Gains from share realisations: Is it time for a legislated capital gains tax?

Unlike many other advanced economies, New Zealand does not have an explicit capital gains taxation regime. The distinction between capital and income is therefore of vital significance. An area in which the capital-income distinction is of considerable importance is that of gains and losses from the sale of shares. Prima facie such gains are of a capital nature and thus not taxable. However, depending on the circumstances, they may well come within the ambit of the income tax provisions. Essentially, gains on share realisation may be taxable where the gain constitutes a business profit, the taxpayer is dealing in shares, the taxpayer purchased the shares for the purpose of resale, or where the taxpayer is involved in a scheme or undertaking for the purpose of profit making. The potential taxation of gains from share realisations is an issue of particular concern to investment companies. Recent case law would seem to indicate that the share acquisition and disposal activity of such companies might potentially be drawn into the income tax net. There remains, however, a considerable degree of uncertainty in respect of the issue and the Privy Council decision in Rangatira[1] has done nothing to clarify the general position of investment companies. The Inland Revenue Department’s recent private ruling in respect of the TeNZ fund has further fuelled the existing uncertainty. The current situation in respect of the taxability of gains from share realisations by investment companies serves as a useful illustration of the problems which arise by virtue of New Zealand having what may be described as an ad hoc approach to the taxation of capital gains. Clearly, uncertainty and the costs this imposes on the economy constitute one such problem. Additionally, the fact that some capital gains are taxed and some are not introduces distortions in the behaviour of individuals and firms. This lack of a level playing field also results in the inequitable treatment of different forms of gains. The appropriate solution, it would seem, would be to introduce a formal, comprehensive capital gains tax. In addition to redressing some of the problems noted above, such a tax would assist in realigning the judicial and economic definitions of income and restore some rationality to the use of income as a basis for imposing taxation. This article reviews the tax implications of gains from share realisations. Particular attention is given to the position of investment companies. Part 2 discusses the capital-income distinction. Parts 3, 4 and 5 consider in some detail the statute and case law in respect of gains from share realisations. This discussion of the applied law is the central focus of the article. Having ascertained the legal implications, part 6 reviews current issues and developments relating specifically to investment companies. Some attention is given to the TeNZ fund and the uncertainty that exists in the market regarding taxability of share realisation gains. Part 7 poses the question as to whether the observed problems in respect of investment funds suggest some need for a formal comprehensive capital gains tax. Part 8 provides concluding comments.