Beware The Hidden Capital Gains Tax
While New Zealand does not have an official property CGT, it’s not that simple, particularly when compared with overseas, writes Sally Lindsay.
1 July 2022
While there is no capital gains tax (CGT) in writing, there are some laws that look like a capital gains tax, particularly on property.
Experts claim it is more accurate to say New Zealand does not have a comprehensive CGT, i.e. a tax that applies to any type of capital gain on any type of asset or financial arrangement.
However, many Kiwis will be surprised to hear that in fact not many forms of capital gain are actually left out of the tax net under existing tax laws.
Law firm Buddle Findlay says in reality not very much is outside that net.
Tax on capital gains now applies to a wide range of activities and investment types including, but not limited to: land dealers, developers and sub dividers; financial arrangements; shares in overseas companies; cryptocurrency assets and land held for short periods of time, say Buddle Findlay lawyers Tony Wilkinson, Fiona Heiford and Maria Clezy.
“The broadening of New Zealand’s capital gains taxes has occurred through expanding the concept of income to tax a much larger range of industries and types of investors or investments.
“These ad hoc CGT rules have led to an unlevel playing field where people are taxed differently on different assets they hold. The existing regime is incredibly complicated, with little or no consistency,” they say.
The most contentious new tax is the IRD’s bright-line test, which to many people is a CGT by any other name.
The test taxes 100 per cent of property gains with no indexing for inflation and rollover relief provided in limited circumstances. For an investor it means if they bought an existing property between March 2018 and March 2021 and sell within five years, or when a property bought since March 27, 2021 is sold within 10 years, the capital gains (profits) will be taxed.
Unlike other countries, there is no fixed rate of tax on the profit. The profit is added on to an investor’s yearly income and will be taxed at their income tax bracket.
However, this is where it can get tricky, as the tax rates apply to an investor’s income from all sources, not just income from selling a property.
If, say, an investor has a job with a salary that is taxed at the 33 per cent rate and they make a gain of $300,000 on the sale of an investment property, it will tip a substantial portion of their income into the top tax rate of 39 per cent, a rate experts says is high by international standards.
That means in order to avoid paying the tax investors need to hold onto the property for five or 10 years before selling it.
This differs from a regular capital gains tax, which applies regardless of how long you own an asset. Many countries have a full capital gains tax but apply it at a reduced rate, rather than combining capital gains with someone’s other income.
The US capital gains tax rules are extremely complex, but generally speaking if an individual has held the capital asset for at least 12 months, then the capital gain tax rate is limited to 20 per cent.
In Australia CGT is at an individual’s tax rate, but discounted by 50 per cent and main homes are exempt.
Unlike New Zealand, Australia also has stamp duty, which is paid by the buyer and is different from state to state and depends on the property price. It often adds tens of thousands of dollars to a property purchase.
People can also be caught if they inherit a property and then sell it as a capital gains tax is then applied.
Across England, houses outside the main home are subject to a capital gains tax at 28 per cent for higher rate taxpayers and 18 per cent for basic rate taxpayers.
Stamp duty is also paid by buyers and there is a complicated inheritance tax with exemptions. Generally, the 40 per cent inheritance tax comes into force on the part of a person’s estate above the normal tax-free threshold.
Wales has a land transaction tax and Scotland a land and buildings transaction tax.
Across the rest of Europe, Denmark levies the highest general capital gains tax of all countries, at 42 per cent; Norway the second-highest at 35.2 per cent; Finland and France follow, at 34 per cent each.
Some of the highest property purchase taxes in the world are levied on prime real estate by European economies. On average property buyers are charged 4 per cent, or NZ$61,610, in tax on a property purchase of NZ$1.6 million.
New Zealand and Russia have the lowest taxes, effectively charging zero per cent on prime property purchases.
In North America, Canadians’ principal residences are exempt from capital gains tax, while for other properties 50 per cent of the gain on a sale is subject to marginal tax rates.
Land transfer taxes are paid by Canadian buyers and although there is no inheritance tax, taxes on capital gains must be paid when someone dies and before the remainder is transferred to beneficiaries.
OECD figures show that compared with Australia, Canada and the UK, New Zealand property taxes make up a much smaller percentage of GDP, with Canada and the UK’s proportion almost double.
On the 2021 International Tax Competitiveness Index Rankings, NZ rates the second lowest on the global scale of property taxes as they mainly apply to the value of land rather than real estate and other improvements.
Hard To Compare
Chartered Accountants Australia and New Zealand (CAANZ) tax leader John Cuthbertson says each country has its own idiosyncrasies when it comes to property taxes, and this makes it hard to compare systems.
“When other countries’ taxes are taken into account, it might look like there are fewer property taxes in New Zealand. One of the problems when comparing the bright-line test with other countries’ capital gains taxes is that there is no discount and there is also only rollover relief in limited circumstances.”
Cuthbertson says taxing capital gains on property all in one year does not take into account some of the gain could be inflation made in previous years. It causes distortions.
Compared to other countries, NZ’s bright-line rule, described by experts as a blunt instrument, is a simple way of applying tax that avoids people trying to find ways around it.
The IRD has a well-established property compliance team which enforces the property tax rules.
One key principle of the tax system is that any property acquired with an intention or purpose of sale will be taxable on sale.
This applies mainly to traders or flippers who run the buying and selling of properties as a business. This is tested at the time of acquisition of the property.
The development of land or subdivision into lots is also taxable in many cases. Other unknown traps include areas around zoning and transferring land to associated parties.
Cuthbertson says when no other land tax provisions apply, the bright-line test comes into play, regardless of intent or circumstances surrounding the purchase.
The family home and inherited property are generally exempt from the test, which was extended to 10 years at a time when house price increases were booming.
There are traps, though. Cuthbertson says, for example, if an owner is seconded to a job in another part of the country or is overseas for two years, then part of that capital gain on the property when it is sold can be taxed.
Financial research company Canstar says there can be further traps. Even if an individual has one home at a time they live in, they could be treated as a speculator or investor by IRD if there is a history of buying and selling.
“They could find themselves subject to the intention rule, for example, by buying a family home, then selling and upgrading after a couple of years, before selling and upgrading again a couple of years later. The IRD could view this as property investing and any sale profit could be taxed under the bright-line rule.”
Unfortunately, says Cuthbertson, there are going to be losers under the bright-line test – those who hit financial difficulties, fall ill or face other life-changing circumstances, meaning they will have to sell before they can avoid paying the tax on their property gain.
CAANZ has been working with the IRD in an attempt to alleviate some of these pitfalls, but Cuthbertson says most of the focus is on rollover relief and if there are any changes to the bright-line test, which he doesn’t believe will happen despite its shortcomings, they will be in the government’s August tax bill.