadily while the number of homeowner households has been falling.

In other words, the American Dream of owning your own home has been fading.

It’s easy to understand why:

US consumer debt is at an all-time high of over $1 trillion (mostly credit card debt), with an additional $1.3 trillion in federal student loans.

Americans… especially younger people, are far too heavily indebted to be able to save any money for a down payment.

Moreover, despite all the hoopla about the low unemployment rate in the US, wages are totally stagnant.

(Plus bear in mind that most of the jobs created have been for waiters and bartenders!)

So the average guy isn’t making any more money, or able to save anything… all while home prices soar to record levels as major funds gobble up the supply.

This means that the new reality in America, especially for young people, is that if you’re lucky enough to not be living in your parents’ basement, you’ll be relegated to renting your house from Blackstone.

But… there is some interesting opportunity in all of this.

With a supply of more than 17 million rental homes in the United States, there’s a LONG way to go for this trend to play out. We’re still in the early stages of the mega-fund consolidation.

And some savvy little guys are figuring out how to cash in on this trend.

Think about it: mega-funds don’t have the capacity to buy up homes one at a time. They just don’t have the time.

They need to buy homes in big volume… hundreds, even thousands at a time. And they’re willing to pay a premium if they can buy in bulk.

That’s why medium-sized funds like the one my friend runs in Texas are basically assembling large portfolios with the sole purpose of flipping everything to the mega-funds.

But smaller investors can play this game too.

Medium-sized funds need to buy in bulk as well. They don’t have the time or resources to buy up homes one at a time.

This creates a unique, niche opportunity for individual investors to assemble small portfolios, say, 10 properties, with the sole purpose of flipping to medium-sized funds.

We know some people already doing this. They essentially put several single-family homes under contract simultaneously (with only a small deposit on each home).

But, BEFORE they close, they make arrangements to flip the entire package of homes to a medium-sized fund through a double-escrow closing.

This structure guarantees a neat profit to the small investor while requiring limited up-front capital.

And like most great investment opportunities, it’s been very lucrative so far because very few people are doing it.

SovereignMan.com

Why a capital gains tax should capture the family home – Mark Lister. 

A capital gains tax is back on the agenda by the sound of it, if we see a change of government. This should worry property owners more than share investors, as they probably have more to lose.

Shares are misunderstood in New Zealand. Many people think the market is somewhat of a lottery, and the only way to do well is by being lucky enough to pick a few winners that go up in value.

The reality is quite different. Over the past 20 years’ NZ shares have delivered a return of 8.5 per cent per annum. However, most of that return is from boring old dividends rather than capital gains, 71 per cent, to be precise.

That’s important, because it means a capital gains tax would only impact the other bit. The vast bulk of the return already attracts income tax at the investors’ marginal rate. In short, share investors are already paying tax on more than two thirds of their return, which is probably a lot more than many property investors.

It’s harder to quantify how the returns for property are split between rental income and capital gain, but I suspect they are skewed much more toward the latter.

The gross dividend yield for the NZX 50 index is 5.5 per cent, whereas the average rental yield across New Zealand is just 3.8 per cent. In Auckland, it’s even lower at only 2.8 per cent, according to QV.

Contrary to popular belief, it seems shares are often the asset class of choice for investors looking for steady income. Property arguably holds more appeal to those after a quick capital gain and looking to make use of easy leverage.

Most share investors I come across are investing for income, rather than chasing big capital gains. They want a passive earnings stream that will grow steadily and keep pace with the cost of living.

Fortuitously, the local market is quite useful in this regard. It is dominated by predictable businesses that generate strong cash flows and pay a good portion of these out as dividends.

These companies have already paid tax on their profits so rather than be taxed a second time, investors get something called an imputation credit. This means the cash dividend they receive is, for the most part, tax paid. It’s actually a very good system, and we are one of the few countries to do things this way.

A capital gains tax might have some merit. It would certainly force people to focus more on the cash flows an asset generates, which theoretically should mean things are valued more appropriately.

It would need to be implemented sensibly though. That means making it free from exclusions (including the family home), otherwise such loopholes leave it open to exploitation and accounting trickery.

Labour leader Jacinda Arden, however, has ruled out including the family home in any capital gains tax policy.

It should also go hand-in hand with a corresponding decrease in our income tax rates. That’s the whole point right? To tilt things away from the wage and income earners, and shift more of the burden onto those focussing solely on capital gains?

– Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. 

NZ Herald 

New Zealand Capital Gains Lunacy. Ryman Healthcare: $362.9m profit, Zero Tax? – Anne Gibson. 

Ryman Healthcare this morning released its annual report to the NZX, showing it made $362.9 million annual pre-tax profit – but have not paid not a cent in tax.

