Capital Gains Tax – Should You Be Worried?
Yesterday the Labour party announced their tax policy and a Capital Gains Tax (CGT) is a principal component of that policy. NZ has never had a CGT, except as it applies to some selected property situations, so this policy is quite a change for us. The question I keep coming back to is “Should I be worried about CGT?” My answer is no, because there are so many things that have to happen before CGT becomes a reality. I have significant doubts that the first requirement of Labour getting into power will become a reality.
Nevertheless, it doesn’t hurt to understand the general thrust of what is being proposed. This must come with a caution – there would be a lot of discussion leading up to implementation so the proposed regime could change significantly.
For business-owners there are three main areas that would impact on them – rental properties, share sales and business sales. Ownership of assets in trust vehicles will also be of interest. We cover each of these below.
1.The rate of CGT will be 15%, and will be payable at the time the asset is sold to a third party.
2.The tax will be calculated on the increase in value between V-Day (ie. the date CGT is implemented – proposed to be April 2013) and the date of sale. There will be no adjustment for inflation and you won’t be taxed on any gains to V-Day.
3. Personal assets will be excluded. This would generally include a home that is owned by a family trust, although the policy document is somewhat vague. It also includes personal assets, collectables, and leisure assets like boats.
4. Capital losses could be carried forward to offset against future capital gains. They are unlikely to be offset against other taxable income like salaries.
5. The treatment for assets which have fallen in value between the date they were purchased and V-Day still needs to be considered, but it might mean that original cost could be used in some cases.
6. If you are already taxed on the profits from the sale of assets you will continue to be taxed at your ordinary tax rate, rather than the lower CGT rate.
All investment properties, farms and holiday homes will fall within the regime. If you sell the property for more than it was worth on V-Day, you will be taxed at 15% on the increase in value since that date. Property values are relatively easy to determine, and I’d guess that rating value will probably be the default value.
If you inherit a property then generally you won’t be taxed until you sell it, but you will be taxed on the increase in value from V-Day. So conceivably, you could be taxed on increases prior to you inheriting. An interesting thought – I have no idea what happens if you inherit the old family home (exempt from CGT) and then rent it out. Perhaps tax is only relevant from the date it ceased to be a family home and became a rental property.
A similar situation will probably apply if you sell an asset as part of a relationship breakup, and possibly also if you sell assets from one business entity to another, or if you sell an asset and replace it with a similar asset.
But the sale of an asset to a trust which must be done at market value) will generally fall with the CGT rules and you will be taxed on any increase in value. I think this is at odds with the proposed rules around property inheritances and the ability to sell assets between two related business entities without a CGT cost.
At the moment, profits from the sale of shares are taxable only if you are a trader. The current investment tax rules sort of tax some of the increase in overseas share values annually. From V-Day profits from the sale of shares will be taxed at the CGT rate, and this will include venture capital investments. The issue for most business owners will be how to determine the value of the shares in their private companies.
Many business owners will sell down some of their shares to internally grown successors, or provide shares to staff. There are inherent problems with valuing the shares in SME’s and particularly if there are restraints or limitations on any of the shares. Luckily, Stephenson Thorner has a very good process for determining the value of shares and businesses which is quite transparent. The process for valuation of non-listed company shares is one that will be left for the Expert Panel which will advise on the tricky issues.
There is one bright spot – if you have been forced to put the business into liquidation, if a liquidator says they do not expect the shareholders to get a return of capital then the shareholder can claim a capital loss on the shares. Which is a good reason to regularly review your business equity structure to see that it is keeping pace with the level of business activity – it would be sad to see the capital loss limited to $100 because that’s all you have in share capital! Also, many businesses don’t go through the liquidation process, but simply apply for removal of the company. I have no idea what happens in those cases, especially if you have done the honourable thing and paid off all creditors from your own pocket.
Business Sales and Liquidations
In many cases, business owners (and purchasers) prefer to sell the business lock stock & barrel into a new company. This is particularly relevant where the succession plan involves sale to a third party, rather than growing a successor in-house.
If you are selling your business to retire, then you might get some concessions provided you’re not planning on early retirement! The proposal is that where you are above a certain age (and 55 is the example provided), and you have owned your business for 15 years and you have worked in the business, then you will have the first $250,000 of gain exempt from tax. We’re hoping that our clients will realise more than $250,000 from the sale of their businesses, but at least not all of it will be subject to tax.
Many NZ’ers own trusts and hold personal and business assets in their family trusts for asset protection reasons. It will not be possible to use trusts as a means of avoiding paying CGT. In fact, there seem to be some proposals that actively discourage the use of trust ownership of assets. We’ve already mentioned that the sale of an asset to a trust will trigger CGT. That reinforces our view that ownership structures are important and should be reviewed on a regular basis.
Gifting an asset (which will probably also include a forgiveness of debt) will also be subject to CGT. So while the current government intends to abolish gift duty later this year, the Labour government intends to bring it back in, albeit in a different guise. You should also be aware that the proposed abolition of gift duty is not without some fishhooks, so the answer is not to just gift off all debt owing by your family trust.
While Labour’s tax policy is not limited to CGT, this is the interesting area for business owners. Although these proposals may look scary and could have a significant impact on you, we re-iterate our view that Labour will not get into power in 2011 and therefore there is nothing to worry about at this stage. We prefer to focus on the probables, leaving the possibles for others to worry about.