The New Zealand capital gains tax debate began a century ago, and we have been avoiding it ever since.
There are signs that Inland Revenue (IR) may become more aggressive in enforcing these ad hoc rules as the government reacts to mounting anger over the country’s housing crisis.
Our historical reluctance to explicitly tax capital gains means that a strange set of arcane rules is now driving up taxation on the income from buying and selling real estate.
And now, advances in IR’s computer systems are making it more difficult than ever for these transactions to go unnoticed.
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Country of the lengthy tax law
We have a lot of taxes on real estate. They’re just confusing, difficult to enforce, and come from successive governments either unable or unwilling to tax capital gains.
Instead of a broad-based capital gains tax, there are decade-old tax rules on the books that require you to pay income tax on capital gains under certain circumstances.
This includes measures to tax income from land if you buy it for the purpose of building buildings. Or, if you are affiliated with a real estate business and you sell a lot within 10 years of buying it, offloading properties that zoning changes make it more valuable or subdividing lots within a decade of being snapped up.
By comparing data with Inland Revenue, you can intercept more taxable real estate transactions.
Almost all of these rules provide for exceptions for owner-occupiers who are not involved in buying and selling real estate. In practice, these distinctions are not as clear-cut as they sound on paper.
Taxes are so complicated that many of the accountants and lawyers who deal with them are in favor of a capital gains tax just to make things easier.
Owens Tax Advisors’ Jeff Owens says IR has always enforced these measures. Something that has sometimes surprised property buyers and sellers.
“Many laypeople have come up with the idea that IR will tax you if you buy a property with the intention of reselling it.
“Of those nine or ten different tax rules [on land sales] only one of them relates to the intention of acquisition.
“Intent is not mentioned in any of the other provisions.”
And there is evidence that enforcement of these little-known regulations by IR may have grown and expanded.
Tax advisor Terry Baucher has often argued that a low-yield rental property (where the rent earned covers only a small portion of the property’s purchase price) is a signal that a buyer is betting on a capital gain from selling the property. That is, the profits from the sale should be taxed.
Recently, an IR officer waved this interpretation of the provision in the face for the first time.
“Which is interesting. Somebody thought about it. “
Add this to the messages. IR sends out letters reminding tax agents to take the Bright Line Test and you might be forgiven for believing that the newly re-elected government is putting additional pressure on them to make these arcane laws in place of capital enforce profit tax.
Treasury Secretary David Parker flatly denies any suggestion to do so. A spokesman said: “The minister has not put any pressure on, but he fully supports IR’s efforts because he is not in favor of tax avoidance.”
Parker argues that IR got there through improvements to the department’s computer systems.
Owens explains that these enhancements will allow real estate sales to be better matched against other data to find out which transactions might meet the threshold for paying taxes under these rules.
ROBERT KITCHIN / things
Treasury Secretary David Parker denies putting pressure on Inland Revenue to chase land and property taxes.
It is up to the taxpayer to demonstrate that they do not owe the tax after the IR highlights these transactions.
“IR clearly has the systems and resources to identify these types of transactions. We’ve helped dozens of taxpayers whose land transactions have been marked as taxable, “Owens says.
“When IR claims that a transaction is taxable, they may or may not be correct, but it is the taxpayer who has to prove otherwise.”
First, there was a capital gains tax – accidentally
Originally, the Income Tax Act, passed at the end of the 19th century, did not distinguish between money earned through capital gains or wages. Both were theoretically taxable.
However, a 2014 paper published in the Auckland University Law Review by Melinda Jacomb argues that this brief introduction of a capital gains tax on our shores was likely an editorial error by lawmakers.
A bug that was fixed within a decade. By 1900, the Income Tax Act explicitly put capital gains out of the taxman’s reach.
And it stayed there. While most developed nations passed a capital gains tax between 1911 and 1965, we bucked the trend.
SCOPE OF DELIVERY
Tax advisor and attorney Terry Baucher.
New Zealand first considered one in 1967, two years after Britain came into existence.
The New Zealand Taxation Review Committee said at the time: “If it is accepted that a tax system should embody the principle of equal treatment for persons of equal solvency, it is difficult to justify the exemption of capital gains from all forms of taxation while the income from the Expenses are fully taxed. “
Eventually, the capital gains made from real estate speculation became so large that the government decided to introduce more targeted taxes on people who bought and sold real estate by amending state and income tax laws.
In addition to these changes, a property speculation tax was introduced as property prices rose 60 percent between 1971 and 1974.
The tax rates associated with the speculative tax have been higher than anything we have considered in recent history.
Ninety percent of capital gains would be taxed if real estate were bought and sold within six months. A number that dropped to 60 percent if the property was held for more than two years.
Coincidentally, after this legislation was passed, our country may have experienced its last real property market crash with stationary property prices when inflation spiked.
The oil crash, combined with higher housing density, had lowered real property prices by 40 percent in six years.
Navigate the rules
Six years after these taxes were imposed on property speculators, the government of Sir Robert Muldoon repealed them.
However, changes to the land and income tax law remained in the books and were incorporated into the income tax law in 2007.
Owens says these cover some real estate transactions, though they still leave condos and rents largely untaxed.
They are primarily aimed at those who can be shown to be buying, selling, or connected to real estate in some way. Each rule also has its own exceptions.
KIRK HARGREAVES / things
A complex set of rules hit those involved in the construction industry.
For example, if you are a building contractor and you are buying a rental property, you are investing in improving it. The sale is taxable if the property is sold within 10 years of these improvements being completed (even if the home was not part of your business).
Others do not require affiliation with construction or real estate investment companies.
The sale of land that is likely to be converted to a new zone may be taxable if sold within 10 years of purchase, even if the owner is not affiliated with a real estate business.
KPMG’s tax partner Paul McPadden says the rules and their exemptions are so complicated that many people can get their bearings with a little planning.
“If they put the right structures in place or make minor deviations in their activities, they can sometimes use exceptions or the limits where the law applies or not.”
These rules are also poorly understood by the public, which is why optimization is more attractive than the introduction of a full capital gains tax.
National’s Bright Line Test was one way of making capital gains that were outside of these rules. It automatically made income taxable properties sold within two years (changed to five years under Labor) unless the family home was involved.
The definition of “Associate Persons” (which is a feature of these rules) was also expanded in 2009 during a national government.
According to Baucher, this change has massively expanded the rules to tax a much larger number of individuals and entities associated with builders and the real estate industry.
“Basically everything is connected, even if you don’t believe it is connected. Even if you try not to tie them together, the rules are so broad that tax avoidance can only occur if you do. “
David Unwin / Stuff
Prime Minister Jacinda Ardern has ruled out the introduction of a capital gains tax.
The complex and often inconsistent set of rules is why tax professionals conclude that with a simple capital gains tax, things would be a lot cleaner and could also generate a lot more revenue.
However, politicians are very reluctant to even mention such a tax.
Prime Minister Jacinda Ardern has ruled out the possibility of ever introducing one, citing the extreme unpopularity of the idea and Labour’s past of failed elections.
And as Parker IR applauds the Bright Line test being enforced, he tries hard to point out that the rule being enforced is “no capital gains tax”.
Baucher says that while there is something in our psyche that appears to be resistant to the idea of a capital gains tax, there is probably also some self-interest in that resistance.
“One of the big lies that was told in the capital gains tax debate last year was ‘it’s complicated,'” says Baucher.
“As you can see from what we just talked about a capital gains tax, it’s really easy by comparison.”