Preliminary thoughts on the government’s new tax

The National Party has announced a new tax on the sale of properties. It will apply to all residential rental properties bought after 1 October 2015. If you buy a residential rental property on or after 1 October, and then you sell it again within two years of purchase, you will be taxed on the difference between the sale price and the purchase price.

A caveat: the full details of the proposals are not available yet, so this analysis is based on the fact sheet issued by Inland Revenue’s Policy and Strategy Division, rather than on any more detailed discussion paper or draft legislation.

First up, is this actually a Capital Gains Tax? Yes, and no. As I’ve discussed before, New Zealand already sort of has, and sort of doesn’t have, a Capital Gains Tax. Our existing tax laws already provide for persons who buy something with the intention of resale, or persons who are in the business of buying and selling something, to be taxed on any gains they make.

This proposed new law doesn’t change those rules. All it does is say that if you sell a property within two years of purchasing it, then you will have to pay tax on the gain on sale, if any.

But some properties will be caught in the tax net when previously they would have escaped it. Previously, IRD had to prove that there was an intention of resale before any gains on sale were subject to taxation, and many investors / speculators would have been able to argue that they had bought the property as a capital asset. That would have meant that any gains on sale were not subject to tax. Now IRD simply has to apply the two year rule. So many more property sales will be subject to taxation. To my mind, that makes this a new tax, or at the least, a significantly expanded tax, and it taxes some capital transactions that previously weren’t taxed.

You can make a reasonable case for this not being a capital gains tax, and not being a new tax. Nevertheless, it’s a significant shift in the way that we tax, or don’t tax, property transactions.

What we don’t know yet is whether losses on sale will be deductable. It would be extraordinary if they were. Most CGT regimes around the world don’t allow the deduction of capital losses, or at best, only allow those losses to be offset against future capital gains. This detail should be clarified when draft tax legislation is released, and in subsequent discussion. Per the IRD fact sheet, a discussion paper will be released in July, and legislation will be introduced in August this year.

So what difference will it make? Very little in terms of tax revenue. I imagine that most property speculators will simply elect to hold onto their properties for at least 731 days, thereby avoiding paying tax on their capital gains. The real effect will be to slow down the property market in Auckland, and elsewhere. It will knock the top edge off the market, winding it back just a little bit. Together with the Reserve Bank’s new rules about the deposits that Auckland property buyers must have, the heat may be taken out of the property market. There will still be pressure due to inwards migration, but frantic speculation in property should calm down.

So why use a tax measure at all, if it’s not going to raise any revenue? And heaven knows that the government must be looking for every possible tax dollar it can find.

It’s a preventative measure, not a revenue raiser. Back when we had a gift duty in New Zealand, there was never very much gift duty raised. Instead, the threat of gift duty meant that people didn’t try to avoid income tax by gifting away assets that earned income. So they couldn’t engage in all sorts of elaborate tax schemes, or if they did choose to do so, there was a price to pay. Most people elected not to engage in the elaborate schemes, and so very little gift duty was ever collected. It was a very effective tax measure.

Likewise, this measure should be very effective in shutting short term speculation down. I suspect that once the two years is up, plenty of properties will end up on the market, but very few properties will be sold under the two year mark, and so very little tax revenue will be collected.

There will be some losers from this new, or expanded, tax. Most property speculators will be able to arrange their affairs so that they are not caught by the two year rule. If you have to move towns for work, and you turn your family home into a rental property, you won’t be caught; there will be an exemption for houses that have been the family home. If your marriage goes belly up, and you have to sell your joint investment property, there’s an exemption for you too. This is more-or-less consistent with other tax law; we try not to tax people on the vagaries of fate.

However, some people who own residential rental properties might get caught out. For example, imagine a small business owner who runs into cashflow difficulties, and so is forced to sell a residential rental property. Or think about someone who has bought a house that they intend to live in, but in the meantime has rented it out, and then loses her or his job and is forced into selling the property.

I suspect that the only people who will get caught by this law will be those who have run into some misfortune. Getting taxed on the sale of your investment property seems to be a harsh consequence, especially when we don’t tax other capital gains.

The big question is whether the two year rule will work. That’s going to depend a little on how investors and / or speculators have structured their finances. A clever investor / speculator will have structured their affairs so that they pay as little tax as possible. Perhaps they will be happy to wear some tax in order to get the cash from a short term gain.

What this tax is not, is a comprehensive capital gains tax. If an investor sits tight for at least two years, then whatever capital gains she or he makes will be completely tax free. The Minister of Revenue has argued that:

They will still be subject to tax under existing rules if they buy a property with the intention of selling the property for gain – even if they do so outside the two-year “bright line” period.

Right, sure, whatever, but at that stage, IRD will have to prove that there was an intention of resale. That has always been hard to demonstrate, and it will be even harder now that government has reified two years as the magical dividing line. Holding onto a property for longer than two years could well be taken to indicate a serious intent to invest for the long time. Those untaxed capital gains will remain, untaxed. And that on-going inequity in the tax system has yet to be addressed.

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One Response to Preliminary thoughts on the government’s new tax

  1. Denny says:

    Good analysis, thanks. But I disagree with your comment about taking the heat out of the Auckland property market. In order to predict if some factor is going to affect the Auckland property market we need data – an analysis of who is buying property. At present we only have anecdotal evidence, comments from the association that represents rental property owners, real estate agents and people buying property. There is a reason that most property in Auckland is sold at auction or by negotiation after auction – demand exceeds supply. Anecdotally, it seems that property speculators are a small proportion of buyers. Young people returning from overseas, migrants and people moving to Auckland from other areas of NZ are increasing the demand for housing in Auckland. Another theory is that Auckland is a safe place for increasing numbers of middle class Chinese wanting to invest outside China.

    I think that taking the heat out of the Auckland property market is a hugely complicated problem that requires a multifaceted, well thought out, unified approach from central and local government. It will involve increasing supply and reducing demand, increasing infrastructure and introducing controls of foreign ownership plus a whole lot of other measures.

    I agree with your comment that this measure will enable the IRD to enforce the existing tax, but I don’t believe for a moment that it will slow down the Auckland property market

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