What would capital gains tax mean in reality?

The Tax Working Group has completed its final report.

What might a capital tax gains look like in practice? Try a $127,007 bill on for size.

The Tax Working Group, which has now finalised its final report, will recommend a capital gains tax be adopted.

How that could work is still up for debate, but the group's plan is believed to be to tax people's capital gains at their marginal income tax rate. If you earned more than $70,000 a year in your day job, your capital gains would be taxed at a rate of 33 per cent.

It is believed that a clear majority of members of the group support applying income tax to capital gains on investment property, shares and businesses. 

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Economist Gareth Kiernan applied that scenario to the gains investors have made over the past decade.

He found that someone who bought a lower-quartile Auckland house in 2008 - that price bracket was used as a proxy for a typical investment property - and sold it in 2018 would have made $384,868 in capital gains.

Capital gains tax at a rate of 33 per cent would have resulted in a $127,007 tax bill.

Outside Auckland, a property investor would have made $155,984 and face a bill of $51,475. A share market investor with $50,000 in the NZX50 over the same period would have recorded gains of $52,570 and have to pay tax of $17,348. 

Even someone who bought a business for $20,000, built it up and then sold it for $100,000 could end up paying tax on the $80,000 difference. Tax Working Group chair Sir Michael Cullen has been asked to consider whether a tax-free threshold could be appropriate on businesses being sold.

Selling an investment property could mean a big tax bill.
CHARLOTTE CURD/STUFF
Selling an investment property could mean a big tax bill.

"One of the key questions is when people will be liable for the tax bill and which years' marginal tax rates will apply," Kiernan said.

He said it seemed unlikely that any capital gains tax would be applied annually because people would not have realised any profit from which to pay. 

But that might make people less likely to sell an investment.

"If I know that I am going to be liable for a large tax bill when I sell an asset, I am going to be more inclined to hold on to that asset, even if I could generate better returns elsewhere.

"If we think about the example of the Auckland investment property, I would have to pay $127,000 in tax when I sell it at the end of 2018. Even though Auckland house prices might track sideways or downwards for the next two or three years, I might still be better sucking up that poor performance than selling for $710,000 but immediately seeing my cash reduced to $583,000. Effectively I've got to try and generate another $127,000 in returns somewhere else to get the size of my portfolio back to where it was before I paid the tax bill… and by the time I've managed that growth, Auckland house prices will probably be about to surge again and I'll want to reinvest in another rental."

He said a capital gains tax would create a more level playing field for tax.

Tax Working Group chair Sir Michael Cullen has been asked to consider whether a tax-free threshold could be appropriate on businesses being sold.
MAARTEN HOLL/STUFF
Tax Working Group chair Sir Michael Cullen has been asked to consider whether a tax-free threshold could be appropriate on businesses being sold.

"It would seem necessary to try and close an obvious hole in New Zealand's tax system that has arguably skewed our investment behaviour towards rental property. However, there are also difficulties with its implementation that need to be taken into consideration. From what I've seen so far, the concern is that the Tax Working Group might be taking quite a blunt approach in terms of its recommendations around a capital gains tax."

David Boyle, of Mint Asset Management, said the scheme would also have to consider how it would deal with people who sold an asset for a loss. "Will they reintroduce tax credits?"

Any new tax would drive behaviour changes as people tried to avoid paying it, he said. 

Cameron Bagrie, of Bagrie Economics, said setting a capital gains tax at a person's marginal tax rate would make it one of the harshest regimes in the world.

"Why don't we just enforce the bright-line test really strongly?  One of the perverse things about the capital gains tax the Tax Working Group is talking about which rules out the home but hits other assets is that it could encourage people to build more McMansion style houses.  Why take a business risk or invest outside of housing if a capital gains tax takes away some of the upside?  So we disincentivise the parts of the economy we actually want to stimulate."

BNZ chief economist Tony Alexander was sceptical about whether a capital gains tax would be introduced.

"First, given the hits building against the government, the flattening of Auckland's housing market and slowing of the rest by next election, plus the reputation of Labour as a tax and spend party, and the veto of NZ First, I reckon the odds are firmly stacked against Labour going into the 2020 general election proposing a CGT."

Stuff