In part three of a Business Herald series on the effects of a capital gains tax, Tamsyn Parker looks into what it would mean for KiwiSaver and direct share investments.
KiwiSaver funds are currently taxed using the portfolio investment entity regime which means individuals are taxed on the income from their fund at a prescribed investor rate which is based on what they earn.
There are three rates - 10.5 per cent, 17.5 per cent and 28 per cent. The income tax is calculated daily and tax is paid annually. The aim is to ensure people are not taxed at a rate that exceeds their personal tax rate.
Currently there is no tax on the gains from trading in New Zealand and Australian shares. Tax on foreign shares is worked out at the fair dividend rate.
The situation is similar for direct investment in shares - people pay tax on the income - the dividends - at their personal tax rate which is up to 33 per cent.
They are not taxed on the gain from New Zealand and Australian shares - unless they are a trader.
Gains on Australian and New Zealand shares would be taxed.
In KiwiSaver funds this would be on an accrual basis.
The tax would be calculated daily and paid once a year like the income tax currently is.
To counter the impact of this tax on gains on KiwiSaver members the Tax Working Group has proposed the lower prescribed investor rates would be dropped to 5.5 per cent and 12.5 per cent.
It also wants the employer's superannuation contribution tax (ESCT) refunded for KiwiSaver members earning up to $48,000 per annum and clawed back for members who earn between $48k and $70k.
It has proposed increasing government contribution from 50c per $1 of contribution to 75c per $1 of contribution up to the cap of $1042 a year meaning a member could get a maximum of $781.50 up from $521.
It also wants the government contribution paid to those on parental leave even if they don't contribute.
On direct share investments the tax would be paid after the shares are sold.
The New Zealand share market has a strong year and the value of the shares in your KiwiSaver fund rise from $100 to $150.
You would pay tax on the gain of $50. As a lower earner you would only pay tax of 5.5 per cent on that gain or 12.5 per cent.
As someone that earns under $48k you would get the tax on your KiwiSaver employer contribution refunded and a higher government contribution of $781.50. This could mean you are thousands of dollars better off at retirement.
What investors' think?
Susan St John, director of the Retirement Income and Research Centre at Auckland University has cautioned against tinkering with retirement savings policies to solve problems caused by introducing a capital gains tax.
She said the changes could have unintended consequences and not enough had to been done to analyse the distributional or gender effects of the proposals.
"The Tax Working Group (TWG) has acknowledged that the introduction of a capital gains tax on shares will have a negative effect on the savings of low income people in KiwiSaver.
"This has led the TWG to require complicated policy changes to provide compensation. This is one of the many reasons to doubt the wisdom of a CGT that includes shares," St John said.
St John said the tax reduction on the investor rate posed the biggest problem in her view as it would only apply to investments in KiwiSaver portfolio investment entities (PIEs) not PIE funds outside of Kiwisaver.
"One obvious problem is that to constrain the lower PIE rates to KiwiSaver alone would mean that people would potentially have two PIE rates.
"There would be inevitable pressure to extend the favourable treatment to all PIE schemes which would be very expensive and compound the inequity between PIE and non-PIE saving."
Michael Midgley, chief executive of the New Zealand Shareholders Association, said it had concerns around inequity.
"The problem with our reading of it to date is the proposals do not treat all investors the same or all investments the same."
Midgley said if that did not happen it meant the system would not be fair.
He said the association was also concerned about the cost of compliance where adding complexity to the way people invested would mean more reliance on experts.
The association didn't want to comment further as it was still analysing the recommendations.
Hamish MacDonald, legal counsel for the NZX, said it was concerned that introducing a capital gains tax on New Zealand and Australian shares would change the way people invested and encourage them to invest in foreign shares.
He said the incentives to counter the CGT on KiwiSaver members were well intended but they introduced more complexity into the regime could distort capital flows as people may decide it is easier to invest via KiwiSaver or other managed funds versus direct share investment.
MacDonald said PIE schemes were set up with a compliance structure which meant changes could be handled easily where as direct investors could see the proposed changes as an admin burden. Fewer individual investors in the share market would not be a good thing, he added.
What should government's final policy look like?
MacDonald said it did not support the introduction of a capital gains tax on shares because it would discourage investment in New Zealand businesses and stunt the growth of New Zealand's capital markets.
"If the primary concerns is the impact of investment in residential property for us the question is do you need to extend it to shares in the first place?"
MacDonald said he believed investing in the productive sector of the economy gave it grounds to be treated differently.
What do you think that policy will look like?
MacDonald said when he looked at the spectrum of the proposals he saw property at one end and farmers and businesses at the other with shares in the middle.
He said most people expected the government to bring in a CGT on property but it could be the equivalent of political suicide for farmers and businesses.
"Shares are still up for grabs, we don't know what will happen."
MacDonald said if gains on shares were taxed it needed to be done in a way that created a level playing field between investing in local and foreign shares and direct share investing and investing via KiwiSaver or managed funds as well as reducing the admin burden.
The expert's view:
Greg Haddon, tax partner at Deloitte, said the disadvantage for KiwiSaver investors was that they would pay capital gains tax before the share investment was sold where as direct investors would only pay after they sold their shares.
"There is slight disadvantages [for KiwiSaver investors]."
The Tax Working Group proposed a lot of off-sets for the capital gains tax for KiwiSaver but Haddon said the biggest kicker was the government contribution increase.
He said the increase would cost around $500 million while the CGT would raise around $2.5 billion.
"If you are going to pay out $500m you have just given it all back without doing anything else."
Haddon questioned the point of creating a more complicated tax system while not gaining any extra income.
"My gut reaction is they will be very wary about pulling up the full MTC [member tax credit/government contribution]."
Haddon said they may have to look at giving it to only some investors. He said it shouldn't be assumed that everyone in KiwiSaver would be okay.
"In any of the analysis the MTC makes the biggest difference."
If the government contribution is not increased those who earn over $70k will likely be worse off as the other off-sets are not available to those investors.
He said one of the benefits of the way that KiwiSaver was set up was that the exemption to pay tax on gains for Australian and New Zealand share investments levelled the playing field with those who invested directly in Australasian shares.
But a capital gains tax on those shares could see investors move towards more investment in overseas shares.
Haddon said he was not convinced the proposals were good for 'New Zealand inc'.
"Are we really going to invest in productive assets and productive companies in New Zealand? "Or are we going to lose start-ups to someone else?"
Haddon urged caution and said if the government introduced the CGT within the timeframe they were proposing it would end up being a mess.
"If you want to something, do it at the residential property level, leave shares for greater thought and to determine what the issues are."