Should New Zealand introduce capital gains tax?

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Introduction:

Capital gain can be explained as an increase in the value of the capital asset that provides a higher price than the purchase price. The exceeding difference between the selling price of an asset and its original purchase price is capital gain. Capital gains can be classified into two categories. Firstly, a capital gain is realized when the asset is sold. Secondly, an unrealized capital gain is an asset which has increased in its value, but it’s still not sold yet. Currently, New Zealand is the only OECD (Organizations for economics co-operations and development) country without a capital gain tax in place. There are good and bad effect on introduction of capital gain in New Zealand. This essay will explain both point of views.

Favour

Firstly, many scholars and politicians have decided to go with capital gain tax in past and recently, Labour political parties agenda for this upcoming election is to introduce capital gain tax in New Zealand. Introduction of the capital gain tax will generally provide the support and reliability in the tax system by reducing opportunities for tax planning and tax avoidance. This is a very important aspect. For example, a New Zealand based company has recently developed an intellectual property and then decided to sell the property to another offshore company to enjoy the benefit of untaxed capital gain, and then licensed the property back to themselves and pay a tax deductible royalty. If there were enough provision in place for capital gain than there would be no tax advantage to this transaction. There are many facts and evidences involved to support that the value of capital gain tax is a backstop against the tax avoidance. It is largely unrealistic but we have to think that it will have a positive effect on the system.

Secondly, the current approach of New Zealand in taxing income from capital is in inconsistent, and a lot of the income generated from capital gains are taxed under changed rules. For instance, certain land transactions, financial instruments, and intellectual property are all taxed to an extent. Whereas, shares and intellectual property transaction fall outside the taxed part. Mainly the part between taxable and not taxable income is always unclear.

Lastly, Capital gain are often used to deliver tax revenues. Less obviously, it increases revenues from the ordinary income tax. This is a one reason many taxpayer now days do not convert their taxable income as not-taxable capital gains.

The main argument for not introducing capital gain in New Zealand are described below:

Firstly, capital gains are quite different from all other types of income. As indicated, capital gains generally increase on risky asset, putting a tax burden on them will discourages risk-taking. This will further give the disadvantage to the economy. Secondly, there are argument in favour of lower tax is that capital gains are eroded by inflation. Profits generated from corporate shares and holding unit trusts also represent income which is subject to be taxed at company’s tax rate, making individual level taxation an inefficient double tax. Capital gains also discourages saving in an economy.s

Taxing gains upon realisation creates special issues. It creates a strong incentive to hold onto appreciated assets to avoid the tax—the so-called “lock-in effect” — an inefficient distortion in financial markets. Moreover, capital losses are generally only deductible against capital gains. Allowing full deductibility of losses would create almost unlimited ability to shelter other income from tax since an investor could purchase offsetting short and long positions in assets and then realise the position with the loss to shelter other income while taking on no risk (or, indeed, making a meaningful investment). Even when such strategies are limited by statute, diversified investors could achieve similar results by selectively realising assets with losses and holding those with gains. However, with loss limits, full taxation of gains may penalise capital gains compared with other less risky investments.

Critics counter that concessional taxation of capital gains is unfair. It favours taxpayers who earn their income in the form of capital gain over those who earn income in the form of interest, rents, or royalties.It favours wealthy taxpayers over those less fortunate (because high-income people are much more likely to have capital gains than those with modest means).

Furthermore, critics complain that concessional taxation of gains encourages tax avoidance, which is unfair, because aggressive (generally high-income) taxpayers pay less tax than others, and inefficient, because the financial wizards, lawyers, and accountants who design tax avoidance schemes could otherwise be doing productive work and because such schemes often involve investments or business strategies that would make no sense without the tax savings.

In 2001, the Fifth Labour Government appointed an expert committee to undertake ageneral review of the New Zealand tax system. The McLeod Committee concluded that New Zealand should not adopt a general realisations-based capital gains tax because it believed that this type of tax “would not necessarily make our tax system fairer and more efficient, would not lower tax avoidance and would not raise substantial revenue that could be used to lower rates. Instead, any such tax would be more likely to increase the complexity and costs of our tax system. The experience of other countries (such as Australia, the UK and the US) supports that conclusion.”14

The McLeod Committee favoured a continuation of the ad hoc New Zealand approach of dealing with capital gains issues as they arose. To address the problems caused by the disparate taxation of different savings entities at that time, it proposed the risk-free return method of taxation.15 Six years later, in 2007, the government chose to achieve “coherence” in this area by broadly aligning the rules for taxing gains of certain collective investment entities arising on the sale of shares in New Zealand companies and Australian listed companies with the non-taxation of capital gains often arising from the sale of shares by individuals. This expansion of capital-gains exempt assets through the portfolio investment entity regime illustrates a danger of adopting an incremental approach to reform issue by issue. Each reform may be logical in relation to a design feature, or even several design features, of the existing income tax but not help produce coherency in the tax system as a whole.16

Conclusion:

A major concern about taxing capital gains at rates up to 38% (and which rise further in an inflationary environment) is that it may discourage saving and investment. Although the concern is likely overstated, if policymakers are worried about that, the right solution is not selective preferences for capital gains assets, but lowering tax rates overall. The best option would be a tax reform that broadened the base, eliminated loopholes and preferences, and cut top rates across the board. A second-best option might be a Scandinavian style dual income tax, in which wages are taxed at a higher rate than all capital income; see Sorensen (2005). However, as Sorensen (2009) notes, New Zealand’s very high rate of international labour mobility may make a Scandinavian style dual income tax system less viable here. A simpler option might be to pay for income tax rate cuts with higher GST or payroll tax rates and offset the burden on lower-income families by increasing the low-income family allowance.

However, in practice, no country has a general capital gains tax on accruing gains. If New Zealand follows this international norm, the issue we need to confront (and the issue that was confronted by the McLeod Review) is whether or not there would be efficiency benefits from bringing in a “real world” capital gains tax which is likely to involve taxing realised capital gains (although it could potentially also include a tax on some accruing gains such as possibly gains on shares in listed companies).

Read more:http://www.investorwords.com/706/capital_gain.html#ixzz3DvetOZcg

http://www.victoria.ac.nz/sacl/centres-and-institutes/cagtr/twg/publications/3-taxation-of-capital-gains-ird_treasury.pdf

http://www.goodreturns.co.nz/article/976485506/capital-gains-tax-the-new-zealand-case.html

http://www.victoria.ac.nz/sacl/centres-and-institutes/cagtr/twg/publications/3-taxing-capital-gains-burman_white.pdf

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