We asked for your questions on the impact of a possible capital gains tax. Here is a selection, answered by Robyn Walker, National Technical Director Tax at Deloitte.
What about losses?
Q: If, under the Tax Working Group's proposals, capital gains will be taxed, is there a provision for capital losses? Or is the proposed fairness only going in one direction?
A: Losses will be available to offset against other income in some instances. All property held on valuation day will be subject to "ring-fencing", meaning that any capital losses can only be offset against capital income. All property which is readily traded (eg listed shares) will also be subject to ring-fencing rules — this is to avoid any temptation to sell to crystallise a realised loss, followed by a reacquisition of essentially the same asset.
Mind the crash
Q: If the Government implement the proposed CGT in 2021 and there is a subsequent stockmarket crash, has the Government factored in the potential huge tax credits that they would have to give? People are talking about how much house prices may be affected; what about share investors? The introduction of CGT could well cause a local stockmarket revaluation which the Government would be partially reimbursing.
I assume changes would also be required to foreign investment funds, as investors are already taxed on assumed share price increases.
One final point: the introduction of a CGT would cause endless extra work for share funds, as each of their investors would likely be on different tax brackets. It sounds like a nightmare in the making.
A: Any losses on listed shares will be subject to "ring-fencing", meaning any capital losses can only be offset against capital income.
The treatment of foreign shares will likely remain largely unchanged. This will lead to questions about whether the tax system will be creating a bias either towards or away from New Zealand shares, based on different tax rules.
The managed funds sector will be materially impacted with compliance costs. The sector is likely to need to heavily invest in IT system changes.
Sitting on a loss
Q: Some years ago I bought Fletcher Building shares when they were up near $10.
Times have changed and they are around $5, so I am sitting on a paper loss. (I'm an optimist about the future!)
Say they are valued at $5 at the point when CGT is introduced. A year later the price has improved to, say, $6. Will that be a taxable capital gain because I am still in a loss situation?
A: It is proposed to have "median rule" which will apply to any property held on valuation day, except listed shares. Under the median rule, the amount deducted from the sale price would be the median (middle) value of:
1. Actual cost
2. The value on valuation day
3. Sale price
Applying that to this example, (1) is $10; (2) is $5, (3) is $6. Therefore the median is $6, and $6 would be deducted from the sale price of $6, meaning there is no capital gain to be taxed.
However, as noted, it is proposed that the median value should not be available to be used for listed shares. Instead, under this example the difference between the sale price ($6) and the value on valuation date ($5) would be a taxable paper gain of $1.
Where's the fairness?
Q: Within our share portfolio we have a reasonable number of Chorus and Spark shares.
As you know, many shareholders in Chorus and Spark obtained the shares when the Government forced Telecom to split into two companies. Because of that Government action, the value of Telecom shares dropped overnight by a large margin.
The combined present-day value of our Chorus and Spark shares is still approximately 25 per cent below the amount we paid to buy the Telecom shares. After the Government's valuation day for shares, we will have a starting point for our Chorus and Spark shares which is well below what we paid for them.
If those shares increase in value after valuation day, we would be required to pay capital gains tax, when in fact we are still in a loss position because of a previous Government's action. The PM said the system will be fair. Being required to pay capital gains tax when there isn't any capital gain doesn't seem fair.
A: The answer is the same as it is for the Fletcher Building example — any (taxable) gain in the share prices will be based on their value at valuation day.
Q: I read with concern that the proposed capital gains tax will be applied to the increase in my KiwiSaver fund. This means my money into the fund is taxed, the income the fund creates is taxed, and now the risk I am taking with investing in share-based funds — as we are advised to do — will also be taxed.
I have been using average returns in the Sorted KiwiSaver Fund Finder to give me some sense that I will be on track with my KiwiSaver during the spending phase of my life. Although there is a proposal to reduce the PIE (income tax) charged on my savings, there does not seem to be any discussion in the media on whether that compensates for the increase in tax because of CGT.
In other words, if an average figure in the Fund Finder now says we can hope for 5 per cent growth, will this now be, for example, 2 per cent? Because I have no time or money to build up sufficient extra savings to compensate for the lower returns, will I have to work until I'm 70?
Alternatively, would you recommend that I switch away from saving in a fund containing New Zealand shares, because that will reduce CGT and improve my already meagre retirement income?
A: Whether you are better or worse off with KiwiSaver investments may come down to the final "package" of reforms agreed to. At a general level, you are correct that taxes on KiwiSaver will be increasing. The question is whether there will be adequate compensating changes to KiwiSaver to offset the additional tax. For example, it is proposed to increase the member tax credit, lower KiwiSaver PIE rates for lower income earners and so on.
Fees plus tax
Q: I note from Sorted's KiwiSaver Fund Finder that the average fee for a balanced fund is 1.26 per cent and the average return over the last 5 years is 7.55 per cent. Let me use those two figures to do some simple arithmetic.
If my fund grows by 7.55 per cent and under the proposed capital gains tax I pay 17.5 per cent tax on that return, then I will pay 1.32 per cent of my fund value in CGT. This would be the same as paying 1.26 per cent + 1.32 per cent = 2.58 per cent in fund fees. Okay, it's not a fee as it is made up of fee plus CGT, but it is going to feel like a fee.
How can we New Zealanders hope to save for our retirement when we are paying the equivalent of an average 2.5 per cent charge on our KiwiSaver? The highest KiwiSaver Balanced Fund fee is less than 1.9 per cent. Is 2.5 per cent some sort of world record for a balanced fund?
Taxing second homes affects maybe 25 per cent of Kiwis (a guess), but increasing the charges on KiwiSaver affects all Kiwis. Surely I must be missing something — it cannot be that bad.
A: It's the same answer as the previous question — whether you are better or worse off with KiwiSaver investments may come down to the final "package" of reforms agreed to.
Q: Could the capital growth in your KiwiSaver fund put you into a higher tax bracket? For example, if you are retired and you have $24,000 (gross) super per year and a KiwiSaver fund of $300,000, then:
If during the prior year your KiwiSaver dropped to $240,000 and next year it increased back to $300,000 again, that is capital growth of $60,000 — meaning your income for the year is $84,000 and you are taxed at the rates that apply. You may even need to dispose of some of the KiwiSaver funds to pay for the tax.
What do you think? Will I pay tax at a higher rate and run out of money before I die?
A: Provided that the KiwiSaver fund has been provided with your correct Prescribed Investor Rate (PIR), then income which is earned through a KiwiSaver fund shouldn't be taken into account when determining personal tax rates.