Threat of capital gains tax will impact the government agenda

If there is one certainty, it is that capital gains tax (CGT) has moved from a principled tax policy decision to one of politics. The government has categorically confirmed that an official capital gains tax will not be introduced on their watch: why would they when there are so many “CGT by stealth” rules already in existence and little revenue would be earned for up to 15 years.

On the other hand, Labour has included a CGT as a central plank of their tax policy. And with the potential for the next election to be a knife edge of left and right coalitions, the long-dreaded introduction of CGT regime is a very real possibility.

This overlay will have an effect on the listing of the shares in Mighty River Power (MRP) today. Whilst most of the focus has been on the reduced uptake of shares due to the Left coalition’s policy statement on the future of the electricity market, the uncertainty of the impact of a CGT on shares will also influence the uptake. Likewise for those who have taken up the shares, the threat of a CGT regime could also have a direct effect on the Government’s desire for shareholders to hold onto their shares.

Firstly, if shareholders feel that a CGT regime will mean any gains made on the sale of the shares would be taxable, they may be more inclined to take a short-term view of their shareholding and sell their shares at the earliest possible opportunity. Of course, if shares are acquired with the intention of disposal, that gain will be taxable anyway.

Secondly, for a more sophisticated purchaser, an understanding of CGT regimes will indicate that most regimes when they are introduced include grandfathering provisions. That is, assets acquired prior to the introduction of the regime are protected and will not be subject to CGT when they are sold. However, if they are sold and replaced with another capital asset, that asset will be fully subject to CGT. As a result there typically is a freeze on the sale of these protected assets through people not wanting to sell them. A long-term hold, therefore, is exactly what the Government is after for the MRP shares.

The MRP share dichotomy reflects the afflicting issues CGT regimes bring when they are introduced. While there are good policy reasons, their distortionary effect on the market and lack of  immediate cash flow questions the rationale for its introduction.

A range of market effects arise on the introduction of a CGT regime, depending on the policy decisions at the time. The structure of the regime needs to be determined, but will usually include protection of pre-CGT regime assets, rollover relief (if assets are sold and new ones bought the CGT liability will be rolled forward until the assets are finally sold), tax is not collected until the assets are sold (realised basis versus unrealised), and some adjustments are made for inflationary effect (tax should not be levied on inflation lifts only real rise in value).

All of these distort the normal impacts of the market. A large group of assets become locked up as people hold onto their assets with protected status. Normal market transactions become compromised when, instead of realising investments, owners must buy further assets simply to avoid triggering their ultimate CGT liability. This of course may be beneficial if they were to be invested in productive assets, and at worst may encourage continued savings in investment assets. However, the rules also typically introduce a range of negative behaviours, where schemes abound to try and get around the rules.

So when New Zealand is keenly in need of a lift through business investment and growth, the threat of a capital tax regime may have a dampening effect on market behaviours. The last thing New Zealand needs right now is for the desire for investment to be tempered by a potential tax liability. The MRP share float may provide an interesting insight into these effects.

Further enquiries, please contact:

Greg Thompson            
Grant Thornton New Zealand National Director and Partner, Tax
T +64 4 495 3775