Frank Newman: Capital Gains Tax details explained

Although the media's focus of the general election has been on dirty politics, there are some critical policy issues defining the parties. Tax is one of them.

Labour, supported by its potential coalition partners, would increases taxes by raising income tax rates at the top end and introduce a capital gains tax (CGT). It says a CGT is needed to tax property speculators and make house prices more affordable. (In reality, speculators are already caught and the CGT net is cast much wider than real estate to include shares and businesses.)

National, supported by its allies, would not introduce a CGT- it says it won't work - and indicated income tax cuts to be a possibility in the future as the economy returns to surplus.

Labour's website has fleshed out some of the details regarding their proposed CGT:

•       The CGT rate will be set at 15 per cent. 

•       Investment values would not be adjusted for inflation. 

•       The tax will be applied to net gains. Presumably this means the cost of property improvements will be deductible from the gains, but that is not specifically stated. 

•       The tax would be payable when the asset is realised. In most cases this will be the point of sale, but may also occur with a change of shareholding where the asset is owned by a company. 

•       A range of assets are exempt. These include: the family home and personal assets like yachts, cars, artwork, and collectables. An exemption will also apply for the first $250,000 gain made on the sale of a “small business” and payouts from retirement savings schemes, including KiwiSaver. Oddly enough, the exemption also applies to  gambling. 

•       Inheritances would not be taxed at the death of the grantor but the capital gain will be rolled over to the heir and payable by them when the asset is realised - in effect the tax is carried forward. 

•       The CGT will only apply to gains accrued after implementation, but will apply to all existing assets, not only those purchased after the introduction date. 

•       All non-exempt assets would be valued at the starting date of the capital gains tax regime. In the case of real estate an owner could choose:
•    The most recent government valuation for rating purposes, or
•    The purchase price in a recent arm’s-length purchase, or
•    A private valuation done at their expense.

•       With respect to property owned in a trust Labour says, “We will ensure trusts are not used as a means of avoiding a CGT.” There is no detail on how that would be achieved.

•       Capital losses would be "quarantined" and could only be used to offset other capital gains. Losses would not be transferable to other forms of taxable income. 

•       The new CGT would add to the CGTs that already exist - although they are not called by that name. The existing rules that treat capital profits earned by those with a resale intention (traders and speculators) as income and taxed at the taxpayers marginal income tax rate, would remain. So in effect there will be a multitude of tax regimes on investment assets.

There are of course lots of question marks about the policy detail. There are also a number of "fairness" issues that come to mind. The first is the effect of not indexing investment assets to the rate of inflation. For example,  lets assume a couple buy a family bach for say $300,000; inflation averages 3.6% p.a.; and the property is sold 20 years later for $600,000.

In real terms there has been no change in the value - the $600k would buy them exactly what $300k did 20 years earlier. According to the CGT regime they would be deemed to have made a $300k taxable gain and would pay $45k in tax (assuming the CGT rate remains at 15%). That's a tax on illusory gains.

The second fairness issue is with respect to the inability to offset capital losses against other income (at the 15% CGT rate). Under Labour's proposal losses could only be offset against capital gains. The problem with that is a taxpayer may not have future capital gains.

Next week I will look at the effects of the proposed CGT and who the winners will be.