Confusion reigns with super funds
Capital gains tax on the sale of shares is perhaps more confused than it has ever been. From recent discussions, it is clear that many trustees, fund managers and even tax advisers don't understand the rules of the game.
Monday, October 6th 1997, 12:00AM
Recent case law has only added to the confusion over capital gains tax on gains made from the sale of shares.On one side we have the Privy Council decision relating to investment company Rangatira where gains on shares were held not to be taxable.
On the other side we have the Alexander & Alexander Pension Plan High Court decision which found that a superannuation scheme was subject to tax on gains made on sale of shares.
The trustees of the superannuation scheme did not appeal this decision to the Court of Appeal. So where does this leave us?
What is clear from the cases is that a superannuation scheme can have capital gains on sale of shares which are not subject to income tax. This is clearly recognised by the Inland Revenue Department as evidenced by a variety of binding rulings issued by them.
There are two principal circumstances in which a gain on sale of a share will be taxable.
That is, where the share was acquired for the purpose of resale at a profit or where the taxpayer is in the business of buying and selling such assets.
It should be noted that special rules apply to financial arrangements (such as government stock and corporate bonds) and also to shares held in companies located outside New Zealand and the grey listed countries. In these latter situations the gain on such investments are generally subject to tax under the accruals or the foreign investment fund regime.
Let us look a little closer at the two circumstances where gains are taxable.
The first, where the share is acquired with the attention of resale at a profit, is clearly a factual matter.
The initial onus of proof is on the taxpayer. It is not necessary that the taxpayer have any particular intention at the time of acquisition.
The lack of intention would not result in a gain made on disposal being taxable. In the Court of Appeal decision in National Distributors a gain made on an investment which was held as a hedge against inflation was held to be taxable.
In that case, the judges held that they were not satisfied that the taxpayer could establish that the relevant shares were not acquired for the purpose of resale.
The recent tax ruling for TENZ clearly indicates that the IRD are willing to accept that purchases and sales for the purposes of matching an index would not be caught within the tax net.
The second circumstance, that is gains on sale of shares as part of a business of buying and selling such shares, is just as complicated.
When does the buying and selling of shares become a business? What is the impact of employing a full time investment manager? What if the manager acts outside of its delegated authority?
The Privy Council in Rangatira stated that the question whether a particular business consists of or includes the buying and selling of shares for profit is as much a business as a legal question.
The answer depends entirely on the evidence produced as to the nature of the business activity. In the Australian case of Radnor, the court stated "ultimately the question whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression."
As a question of fact these issues should be determined by the lower courts and not disturbed by subsequent courts.
So where does this leave the trustees of superannuation schemes?
It is essential that trustees and their advisers review the facts in their scheme and come to a conclusion on whether a business of buying and selling shares exists.
If they determine, based on their interpretation of the facts, that a business does exist then they will need to treat the profit on sale of such shares as taxable. If they determine that a business does not exist they should prepare their tax return on this assumption. They cannot be certain that a court would agree with their conclusion unless the IRD issue assessments and they pursue an objection to the Court.
Even if they conclude that a business does not exist, it is still necessary for the trustees to determine if any particular parcel of shares had been purchased with the intention of resale at a profit and if the answer is yes, then again, the profit on sale of such parcel will be taxable.
If the answer is no to both these questions then in the majority of situations the gain will not be taxable.
The fact that a scheme carries on a business of dealing in shares or has acquired shares for the intention of resale at a profit, does not necessarily mean that the gain on all shares sold will be taxable. Based on case law it is possible to have a separate parcel of shares held, as a long term investment, where the gain on sale would be tax-free.
It is interesting to note the following observation made by the Privy Council in Rangatira. "It may well be that in the case of individuals or trustees the holding of investments will very rarely amount to the carrying on of a business."
Whilst this statement in itself had no bearing on the ultimate decision in that case it seems clear that the Privy Council were trying to give some direction.
There is little doubt, and some evidence, that the IRD are intending to take further cases to court with a view to establishing some certainty on the issue. Unfortunately, each case will be based upon its own facts.
Accordingly it is difficult to see how we can ever obtain clarity.
The other alternative is legislative reform and this has been intimated in the recent Todd Report.
Any legislative reform needs to cover all taxpayers, not just superannuation schemes and in view of this, it is likely to be in the 'too hard' basket in the current political environment.
In the words of the Todd task force, "We do not see any easy solutions to the remaining distortions in the (tax) system. … we think it unlikely that significant further progress towards a truly neutral tax system is likely to be made without further major adjustments to tax rates or the tax base."
In the meantime confusion will continue.
Declan Mordaunt is a financial services tax partner with Price Waterhouse.
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