John Dorbu writes on capital gains tax and selling investment properties on the cheap.
Capital Gains Tax (CGT) is tax levied on net gains realised after the sale or disposal of a capital asset. The tax is roughly calculated by deducting the cost base of the asset from the proceeds of sale or disposal.
The cost base of an asset is defined for this purpose as the cost of acquiring it, expenses incurred in defending it, and commissions paid in the course of acquisition.
Many OECD countries, including Australia, levy CGT on their citizens; New Zealand does not. The reason is probably socio-political.
New Zealanders are homeowners (73 per cent), a higher average compared to other OECD countries. This is why this tax is such a sensitive issue.
About 68 per cent of government revenue presently comes from income tax. Capital gains tax accounts for 19 per cent.
The Government seems poised to increase the GST rate to 15 per cent from 12.5 per cent. Like any value added tax, GST is a consumer tax and is paid mostly by households. This means 87 per cent of government revenue comes from tax borne by predominantly the same group of taxpayers.
There is missing a significant tax contribution from investors and the owners of capital. As the economy relies mainly on personal income and consumption tax, whenever recession occurs and employment suffers, tax revenues fall and the Government cannot spend without borrowing.
The absence of capital gains tax produces a further fiscal abnormality - the tendency for financial institutions holding mortgages to dispose of properties at less than full value. As a majority of New Zealanders invest in real estate, the problem is far-reaching.
When defaults on mortgage repayments occur, institutions which hold security assets often sell them, invariably at prices far less than they are worth.
They would normally have insured the loans and are able to recover any shortfall as indemnity under the policies. The insurers would then sue the borrowers in subrogation.
This happens because in our tax system the authorities are not interested in capital gains. The only person interested in capital gains is the borrower, who unfortunately is voiceless for practical reasons when the mortgagee strikes.
It is rare in New Zealand for a mortgagee to sell at a price that covers the amount it had lent the borrower let alone what the property was truly worth. There is simply no incentive for it to do so and there is no framework in our tax regime that ensures mortgagees sell at market value.
In jurisdictions such as the UK where capital gains tax exists, asset values are taken seriously.
In contrast, financial institutions have abused and will continue to abuse the system in New Zealand. The costs to society are the roads, hospitals and other social services that government is unable to provide.
Does it make sense that a lender which advanced money on the registered valuation of an asset should turn around 12 months later to sell it at 50 per cent or less of that value?
Between 1999 and 2009, property values have not dropped more than 20 per cent on average in New Zealand, yet there are few mortgagee sales throughout the country during that period that had achieved 80 per cent or more of the registered value of the security.
CGT is not a panacea for dealing with recalcitrant financial institutions selling security assets cheap. An alternative approach could be for the Inland Revenue Department to develop a system of monitoring every sale of real estate with reference to a national benchmark.
There is nothing wrong with IRD asking a lender to provide a copy of the valuation submitted to it when it made the initial advance, and compare that with the price for which that lender purported to have disposed of the asset. Such a measure would increase the GST revenue on sales and generate income tax.
The practice whereby financial institutions lending on assets accept valuations from one registered valuer but use a different valuer when selling should be abrogated.
There's nothing wrong with a lender seeking a second or third opinion before lending but logic is compromised when that institution discards all such opinions and brings in a completely new valuer for the purpose of justifying a rogue sale.
Why should the opinions of valuers who had researched the asset at the pre-lending stage be discarded at times of sale?
Government needs to disabuse the public of the mythical phobia attached to CGT. In Australia, CGT excludes taxpayers' residential properties and only applies to investment properties.
The tax applies only when you have sold or disposed of the asset, and only when you have actually made a profit after sale, and at a personal level the tax applies only to 50 per cent of the net profit. What is wrong with that?
Our Government should embark on a comprehensive consultation of the investment and voter public about developing a tax system that ensures that capital assets generally and real estate in particular are sold at their market value.
I would personally prefer a system where my property when sold would put $2000 into my pocket after all debts have been paid, whether or not tax would apply to half or the whole of that amount, to a system where the same asset would be sold leaving me with a debt of $100,000 to pay.
* John Dorbu is an Auckland barrister.