Capital and wealth

Tax Working Group Interim Report

By Patrick McCalman

No one following tax in New Zealand would be in any doubt that a major driver behind the establishment of the Tax Working Group (TWG) was to get a view on the suitability of a capital gains tax (CGT) in a New Zealand context. CGT has long been held out, including by the OECD, as a vital tax which has been missing from New Zealand, an essential tool to buttress the tax system.

What is clear from the Interim Report is that the TWG has devoted considerable effort to considering what a CGT would mean in New Zealand; with the result being that the answer is not as clear cut as some may have been expecting.

While we refer to a CGT, the Interim Report avoids this terminology and refers instead to the “extension of taxation of capital income” (EOTOCI). Although in many cases they are essentially the same thing, EOTOCI is “taxing realised gains not already taxed from specific assets”. This reflects that we do already have a collection of ad hoc rules (including for land) which tax capital transactions in certain circumstances. The terminology also reflects that some assets will be outside the scope of the tax, for example personal assets such as jewellery and vehicles.    

The capital / revenue boundary

Outside of specific tax rules, in New Zealand we have applied a capital / revenue boundary to taxation. Revenue gains are subject to tax, capital gains are not subject to tax.

What is meant by the term “capital” is not defined in the statute.  Case law has established various factors to consider when determining whether a particular receipt is income or capital in nature. One of the more famous observations on the distinction between capital and income was made in the case Eisner v Macomber 252 US 189 [1919].  Pitney J drew a distinction between income and capital by likening the latter to the tree (e.g. land or other property) and the fruit or produce (e.g. dividends, rents, royalties) of the tree. It would follow that the profitable sale of an asset, “the tree” without more, would produce not income but a gain of a capital nature.  That proposition has been applied by the courts so that the proceeds of a mere realisation of a capital asset are not regarded (in the absence of a specific legislative provision to the contrary) as producing income gains. In contrast, assets ventured in a successful profit making scheme will generally realise gains of an income nature. 


In addition to EOTOCI, the TWG is also considering the option of taxing certain assets on a deemed return basis (e.g. a risk-free rate of return method). The TWG has, however, ruled out a general wealth tax or a land tax.

Ultimately any changes in this area will apply from a future date and will not have a retrospective element.

Extension of taxation of capital income

The TWG have provided a specific judgement that they will need to make in order to recommend EOTOCI:

“In broad terms, will the fairness, integrity, revenue, and efficiency benefits from reform outweigh the administrative complexity, compliance costs, and efficiency costs that arise from the proposed additional capital income taxation?


Fairness. In order to maintain trust and confidence in the tax system it is essential that there is a sense of fairness. Unfairness erodes acceptance of the tax system and voluntary compliance. EOTOCI will evoke many thoughts of unfairness. Some will think it is currently unfair that others can profit from the sale of capital assets with no tax while all of their income is fully taxed as employment income.

Efficiency. Whether EOTOCI would have positive effects on efficiency is a complex question. The efficiency of such a tax would depend on whether the consequences of it would be to either encourage the flow of investment to sustainable productivity growth or inhibit the flow of capital to the productive sector. The impact on efficiency would depend on the detailed design and who actually bears the cost of the tax. The Interim Report gives some examples of the impact of EOTOCI:

  • A reduction in domestic private savings and investment in the affected assets
  • Savings and investment decisions becoming more neutral, thereby encouraging investment to flow to areas of greatest productivity rather than tax advantage
  • Assets held for longer than economically efficient to avoid taxation on realisation (known as “lock-in”)
  • The ability to allow deductions for capital expenditure if the equivalent income is being taxed
  • EOTOCI may result in a fall in the price of assets
  • Savings can be especially sensitive to tax, and EOTOCI has the potential to distort capital markets
  • If EOTOCI is comprehensive, with only an exclusion for the family home, this may have what is called a “mansion effect” whereby capital is invested into the family home rather than productive assets which would be subject to tax on sale
  • Rents would be expected to rise in the residential rental sector (potentially leading to the need for greater government support through accommodation supplements for low income earners)

Because of these potential impacts, the efficiency measures are perhaps the most critical aspect against which any EOTOCI should be measured.

Integrity, base protection, and the treatment of income. The current approach of only taxing certain forms of capital income arguably provides incentives for taxpayers to push the boundaries classifying income on capital account and expenditure on revenue account. Removing the capital / revenue boundary can reduce this type of tax planning, but it can also simply change where the distortions in the tax system are depending on the design of the rules and any exemptions or exclusions.

Legislative design, administration and compliance. While some existing tax rules dealing with the capital / revenue boundary could be removed, the overall expectation is that complexity will significantly increase. As an example, South Africa recently introduced a capital gains tax and the taxpayer guidance is 904 pages long.

Design issues

Many of the issues associated with EOTOCI will come down to how the regime is designed. Some of the major design issues being grappled with by the TWG include:

  • When to tax? Taxing realised capital gains vs taxing accrued capital gains annually. Taxing realised gains can create issues of lock-in, whereas taxing unrealised gains will have valuation challenges, cash flow issues and perceptions of unfairness.
  • How to tax? Any tax would likely be treated in the same way as revenue account property, with income taxed at normal income tax rates and a deduction available for costs at the time of sale.
  • What to tax? A targeted approach vs a broad-based approach. Interests in land, intangible property, business assets and shares in companies and other equity interests may all be subject to tax. It is likely that the family home and the land under it (excluded under the TWG Terms of Reference) and personal assets such as cars, boats, household durables, jewellery art work and collectibles will be excluded from tax.


