More thoughts on capital gains tax

Leighton Smith talked about capital gains tax a couple of days ago, having received an e-mail from a concerned listener, who also happened to be a chartered accountant. We have discussed some of these issues before, but there are a few more that also need to be considered in what is an interesting and analytical discussion, which will be enough to put you off the idea of the tax forever.

The first point, which I have said before, is that capital gains tax will be very far reaching, and will increase compliance and collection costs, both for taxpayers and for the IRD. It may not apply to the family home, but it will apply to just about everything else, such as holiday homes, commercial and residential property, intellectual property, goodwill, business sales, KiwiSaver and retirement funds, shares and overseas investments of all kinds. The best way to avoid it seems to be to invest everything into your family home, but it seems cars, boats and artworks that are personally owned will not be touched by the tax, at least for now, so invest in those too.

The Tax Working Group has indicated at this stage that, rather than a flat rate of tax, as I was expecting, capital gains tax will be applied at the applicable marginal rate. For individuals, this may be 33%, 28% for companies and a flat 33% for trusts. Compared to other countries, these are very high rates.?In the US, for example, capital gains tax is pretty much at a flat rate of 20% but people on low incomes do not pay it. But it is also worth remembering that, in the US, there are lots of tax exemptions, so we will indeed be taxed out of existence if this proposal by the Tax Working Group goes ahead.

It is my belief that there would be less avoidance of the tax if a lower, flat rate was set, say at 15%, but that looks unlikely. So, it becomes a tax to avoid at all costs, wherever possible.

We have long been told that we should all?save for retirement and invest in productive assets such as shares and businesses, but of course, the proposed tax takes a sledgehammer to that idea, because investments in those assets will be caught by the tax as well.

The proposed date for the introduction of the tax is April 2021. This means that every residential or commercial property, every holiday home, every business or piece of intellectual property or goodwill will have to have an independent valuation done as of that date. If this is not done, then the asset owner runs the very significant risk of ending up paying too much tax once the asset is sold.

But just think for a moment of the reality of trying to get all of those assets valued at that time? It just isn’t going to happen.

Valuing shares is easy enough. Valuing property is not quite so easy, because government valuations can be wildly inaccurate and the value of the property will depend on the market at the time. This will result in wild discrepancies of starting values, and you can bet your life that there will be a lot of tax disputes over this.

I’ve done a few business valuations, and quite frankly, they can be a bit subjective. The only way to determine the value of goodwill, for example, is to actually sell a business. Valuing a business at a given date can often result in anomalies that will then feed into the tax system. What if a business was going through a temporary rough patch in 2021, but things picked up before it was sold? Business valuations are always based on recent earnings, but these things can change dramatically in a short time.

The thought of every business having to have an independent valuation done around April 2021 to establish a starting point is a nightmare. It will not go well. These things take time, cost money and, as I said, can be subjective.

Here are a couple of scenarios that could prove difficult to manage. Imagine if you invest for your retirement by buying shares over a number of years, with the intention of selling them down a few thousand here and there after retirement to support yourself. Think about the record keeping required. At the moment, records are required to be kept for 7 or 10 years, but this scenario might require records to be kept for 30 years to establish the original cost of the shares.

Or what if you rent out part of your houses on AirBnB. Does that mean you will have to pay capital gains tax on part of the house when it is sold?

Certain life situations may force the sale of assets, such as redundancy, divorce or sickness. I have already seen this happen with the Bright Line Test where the sale of an asset due to hard times triggers a nice fat tax bill at the same time. It is monstrously inequitable.

What will happen if you die? Will there be?rollover relief for assets transferred to your spouse? What if they were owned in joint names? Does that trigger a tax bill for half of the value? What if the assets are transferred to your children? We can envisage the scenario where estates are forced to sell assets just to pay the tax bill.

If assets are owned in a trust, there is no change in ownership on death. This means that assets held in trusts will presumably avoid the tax on the death of a trustee. Is it possible that in one scenario,?one lot is forced to sell while the other does not? That is a major anomaly.

What happens when you sell a property into a trust or another associated entity? Will there be capital gains tax payable on the sale between related entities, even though no actual money changes hands?

With baby boomers ageing, there will soon be a massive transfer of wealth to the next generation, and the government wants to take what will be a big chunk of that. Think about a family bach that has been in a family for generations. When the current owners depart, will this mean that tax will have to be paid on the deemed sale to the younger generation? I suspect it will.

This tax is misnamed. It should be called capital transfer tax, as wealth is transferred from those that have worked for it to those that have not. This tax will fund WFF, social welfare or be splashed around the Pacific. There will be no incentive to work hard and grow assets, as effectively the inflation on them – not just a value increase but the inflation portion as well – will be taxed at a high rate. As far as I know, there is to be no inflation adjustment, so tax will be payable on the entire gain.

But we are going to have to find ways to pay for Cindy’s Marxist programmes somehow, and this is partly it.

Time to start the war against capital gains tax… according to Leighton. I happen to agree with him.