A level playing field for capital gains

A heated Auckland property market has prompted the Government to target speculators and foreign buyers in this week’s  Budget announcement. A capital gains tax will be introduced on property sold within two years of purchase with exemptions: the property is the seller’s main home, it is an inheritance or deceased estate, or it’s transferred as part of a relationship settlement.

The announcement has been made despite  the fact that speculators are already subject to tax on any gains made from sales of property – as are those whose business comprises dealing in property - and their associates (with a general ten year limitation).

Whether someone is a speculator or simply a genuine investor is a vexed question, and it depends on a range of factors, some of which can only be divined after the fact. As has occurred in previous years, Budget 2015 is expected to see additional resources allocated to Inland Revenue to investigate property deals and pursue those who cross the broad grey line that often delineates the taxable and the tax-free.

Land transactions are an attractive, low-hanging fruit to target for a capital gains tax. New Zealand operates a computerised land registry system that makes tracking ownership (and changes thereof) relatively easy.  There’s also a certain amount of political acceptance based on the current housing crisis, regardless of its  causes.

It sometimes seems that the ill-will generated by the unwelcome consequences of speculator behaviour spills over and taints genuine property investors. Yet what is it that investors do that is so different from any other form of capital investment? 

Landlords pay tax on rental income, after deducting expenses incurred in earning that income, such as insurance, rates, repairs, and interest incurred on debt used to acquire the property. Provided property is not acquired with the intention of sale, and is not caught by any of the other specific provisions relating to land transactions, any capital gain is not taxed.

Compare that with a person who buys a business. Just like landlords, they pay tax on income, with a deduction for expenses incurred in earning that income, such as cost of goods, utilities, and wages – and interest incurred on funds borrowed to finance the business. On selling the business, any capital gain (usually represented by goodwill) is generally not taxed. However, a person in the business of developing businesses for sale would be taxed.

And someone who buys shares pays tax on dividends earned. There’s a deduction for costs incurred in earning that income, such as portfolio management and accounting costs, as well as any interest costs on funds borrowed to acquire the shares. Unless a person is a dealer, there’s generally no tax charged on any capital gains incurred (although capital gains on foreign shares can be taxed under a separate regime that can tax even unrealised capital gains).

In some ways, land already suffers from a tax disadvantage compared with other investments because of the specific provisions that can rope in other transactions. In particular, the “associated person” rules mean that the activities and proclivities of Taxpayer A affect the tax treatment of Taxpayer B. That generally does not occur in other capital investment contexts.

It’s not so much the tax treatment that gives property a perceived advantage over other investments. It’s the perception of the security of the investment and the willingness of financial institutions to provide funding. Bankers give a different response if asked to lend $500,000 on the security of shares to be purchased with the funds compared to being asked the same thing about a rental property.

A number of other suggestions have been put forward for taxing property investment, ranging from a land tax to a deemed rate of return. There is some precedent for this, as the concepts run very close to the fair dividend rate method applicable to certain investments in overseas shares.

Whatever happens, it’s important to remember that land is simply one form of capital investment. Using tax to address issues that are less the making of perceived tax advantages than they are of surrounding economic conditions runs the risk of being seen as a knee-jerk reaction.

Further enquiries, please contact:

Geordie Hooft
Partner, Tax
Grant Thornton New Zealand
T +64 (0)3 379 9580
E geordie.hooft@nz.gt.com