Received this e-mail from a top tax accountant (over 30 years experience with one of the big 4 firms) on the proposed CGT:
I have just read your post re how CGT is a double tax on a business owner that has accumulated (tax paid) profits within their company. All very interesting.
However, the idea of a CGT on sale of a business is even more flawed than that.
Assume that I have established a lawn-mowing service from nothing. After years of slog, I have built up a very loyal customer base, but it is time for me to retire, and so I sell my business to you. As part of the sale, you agree to pay me $50,000 for the goodwill of the business that I have built up. Under the CGT proposal, this $50,000 would be a capital gain and I would have to pay income tax on that amount.
But the $50,000 of goodwill is not a “magic” number – as a business asset, it represents the economic net present value of the future earnings potential from the loyal customer base I have nurtured. Now, when those future earnings are derived, they will be on your tax return as part of your business turnover – and you will pay tax on those amounts. Given that I have already paid CGT on the goodwill amount, the direct result is economic double taxation.
I do note that this double tax position could be alleviated if you were allowed to claim an income tax deduction for the goodwill amount. However, insofar as I am currently aware, beyond a suggestion that depreciation be allowed on commercial buildings again, there is no firm suggestion of deductions for goodwill and the like being offered in the TWG report.
At a macro level, if the CGT were sufficiently thought out so as to give you a deduction for the goodwill, then the net of the two positions would effectively cancel each other out (i.e. I pay tax on $50,000 and you get deductions for $50,000). So the net revenue position for Government would be largely neutral (except for some timing considerations between taxation of the gain and deductions allowed for the goodwill and perhaps if you and I were on different tax rates). This begs the question of “why even bother” for something so hideously complex as a comprehensive CGT when you get the same neutrality under the current system (i.e. no tax for me to pay on the goodwill, and no deduction for goodwill for you to claim).
The above analysis suggests to me that “if it ain’t broke, don’t fix it”. Our current tax model for capital gains made by businesses seems fit for purpose, whereas the CGT proposal from the TWG carries a fundamental flaw if it does not afford corresponding tax deductions to purchasers.
I must admit, however, that the one place where the CGT model proposed could actually work effectively is for non-business assets (i.e. where the asset does not give rise to future cashflows that would be subject to tax). A perfect example of such an asset would be the family home … oh, wait, this is the one thing that they have exempted from the CGT regime! There goes the main opportunity for the fairness of the tax system to be improved.
I predict that, before the CGT raised the $8 billion (in first 5 years, as suggested by Dr Cullen), New Zealanders will first spend potentially billions in fees for accountants, lawyers and business valuers. I might have been thinking early retirement, but the current Government seems to be intent on loading up the gravy train….
It certainly will be a boon for tax accountants.