Mark Lister, 21 February 2019

The final report from the Tax Working Group (TWG) was largely as expected, in principle at least. There is a lot of material to work through amongst the hundreds of pages, although we have a few initial thoughts with a focus on the issues for share investors.

What was in the final report?

Unsurprisingly, the centrepiece is a capital gains tax (CGT). The TWG recommended that all types of land and improvements (except the family home) be included, including shares, intangible property and business assets.

The CGT would be applied at marginal tax rates, with no allowance for inflation. It would be imposed on a realisation basis (in most cases), and rollover relief would be available under certain circumstances (such as death, divorce or small business reinvestment).

Capital losses will generally be able to be used to offset taxable income, and the TWG has suggested the Government reconsider loss ring-fencing on residential rental property. However, the TWG has recommended that ring-fencing apply to portfolio investments in listed shares.

Changes to the company tax rate and the imputation regime were ruled out by the TWG, as was a wealth tax or a land tax. The TWG sees no need to make changes to GST, nor is there any support for a financial transaction tax.

There would likely be reductions in personal income tax rates, with these focused on those in lower income brackets.

What do we think this means for investors?

Turning to the impact on share investments specifically, the CGT would only apply to New Zealand and Australian shares, and only to domestic investors.

Global shares would continue to be taxed under the existing fair dividend rate (FDR) regime, while foreign investors in local shares will not face any additional tax burden.

One important detail for share investors is the tax treatment for individuals, compared with that of PIEs (managed funds, including KiwiSaver funds).

The TWG has recommended that individual owners of New Zealand and Australian shares be taxed upon realisation, while PIEs should be taxed on an accrual basis. The latter approach has been proposed because it fits better with the systems required to comply with the existing PIE tax rules.

The TWG noted that a discount could be applied to PIEs, to recognise the time value of money (as the accrual basis means tax would be paid every year, rather than upon realisation for individuals). It suggested lowering the 10.5% and 17.5% rates PIE rates for KiwiSaver funds by five percentage points each.

On the face of it, the news could’ve been worse for private investors. The interim report suggested that a CGT-exemption for PIEs was one option, which would have made for a very uneven playing field to the detriment of private investors.

Still, it isn’t ideal that these two groups face a slightly different approach or tax rates, and there are pros and cons to both. For private investors, paying tax upon realisation is probably far more palatable than on a regular basis (as with the accrual approach), although PIEs may provide more favourable tax rates.

What happens next?

From here, Cabinet will consider the recommendations before reporting back in April with a more considered view. At that point, we will have a clearer picture of which recommendations the government wants to adopt, and how they intend to implement the changes.

While legislation could be passed during this parliamentary term, no changes would come into force until 1 April 2021. As this would be after the 2020 election, the voting public will have the opportunity to voice their opinion at the ballot box.

For now, we will have to wait and see how this situation develops. There will be a strong political element to any eventual decision about which aspects of the TWG report turn into policy.

The Government will want something that can be easily explained to the public, and which will resonate with a majority of voters. There will also be a number of differing views within the coalition, most notably New Zealand First, which has in the past been reluctant to support a CGT.

The outcome of the report wasn’t a consensus view, with only eight of the 11 TWG members in support of this approach and a CGT. Interestingly, the three who were not in favour released a “minority view” document that is available on the TWG website.

The three TWG dissenters agree there is a strong case for taxing capital gains, especially when it comes to residential rental property. However, they also believe that if a CGT is applied more comprehensively, the costs could easily outweigh the benefits.

If implementing the recommendations in this report is as difficult as trying to read and interpret it, I think I’m with the dissenters.