Is a capital gains tax looming closer to New Zealand Market?

On the 6th of April the Reserve Bank together with Treasury released a report with the grand title "Supplementary Stabilisation Instruments". The title would put you off before you even start. Massive volumes of paper were produced and you would be forgiven if your eyes glazed over a quarter of the way through to eventually dismiss it as yet another "burp" from officialdom as the Minister of Finance Dr Cullen once described such reports.

This report is the second missive in recent months from Treasury and the Reserve Bank on the same subject (the first being a statement that this full report was being prepared). It is a fuller and more comprehensive version of that previous paper on how to cool the rampant housing market.

If you are a residential property investor, or even a simple home owner, then get hold of this report and make careful notes. (You can download it here.) Of even more interest was the accompanying letter signed by the Governor of the Reserve Bank Alan Bollard addressed to the Minister of Finance Dr Michael Cullen which summed up the thinking of the pointy heads as they mulled over how to pull the rug out from under the housing market. Their ideas range from loopy to downright dangerous -- but that's not the point. The whole point of the exercise is to give the Government ideas on how to dampen the housing market. In other words the Reserve Bank has done the dirty work so, should the time come, the Government can say "we had independent advice" and that this has all been "in the public domain" for months etc. etc.

Sooner rather than later
However if any action is planned it would have to be early in the life of the present government. Controversial taxes or interference in the market would be the kiss of death in the lead up to an election year so it has to be now or never. The good news is that the market seems to be cooling down by itself -- as all markets do. Should the market continue to correct itself over the next few months then it is likely nothing more need be done and we can all breathe a collective sigh of relief (until next time that is). But if the headlines keep gushing about massive property price rises, booming townships and spectacular profits out of property then I am afraid, as sure as night follows day, the axe will fall.

What isn't helping are the shameless spruikers who keep advertising that in only "four action packed hours" everyone can be rich through property (only $39.99). This sort of rubbish plays straight into the hands of the bureaucrats who are charged with "Stabilising the Economy". Why people bother to attend these joke presentations is beyond me -- but we all know "there's one born every minute".

Then of course we have the banks which are doing their damnedest to keep pushing prices up. Currently Kiwis owe $114 Billion in mortgages, a huge increase over the previous years. The BNZ boasts that it lent an extra $610 million in loans in the last quarter and this begs the question: Where is all the money coming from? Well I can tell you that a lot comes from overseas lenders. 'Our' banks and finance companies are borrowing overseas at cheap rates (e.g. 4% from the US, 2.5% from Japan) and on-lending it to us here at 7.5% to 19%. A nice little earner if you can pull it off.

Conversely, overseas banks are pouring in cash to take advantage of our high interest rates -- among the highest in the Western World in fact. The trouble will come when it's time to pay these loans back. The NZ dollar has depreciated by so much and so rapidly that I am picking that some finance houses could be in trouble finding enough newly-depreciated NZ dollars to pay back the overseas bankers the original value of their loans! Not everyone has hedged their loans because the cost can be prohibitively high (especially now that the dollar is dropping!)

Desperate measures So what exactly does this Treasury-Reserve Bank report suggest as a means to cool the property market?
In its opening paragraphs the report states that "the housing market is currently more stretched than any time since the housing boom of the early 1970s." I was around in the early 1970s and I saw what happened. Prices leapt up -- just as they have this time -- resulting in a 'Property Speculation Tax' which confiscated 90% of any profits made within two years of purchase. Can it happen again? Well, read the report:
One of the ideas is to bring in (or at least apply more harshly) a capital gains tax. I quote: "further measures can be employed to reinforce existing tax law applying to capital gains on housing. For example a reporting requirement could be imposed in respect of all sales of residential property occurring within (say) two years of acquisition..." (Sound familiar?)

But wait, there's more. Some of the other loopy ideas include: (1) Tightening up the amount banks can lend on housing, by requiring them to keep more cash on hand at all times "a comprehensive loan-to-value ratio limit, applicable to all loans secured on residential properties by all lenders. This measure would have a direct impact on the most leveraged portion of the housing market." There would go 100% finance. There would go the chance for the needy to get into a home. There would go encouragement to provide rental accommodation. And here would come a windfall for the loan sharks who will eagerly fill the gaps.

(2) Doing away with the benefits of LAQC 's by eliminating or curtailing losses so that these losses could not be used to offset personal taxes.

(3) Putting a "levy" i.e. a tax on interest paid on a mortgage "an adjustable mortgage interest levy, which could be imposed on all mortgages on residential property and designed to force a wedge between the price paid for credit by borrowers and the returns available to savers financing those loans." Nice one that! Interest rates are starting to cripple many borrowers already. A "levy" would be the final blow.

(4) Finally how about this suggestion: "it may be appropriate to consider further tax measures such as tightening the tax net on profits made on properties held for relatively short periods and/or ring fencing operating losses on investment properties." This has shades of the old 'Property Speculation Tax' and reinforces the question around the use of LAQCs etc to minimize personal tax.

There were several more suggestions all as loopy as the others -- but that's not the point. The point is that this report is most likely the final warning to the market.

It is indeed fortunate that the latest statistics show that the housing market is cooling quite significantly both in price and turnover. Even the bank economists admit "negatives far outweigh the positives for the property market" with negative factors including "low employment growth, below average net migration inflows, rising average mortgage rates, lower consumer confidence and a continuing stream of new property". So, with fingers crossed, it is more and more likely that we will avoid being burdened with the crackpot ideas of the bureaucrats ... for the time being. But you can never be too careful. We have populist left-leaning government backed by even more left wing smaller parties in coalition so anything is possible. History shows that reason and logic are often sacrificed in the name of idealism and power.

And Michael Cullen is quite capable of pulling surprises out of the hat. Consider how swiftly he changed rules allowing Trusts to split income to minor beneficiaries (from 19% to 33% tax rate overnight) and how on his watch the IRD is knocking back chattels depreciation for residential investors. Already we've seen commentators bemoan the 'lost opportunity' for a capital gains tax. If that's how the business writers think we have to be ever more vigilant because their influence in shaping public opinion must not be under-estimated.

It is also interesting to note that the Reserve Bank was instructed not to discuss a capital gains tax per se. Silence is a form of communication as we all know. Had it been raised in the report there would have been hell to pay and riots in the streets. Watch this space.

Be Prepared:
Whether or not a capital gains tax is ever introduced it is never too early to be prepared.
To this end I would recommend:
(1) Selling off poor quality property while the going is (relatively) good.
(2) Reducing debt.
(3) Deciding whether or not to hold on to your current investments for at least the next five years -- if not, get out of the market now.
(4) Look at commercial property as a better alternative. The real returns are higher and with less emotion it runs on different rails from residential.
(5) Don't believe the rubbish put out by the spruikers promising you instant wealth through residential property.
(6) Put spare cash into solid banks and finance companies even if the rates being offered are lower.
(7) Don't go into big-time developing at this point unless you're fully cashed up.
(8) Buy alternative investments which have international value e.g. art, antiques, gold, foreign cash accounts or blue chip shares as a natural hedge against any down turn or interference in the property market.
(9) Get advice from truly impartial experts and be prepared to pay for it.

Last words
Be warned. Make hay while the sun still shines. Re-organising your property portfolio can take months if not years. Dragging your feet could be injurious to your financial health.

Olly Newland
April 2006

COLIN KUMAR
Barfoot & Thompson Commercial
m. 64 27 684 1114 | p. 649 358 0989
c.kumar@barfoot.co.nz

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