The Tax Working Group’s proposals for property investors – purism v practicality v politics
As the dust settles on the Tax Working Group’s (TWG) Final Report (Report), it is becoming increasingly likely that property investors will be singled out for capital gains taxation. This article covers the key recommendations of the Report for property investors, and our view on the likelihood of these recommendations surviving the political process.
The Report recommends that:
- the new tax should apply to most forms of real property located in New Zealand or offshore, including residential properties, holiday homes, commercial properties and farms. Importantly, the tax would not apply to the family home and the land beneath it, up to the lesser of:
- 4,500m2 of land; and
- the area of land required for reasonable occupation and enjoyment of the house.
The TWG has suggested that the exclusion should apply to homes owned through a trust where a person occupying the home as their main residence is a settlor, or a beneficiary of the trust who becomes irrevocably entitled to the property or to the proceeds from the sale of the property as beneficiary income. The TWG has also suggested that Māori Freehold Land under the Te Ture Whenua Māori Act 1993 could be excluded from the new tax:
- the new tax should be limited to gains arising after the implementation date (the Valuation Day) for the new tax. This approach will require taxpayers to establish a value for their properties as at the Valuation Day. The Group has suggested a variety of proxies that could be used to establish an appropriate value (e.g. rating valuations), and has recommended that taxpayers should have the right to apply a professional valuation should they choose to;
- losses from assets held at Valuation Day should be ring-fenced, so that they can only be offset against gains from other capital assets;
- the new tax should generally be payable on disposal of a property. “Rollover relief” would apply in certain circumstances so that certain disposals can be ignored, for example disposals on death, disposals under relationship property settlements, and disposals under certain transactions within wholly owned groups;
- the new tax should be assessed at the ordinary rates of income tax, i.e. there would be no tax rate discount for capital gains;
- if a capital gains tax is introduced, the Government should consider:
- whether the separate ring-fencing rules for residential property losses that will take effect on 1 April 2019 should be retained;
- reinstating depreciation deductions for buildings. Importantly, the Group does not recommend reinstating depreciation deductions for standalone residential buildings; and
- allowing deductions for seismic strengthening in some form over time, even if the Government does not choose to reinstate depreciation deductions for buildings generally.
The TWG has recommended a purist capital gains tax regime that would be complex, costly to administer, and perhaps most significantly, unpopular with large segments of the voting public.
The coalition Government is expected to release its full response to the Report in April, with Prime Minister Jacinda Ardern stressing that it is her job to establish consensus amongst the coalition partners before commenting further. Deputy Prime Minister Winston Peters has previously rejected the notion of capital gains taxation, but recently stated that the TWG’s recommendations need to be considered carefully.
Given the political factors in play we would not be surprised if the Government’s response to the Report is to introduce a scaled back capital gains tax that is primarily focussed on residential property investment. This would be relatively simple to implement, for example, by removing the 5 year requirement from the existing “bright line” test for residential land. If the Government took this approach (without making any other changes), residential property could become the most heavily taxed major asset class in New Zealand, with:
- all gains on residential property (other than gains on the family home and the land beneath it) subject to tax; and
- some losses on residential property “ring-fenced” so that they are not able to be set-off against other forms of income.
Given the potential impact of the TWG’s recommendations on the property sector, we recommend that all property investors keep a close eye on developments.