Capital Gains Tax: What it means for farmers

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In part two of a series on the effects of a capital gains tax, ANDREA FOX looks into what it and other taxes recommended by the Tax Working Group would mean for farmers.

Status quo:

Farms are currently not subject to a capital gains tax (CGT) when they sell. However if someone buys a property that is not their home they are taxed on its sale if they keep it less than five years.

Farmers pay GST on all purchases and company tax of 28 per cent. If they use a trust structure, any profit is subject to 33 per cent tax.

What's proposed:

The Tax Working Group (TWG) has recommended land be subject to a CGT.

The farm's family home would be exempt but any home site area over 4500sqm would be subject to a CGT. Increases in livestock herd value would be subject to tax.

Environmental taxes on water uptake and discharge, and pollution.

Revenue from the proposed environmental taxes is not included in the $8 billion of revenues the TWG has estimated a CGT would raise over its first five years.

Of this 10 per cent or $800m would be contributed by a "rural property" CGT.

Short and medium term outlook:

Few specific TWG recommendations impact farmers in the short term. An environmental tax structure for water uptake and discharge, for example, would need a lot of work because the issue of Maori water rights has yet to be resolved.

But environmental taxes, designed as they were to change user behaviour and help finance the economy's transition from unsustainable to sustainable activity, would add costs to a farming operation in the medium to long term.

What the farming sector thinks:

Federated Farmers vice-president and dairy farmer Andrew Hoggard says environmental taxes would have the greatest impact on farmers because they will hit "year after year" whereas a CGT will tend to be a one-off tax at the time of the property sale.

Hoggard asks what is the purpose of a CGT? "What are we trying to achieve? Everyone has been talking about housing affordability but (the recommendations) don't include the vast bulk of the country's housing, so how is that going to achieve the outcome?"

He says for all the talk about a CGT being needed for "tax fairness" it is impossible to reconcile how in the comparison of a farming couple and an Auckland couple planning to sell their respective properties for $2 million to move to retirement villages, only one - the farmers - have has to pay a CGT.

TWG member, PwC tax partner Geof Nightingale agrees with Hoggard.

"The excluded family home is the source of a new unfairness in the system because of exactly that example. But it's a bit more nuanced than that," Nightingale says.

The urban Auckland working couple may have built equity in their home while paying income taxes and paying off their mortgage. The farmers may have built equity through tax deductible expenditure like fertiliser and fencing "and all the hard work".

"So just comparing their wealth at the end of their working life might not give you the right answer on each one's relative contribution," he says.

What a rural specialist accountant thinks:

A key issue of a CGT would be the added difficulty it will throw up for farm ownership succession planning, says Stephen Stafford Bush of McConnell Stafford-Bush.

A feature of farming is typically lower returns but high asset values.

This makes succession planning difficult anyway "but you throw in some sort of capital gains tax and it will make succession planning and the ability to transfer inter-generationally to the next group of family members impossible", he says.

He notes the TWG recommendation that tax could be deferred to a later date in some circumstances, including death, when an asset is transferred or sold, is just that - a proposal.

"The Government could totally ignore that. It's only a recommendation. I still foresee potential in some form or another of some level of taxing if they don't exempt it that could make inter-generational transfers difficult.

"The highest performing farmers in New Zealand are the family-owned farms, not the corporate-owned ones. Because they have skin in the game."

Stafford-Bush also notes TWG's vote to remove the current tax exemption on livestock value fluctuations.

"At present in the Herd Scheme (a livestock valuation methodology) any increases in herd values are not subject to tax and for any decreases they don't get a tax deduction. The intent is that will be removed and any increases/decreases will be subject to tax."

The expert's view:

TWG member Geof Nightingale said a point that's been missed in the analysis around a CGT on farming is that "very few" specific recommendations would affect farmers short-term.

On probably the biggest impacter, environmental taxes, Nightingale said the TWG wanted to show they were "part of the Government's toolkit for helping to deal with the degradation of our natural capital".

The TWG set out two frameworks - one suggested under what conditions these taxes might be used; the second suggested how to design the taxes and the necessary conditions for them.

"Those two frameworks were quite important because they allow the various stakeholders to frame up the debate - whether it be Government, farmers, environmentalists. Those frameworks hopefully allow them to understand each other and to discuss the impacts and the design around those taxes."

The TWG had three time frames for environmental taxes, says Nightingale.

Short term, say the next one to five years, the tax might be used to price damage caused by an activity.

"If that damage is not priced or regulated in any other way you might think about environmental taxes as a way to recognise the cost of that activity on the community and raise some funds either to discourage that activity, or encourage people to shift their behaviour. Second, they could raise funds to help mitigate that activity - a classic one would be pollution.

"In the medium term (5 to 10 years) as revenues started to be raised we thought they could be used to assist transitions of the economy from unsustainable activity to sustainable activity.

"So if you think about intensive dairy farming in a particular catchment and at some point the community, via the government, decides that activity is not well-suited to the catchment and the government wishes to encourage a change of use of that land to something less damaging, the TWG is saying those taxes could be used to help that transition."

Nightingale says the transition might see the government regulate against the activity and compensate the affected farmer for their loss of rights and value.

The revenue could provide an incentive for use of better technology for a different form of farming or for the government to buy the land and retire it.

In the longer term, 10 to 30 years, environmental taxes could form part of New Zealand's general tax revenue, suggested the TWG.

Before pollution, such as leaching and runoff into waterways, can be measured in cities and on farms, a very precise measurement mechanism has to be found, says Nightingale - another reason why a water tax on pollution or extraction is a way off.

"Solving that measurement issue is critical."

Nightingale says the TWG recommended the emissions trading scheme continue and that agriculture be brought into it over time.

"Not all at once and in quite modest increments over the medium term.

"What the TWG was really conscious of was that we need to transition some of our activities (from damaging to sustainable). We need to do those transitions in a way that doesn't collapse the economy.

"It needs to be done carefully - but it needs to be done. The working group is convinced that if we are going to get anywhere near zero carbon in 2050 some significant shifts in the economy need to happen."

Nightingale says the TWG consulted closely with primary industry groups and received many good submissions.