“In broad terms, will the fairness, integrity, revenue, and efficiency benefits from reform outweigh the administrative complexity, compliance costs, and efficiency costs that arise from the proposed additional capital income taxation?”


Find out more

Tax Working Group Interim Report

Deloitte's perspectives


Extension of taxation of capital income – Detailed design questions

Beyond these main design issues of “when to tax”, “how to tax” and “what to tax”, there are a number of more detailed design questions which can materially impact on any proposed tax regime. These are set out in Appendix B of the Interim Report and include:

  • How to define the family home?
  • What to do when an asset changes use (for example a family home becomes a rental property)?
  • What costs are deductible in relation to holiday homes, and second homes?
  • Should foreign property owned by New Zealanders be included in the rules?
  • What happens when assets are transferred for no consideration; for example on death, as a gift, as a relationship property settlement or a settlement of a trust?
  • Should there be a taxing event if a taxpayer is forced to dispose of an asset; for example if land is taken under the Public Works Act 1982 or an asset is destroyed by a natural disaster?
  • What should happen with business sales where the proceeds are reinvested in a new business?
  • Should there be any consequences of a corporate restructure or intra-group transactions?
  • Should there be an inflation adjustment to ensure only actual gains are taxed?
  • What impact should capital gains have on social policy schemes?
  • When fungible assets are being sold (e.g. shares) how should the cost of the shares be determined?
  • How should capital losses be treated?
  • Will every asset need to be valued at the commencement of the regime?
  • How should international investments, including ownership of controlled foreign companies be treated?
  • If an individual ceases being a New Zealand tax resident should there be a deemed disposal of all assets?
  • If part of a company’s share price is a reflection of undistributed taxed profits, does a tax on share sales result in double taxation? What impact would this have on New Zealand’s capital markets?
  • How should KiwiSaver investments be treated? What impact will EOTOCI have on levels of retirement savings?
  • What should happen with the existing fair dividend rate (FDR) regime which currently taxes foreign equity investments?
  • Will a taxpayer making a one-off capital gain then fall in the provisional tax rules in future years?


Will EOTOCI raise revenue?

The revenue impact of EOTOCI will depend on the design of the regime, as well the behavioural responses and movements in asset prices. It is therefore difficult to predict what level of revenue could be expected to be raised, and any income will be volatile from year to year. The TWG has attempted to predict potential revenue, as set out in Table 1.

Projected revenue from taxing capital gains on realisation

[Source, Table 6.2 Tax Working Group Interim Report. These estimates are preliminary and presented for indicative purposes only]

Tax revenue ($m)

Year 1 2021-22

Year 2 2022-23

Year 3 2023-24

Year 4 2024-25

Year 5 2025-26

Year 6 2026-27

Year 7 2027-28

Year 8 2028-29

Year 9 2029-30

Year 10 2030-31

All residential land, excluding the family home











Commercial, industrial and other land











Rural land











Domestic shares






















Risk-free rate of return (RFRM) method

As an alternative to EOTOCI (or an option that could be introduced in conjunction with EOTOCI), the TWG is also exploring introducing a risk-free return method of taxation for certain asset classes. Under this method the equity held in an asset is multiplied by a risk-free rate of return and then taxed at the owner’s tax rate. This method of tax would replace any existing tax rules for the relevant assets; for example a residential rental property owner would no longer return rents or claim deductions for costs but would pay tax on a portion of the net equity in the property each year.

A RFRM approach would have some benefits. As tax is not due on realisation there would be no lock-in effect, it would be simple to apply and it would provide more consistent and predictable cash flows for government. However this method would require regular valuations, the establishment of the risk-free rate each year, and it could result in cash-flow difficulties for taxpayers, particularly if it is applied to assets which do not generate income (for example holiday homes), making it akin to a wealth tax that isn’t correlated to derived income.

Our comment

The TWG outline a number of critical design decisions which need to be considered.  It is important that business reflect and consider these aspects.  Take for example the question of roll over relief: if roll over relief is not available for businesses who upgrade assets then the imposition of tax on exit from an asset may actually lock investment into low performing assets. It is interesting to note that the Ministers of Finance and Revenue have written to the TWG and asked them to consider whether there should be a tax-free threshold for the sale of businesses.

A case for EOTOCI can be made on the basis that it would result in the re-allocation of resources from the unproductive towards the more productive setting. And that it would also level the playing field between those who generate wealth through capital appreciation versus through personal exertion.  This is a critical measure against which any final recommendations for an EOTOCI (or other similar tax) must be measured. The terms of reference for the TWG already provide some challenges for this, in that they place out of scope any taxation of the family home or land under it. This means that there will always be a bias towards owner occupied housing. While this is not that different from what almost all other jurisdictions with a capital gains tax do, other design questions are critical to the efficiency of such a tax. A design outcome which, for example, results in higher taxes on the productive sector, or tax distortions in investment decisions, will struggle to get a pass mark on efficiency grounds.  In this respect it is interesting to note that a large portion of the potential tax revenue is forecast to come from domestic shares. Care needs to be taken in the design of an EOTOCI so it does not dissuade investment in New Zealand companies.

What’s clear is that EOTOCI is far from the panacea that some believe it to be. The real issue is whether it solves more problems than it raises given we already have a plethora of measures that tax capital. The jury is still out in the Interim Report.


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