A lot of people don’t realise that including sales of businesses in a CGT result in very punitive double taxation on business owners. So I thought I’d give an example.
Let’s say Michelle is a plumber. She works for other plumbers for 20 years and then sets up her own plumbing business. She puts $50,000 of her savings into it.
Michelle’s business does well. She pays herself $100,000 salary from it, and any profit beyond that she keeps in the business to allow it to grow reserves and capital.
On average the company makes a $40,000 profit every year for 20 years. Michelle pays company tax of 28% on that profit. So each year we have:
- Profit $40,000
- Tax $12,000
- Increase in Equity $28,000
Now after 20 years Michelle wants to retire and sell her business. It is no longer worth $50,000 but $610,000. If she sells it for its net worth (so not even taking goodwill etc into account) then she gets told by IRD she has made a capital gain of $560,000. She must pay tax at 33% on that capital gain so She has to pay $184,800 CGT.
But that $184,800 CGT is basically taxing her for the annual profit she has already paid tax on. It is double taxation. That increase in the worth of the company is solely due to her keeping annual profits with the company. So here’s the net taxation she pays:
- Profit $800,000
- Company Tax $240,000
- CGT $184,800
- Total Tax $424,800
So Michelle effectively pay 53% tax rate on her plumbing business. Totally unfair right. But this is what the Government wants to do.
Now if Michelle didn’t reinvest any of the profit back into the business allowing it to expand, take on more staff etc then she’d be better off. Instead of paying herself a salary of $100,000 a year she would be best to pay herself $140,000 a year and then she only pays 33% tax instead of 53% tax.
This is why the Government’s proposed CGT is an unfair tax. It is a double tax on business owners.