Capital Gains Tax: Relief for SMEs

In the fourth of our series, David Snell, executive director at EY, questions the wisdom of allowing businesses a 'get out of jail free' card from capital gains tax

New Zealand is a land of small, family owned businesses.

According to a recent study from the Ministry of Business, Innovation and Employment, 97 per cent of all businesses in New Zealand have fewer than 20 employees and 69 per cent have none at all.

Almost all retail, hiring, real estate, financial services, agriculture, forestry and fishing businesses are small. (Of course, a few are enormous, but that's another story). Small business contributes massively to employment and to New Zealand's gross domestic product.

Capital gains taxes typically recognise the importance of small business, and of business reorganisations generally, by allowing so-called "rollover relief" where the proceeds are reinvested and "retirement relief" where the business owner sells up for good.

And there's a case for retirement relief. In New Zealand, more than 200,000 self-employed business owners - 55 per cent of all our self-employed - are aged 40-59. Their business is their life and selling that business their retirement plan.
Yet a dollar is a dollar. With fair lead times and taxation of capital gains made only after enactment, it's hard to defend a tax system that allows business owners effectively to save free of tax while employees and landlords must save from their after tax income.

As TradeMe founder Sam Morgan put it back in 2010, having made an estimated $700 million tax-free gain: "I was lucky enough to sell my company in a country with no capital gains, so I paid no tax on the sale. And that's not right, but what am I supposed to do?"

Then there's the question of design. Again, there's a case for rollover relief. By deferring any tax where proceeds are reinvested into a new business, businesses can reinvest and grow. But where to draw the line?
Businesses will always push the envelope to fit into any relief; the tax man will always try to tax the gain. International experience shows rollover reliefs, and associated anti-avoidance measures and limits, breed like rabbits.

Australia has four overlapping concessions for small businesses alone. The UK found it had inadvertently rewarded hedge funds with a 10 per cent tax rate. Amending transactions to fit within the terms of any given relief distorts resource allocation and makes the whole economy less productive.

And once a relief's in the law, the chances of removing it are slim.

That's not to say there's no case for reliefs. And it's not a one-way bet. As we saw through the Global Financial Crisis, businesses make losses too. If the government's sharing the profits, should it take the losses as well?

So, relieve if you must. But keep that relief simple, narrow and focused on reinvestment.

Read David's first, second and third columns in this series.

David Snell is an executive director at accounting firm EY. He used to work for Treasury.