Capital gains: NZ’s century of tax avoidance
With a capital gains tax off the table the Government looks to be going down the long and winding taxation path others have trodden before it. Dileepa Fonseka reports.
The debate over taxing capital gains in New Zealand started a century ago, and we’ve been avoiding levying them ever since. There are signs Inland Revenue (IR) might be getting more aggressive in enforcing these ad hoc rules as the Government responds to rising anger over the country’s housing crisis.
Our historic reluctance to explicitly tax capital gains means an odd assortment of arcane rules are now doing the heavy lifting when it comes to taxing the income raised from the buying and selling of property.
And now, advances in IR’s computer systems are making it more difficult than ever for these transactions to go unnoticed.
We have a lot of taxes on property. They’re just confusing, hard to enforce and came through successive Governments who were either unable or unwilling to tax capital gains.
Instead of a broad-based capital gains tax there are several decades-old tax provisions on the books which make you liable to pay income taxes on capital gains under specific circumstances.
They include measures to tax income gained from land if you buy it with the purpose of putting buildings up. Or if you’re associated with a property business and sell a piece of land within 10 years of purchase, offload property which becomes more valuable through a zoning change, or subdivide land within a decade of snapping it up.
Almost all of these rules have exceptions built in for owner-occupiers who aren’t in the business of buying and selling property. In practice these distinctions aren’t so clear-cut as they sound on paper.
The taxes are so complicated many of the accountants and lawyers who deal with them are in favour of a capital gains tax just to simplify things.
Jeff Owens, of Owens Tax Advisors, says IR has always enforced these measures – something which has sometimes taken buyers and sellers of properties by surprise.
‘‘A lot of lay people have this idea that IR taxes you if you buy a property with the intention of resale.
‘‘Of those nine or 10 different taxing provisions [on land sales] only one of them refers to intention of acquisition.
‘‘Intention is not mentioned in any of the other provisions.’’
And there are signs IR’s enforcement of these little-known provisions might have ramped up and broadened out.
Tax consultant Terry Baucher has often argued a low-yield rental property (where rent earned covers only a small portion of the property’s purchase price) is a signal a buyer is banking on a capital gain from selling the property. Meaning the gains from sale should be taxed.
Recently an IR officer waved this interpretation of the provision in his face for the first time.
‘‘Which is interesting. Someone’s been thinking about it.’’
Add this to the news IR is sending out letters reminding tax agents to enforce the bright-line test and you could be forgiven for thinking the newly re-elected Government is putting added pressure on it to enforce these arcane laws as a substitute for a capital gains tax.
Revenue Minister David Parker flatly denies any suggestion he’s doing this. A spokesman says: ‘‘The minister has not put pressure on, but he is completely supportive of IR’s efforts because he is not in favour of tax avoidance.’’
Parker argues IR got there itself through improvements in the department’s computer systems.
Owens explains these improvements allow it to better match property sales with other pieces of data to figure out which transactions might meet the threshold for paying tax under these rules.
It’s up to the taxpayer to prove they don’t owe the tax after the IR highlights these transactions.
‘‘IRD clearly has the systems and resources to identify these types of transactions. We have assisted dozens of taxpayers whose land transactions have been flagged as taxable. If IRD asserts a transaction is taxable they may or may not be correct, but it is the taxpayer that must prove otherwise.’’
Originally, income tax legislation passed late in the 19th century didn’t distinguish between money earned through capital gains or wages. Both were theoretically taxable.
However, a paper published in the Auckland University Law
Review by Melinda Jacomb in 2014 argues this brief introduction of a capital gains tax to our shores was probably a drafting mistake by legislators. An error which was rectified within a decade. By 1900 the Income Tax Act explicitly put capital gains out of reach of the tax man.
And it stayed there. While most industrialised nations passed a capital gains tax of some sort between 1911 and 1965, we bucked the trend. New Zealand first properly considered passing one in 1967, two years after Britain passed theirs.
The New Zealand Taxation Review Committee said at the time: ‘‘If it is accepted that any system of taxation should embody the principle of treating equally those who have equal capacity to pay then it is difficult to justify the exemption of capital gains from all forms of taxation while income from effort is taxed in full.’’ Eventually the capital gains made from property speculation got so great the Government decided to go for a more targeted set of taxes on people who bought and sold property, by amending the Land and Income Tax Act.
A property speculation tax was also introduced on top of these changes as house prices rose 60 per cent between 1971 and 1974.
The tax rates attached to the speculation tax were higher than anything we’ve considered in recent history.
Ninety per cent of capital gains would be taxed if property was bought and sold within six months – a number which went down to 60 per cent if the property was held for closer to two years.
Coincidentally, after this legislation was passed our country experienced perhaps its last true housing market crash with house prices stationary as inflation soared.
The oil crash coupled with greater housing density had driven real house prices down by 40 per cent in six years.
Six years after those taxes on property speculators were brought in, Sir Robert Muldoon’s Government repealed them.
However, changes to the Land and Income Tax Act stayed on the books and were carried over into the Income Tax Act in 2007.
Owens says these cover quite a few property transactions although they still largely leave owner-occupied properties and rentals untaxed.
They largely target people who can be proven to be in the business of buying and selling property or associated with them in some way. Each rule has its own set of exemptions too.
For example, if you’re a builder and buy a rental property then invest in improving it, the sale is taxable if the land is sold within 10 years of completing those improvements (even if the house was not part of your business).
Others don’t require any association with construction or property-investment related
businesses.
The sale of land which is likely to be rezoned can be taxable if it’s sold within 10 years of you having bought it even if the owner isn’t associated with a property business.
KPMG tax partner Paul McPadden says the rules and their exemptions are so complicated many people are able to navigate their way around them with a bit of planning.
‘‘If they set up the right structures or undertake slight variances in their activities they are sometimes able to take advantage of exemptions or the boundaries of where the law does or doesn’t apply.’’
These rules are also poorly understood by the public, which makes tweaking them more appealing than embracing a fullblown capital gains tax. National’s bright-line test was a way of hoovering up capital gains not covered by these rules. It made property sold within two years (changed to five years under Labour) automatically liable for income tax unless the family home was involved.
The definition of ‘‘associated persons’’ (which is a feature of these rules) was also widened under a National Government in 2009.
Baucher says this change massively expanded the rules to tax a much larger set of people and entities associated with builders and the property industry.
‘‘Basically everything’s associated even if you don’t think it’s associated. So even if you try to make them not associated, the rules are so broad that it could only be tax avoidance if you did.’’
The complex and often inconsistent web of rules is why tax experts conclude things would be a lot cleaner with a simple capital gains tax and it could raise a lot more revenue as well.
Yet politicians are very reluctant to even mention such a tax.
Prime Minister Jacinda Ardern has ruled out the possibility of her ever introducing one, citing the extreme unpopularity of the idea and Labour’s past history of failed elections campaigning for it.
And as Parker applauds IR for enforcing the bright-line test he is at pains to point out the rule being enforced is ‘‘not a capital gains tax’’.
Baucher says while there’s something in our psyche which seems to be resistant to the idea of a capital gains tax, there’s probably quite a bit of selfinterest in this resistance too.
‘‘One of the great lies that was perpetrated last year in the debate about a capital gains tax was ‘it’s complicated’,’’ Baucher says.
‘‘As you can tell by what we’ve just talked about, a capital gains tax is really simple by comparison.’’
‘‘One of the great lies that was perpetrated last year in the debate about a capital gains tax was ‘it’s complicated’.’’ Tax consultant Terry Baucher