Notes to the accounts showed New Zealand’s largest listed retirement business, with a market capitalisation of $4.1b, incurred a tiny $6.2m income tax expense.

But even that was deferred, meaning it didn’t need to be paid.

Under the item ‘current tax expense’, there appeared a bar, indicating no tax was paid for the March 31, 2017 year. The company’s statement of cash flows also showed no tax payments.

Yet Ryman’s applicable tax rate is the corporate 28 per cent, the accounts also showed. The accounts filed showed that if Ryman paid tax at the applicable 28 per cent, it would have incurred a $101,637,000 tax bill (last year $86,613,000).

But that was whittled down to zero.

Deborah Russell, Labour’s candidate for New Lynn and a former Massey University senior lecturer in taxation at the accounting school, said Ryman had done nothing wrong because as the notes to the accounts showed, its non-taxable income principally arose from fair value movement in investment property.

“So that’s capital gains. They’re not [so much] in the business of providing retirement accommodation as much as in the business of earning capital gains. Those are not taxed. It’s all perfectly legal and in fact, New Zealand tax law allows this at the moment. The issue is whether we should be taxing capital gains.

Wage earners might find Ryman’s tax situation unpalatable, she indicated.

“For wage and salary earners, all our income gets taxed but capital gains are earned over a time and they don’t get taxed. It’s all perfectly legal but what’s legal is not necessarily fair.”

Gordon MacLeod, Ryman chief executive, appeared in a Herald video at the latest results briefing, talking about the tax issue.

Asked why only an approximately $6m tax sum appeared in the accounts, MacLeod said: “It’s really simple, because we actually invested in so much development, so we have a really strong development pipeline.”

Jeremy Simpson, a senior equities analyst Forsyth Barr who specialises in property, said today the zero tax bill didn’t surprise him, it was known when the annual result was announced a few weeks ago and he also emphasised nothing was wrong.

“Because they’re such a big developer – one of the biggest in New Zealand – there’s a deduction associated with the development. If the Government decided to tax capital gains… but there’s no capital gains tax in New Zealand,” Simpson said.

Ryman was no different to fellow listed retirement businesses Metlifecare or Summerset in deferring its tax, he said, adding that New Zealand would be much the poorer if such big businesses were not developing new aged-care facilities.

The state was certainly not keeping pace with providing facilities for the rapidly ageing population, he said.

Asked of his opinion about Ryman paying no tax, Simpson said: “I’m absolutely OK with the tax situation. They’re been listed since 1999 and that’s the way the model works.

“No one is building new aged care facilities in New Zealand except the retirement village operators and we’re going to have a chronic shortage. If you start reducing the profitability…they’re using the profits from the retirement villages to subsidise building the care. If we didn’t have the retirement village operators building the care beds, we would be in a dire situation in New Zealand with regard to having enough care beds.”

Simpson emphasised that Ryman shareholders were liable to pay tax on the dividends they received.

“We have a situation in New Zealand where you only pay tax once. While Ryman doesn’t pay any tax, the shareholders do pay tax on the dividends so there’s still a tax take. Ryman also pays tax a lot of GST on their development.

“So there’s a bit more to it than the headline ‘they pay no tax’,” Simpson said.

A Ryman spokesman said: “Since listing, Ryman has paid 50 per cent of its underlying profit as dividends to shareholders, and those dividends are subject to resident withholding tax at 33 per cent with no imputation credits.

“In New Zealand, either the company pays tax or its shareholders do – but not at both levels.

“Ryman is currently not paying tax at a company level because of its very significant and growing investment in critical healthcare infrastructure for the elderly. In the last 10 years Ryman has built over 2000 care beds and 1000 assisted living units, providing great care options for thousands of New Zealanders,” the Ryman spokesman said.

“Half of Ryman’s build is centred around care provision and accordingly tax depreciation deductions are greater than what is allowed for accounting, because of the wear and tear in care centres that occurs each day. In addition, Ryman is able to deduct interest costs from bank debt in full – as can all other New Zealand companies. Ryman only incurs bank debt to fund development activities.

“Finally, a significant proportion of Ryman’s reported profits occur from fair value investment property gains, which are not subject to tax. This is because the gain is either unrealised from a paper valuation movement only, or relates to cash flows from resident capital sums – which are not taxable because we have a repayment obligation when the resident vacates their unit.

“On a broader level, Ryman pays significant amounts of GST which cannot be claimed back on the cost of developing independent living units for residents, and also creates an increasing PAYE take by creating additional jobs at the new villages we build every year – in total tens of millions per annum,” the Ryman spokesman said.

NZ Herald