The recent report by NZ Treasury, which concluded that the wealthiest families paid only 8.9% of their economic income in tax, has received wide publicity – however, there has been little critique or factual knowledge of the current tax system, which is generally fair and easy to administer.
According to NZ and Australian tax rules, tax paid by a company is imputed to have been paid by the owners. This applies to both private companies and publicly listed companies. So to say, as IRD does, that “Treasury’s analysis does not include tax from companies or Trusts controlled by individuals” makes the whole statement above misleading. All owners, whether trusts, individuals, or companies declare each year the gross amount paid as a dividend including the tax paid by the company, and then the net amount received.
The rule was introduced in 1987 in Australia by the Labour government – Hawke and Keating, noting that the double taxation which had existed before was inequitable. New Zealand followed in 1989.
It is also NZ law that benefits paid in cash or kind to beneficiaries of a trust, which is a completely separate entity from the beneficiaries, is taxable in the hands of the beneficiary. The trust is obliged to pay tax on its net income. In that case, double taxation persists, because trusts are not owned by the beneficiaries. To say that 67% of the economic income made by the wealthiest families in NZ is made in trusts, and then to omit that tax from the total paid by those families, is disingenuous. Attempts to write profits down by exaggerating expenses, and including private expenditure, is currently supervised by public accountants and IRD, although most would argue that the supervision is inadequate.
It is equally disingenuous for politicians and media reporters to claim that Labour may introduce a capital gains tax. We already have several types of tax on capital gain. Any entity which trades in an asset, is charged on the net gain on disposal of that asset. That applies to property developers, art dealers, and share traders and any other merchant. On the extended bright line test, the capital gain on investment residential property (both NZ and overseas) is taxable as income, for new- build properties sold within 5 years from 2021, and other properties sold within 10 years, with exclusions for some owner-occupied homes and farms. For foreign shares above NZ$50k, you have to show a year’s capital gain on the portfolio, and then calculate income tax on an assumed 5% dividend from the opening value. That is another form of capital gains tax.
The real questions are how far the existing taxes should be extended and what happens to the existing regulations when a new CGT is applied. We should also remember that as an asset gains in value that capital gain is expected to produce an increased return on funds – part of the cost of capital and a taxed gain which usually overlooked by advocates of CGT.
As NZ is an outlier in its tax structure at both the top and bottom ends of the income scale, we should ask what sort of CGT should be adopted. Ignoring the lowest income scale which is too high, here are some thoughts that this contributor feels should be considered as part of any review
- The accounting difference between annual income and capital should be preserved. The Cullen report tried to argue that any gain was income and should be taxed accordingly. I believe we should have rules for income and rules around capital gain to preserve the objectives of long term investment in the interests of all New Zealanders. The Australians after debate observed this, imposing lower rates on capital than on income.
- Any capital gain should be discounted by the rate of inflation over the period that the asset is held. This could easily be related to the CPI, and the figure published by IRD for each year over the past 30 years. It would be unreasonable to tax government-sponsored inflation as though it were a real rate of return when it is clearly not. Family wealth usually comprises assets which have been held for the long term.
- All existing rules for the taxing of capital gain, including those above, should be scrapped in favour of new regulations over realised capital gain. The use of deemed rates of return (FDR) are complex and avoided if possible.
- The rate of tax applied should take some account of the economic viability of companies owned by the taxpayer. It would be quite silly to apply a wealth tax which forces the sale or windup of whole companies which contribute or are expected to contribute to the health of the NZ economy. It may be desirable to force the sale of some shares held by very wealthy individuals or families, if the social aim is to promote greater equality to disadvantaged sectors of the community. Capital gains taxes overseas have stimulated the sale of loss-making assets, when these are often the assets that develop an economy in future.
- Any new CGT should be applied as widely as possible to any form of asset – including works of art, recreational assets such as boats and holiday homes, stocks shares and bonds, and even under certain circumstances, the family home (as is covered in the current bright line regulations.) I doubt whether any government would get away with taxing the family home, but I favour including it, if it will lower the tax rate on the whole base.
It is recognised by all governments that designing changes in the tax system takes time, and initially may open new gaps for the well-to-do to use to their advantage. That much was clear when the tax on foreign assets was developed, and further changes were made after it was imposed. The existing tax system is complex enough. Currently IRD struggles to investigate privately-owned companies and family trusts, and so the structure favoured by the very rich in which a range of properties and companies are owned by a trust, will demand more not less, surveillance.
Alan is a Life Member of NZSA, and a regular supporter of NZSA’s proxy voting service. While the views expressed in the article do not constitute NZSA policy we would welcome comments and debate.