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Share Disposal Gains – To tax or not to tax? That is the question
It is indeed strange times and somewhat hard to believe how different life was two years ago prior to Covid making itself known. We also have the uncertainty of 2022 now ahead of us, particularly as the Omicron variant knocks on our door and is already in the community and we’ll all being seeing red in the next few days as attempts are made to slow its spread.
One certainty among the present greyness that surrounds us however, is that if you have managed to find yourself with some spare cash and are wondering what to do with it to make it work for you, and provide any decent return, then there is not much point putting it in the bank, where term deposit rates are now sitting around 2%pa.
Some of you therefore may consider the share market and investing in shares and online portals such as ASB securities or apps like Sharesies, which have certainly made the process easy for the average Joe Bloggs.
As with any investment asset, it is important for the investor to fully understand the potential income tax implications attached to the asset, not only with respect to any returns generated by the asset during the lifetime it is held by them, but also upon its ultimate disposal.
With shares, the most common return to the investor would be a dividend payment, and I would suggest that you would struggle to find a single investor who would consider these amounts received were not income and therefore taxable.
The same could not be said when it comes to the disposal of the share, hopefully for some level of gain, but life’s never perfect. Unfortunately in this regard, there is for some, an ‘honest belief’, that because New Zealand does not presently have a capital gains tax, any gain made on the sale of an asset over and above its original purchase price, has no income tax implications for the investor – particularly where the investor is an individual, and they are not holding their share portfolio as part of any business activity they are presently carrying on.
My goal in preparing this article for you, is to provide some ‘food for thought’ as to how Inland Revenue is likely to view your disposal of a particular share, and what contribution if any, you should consider making to the Government’s revenues, if you have made a profit on the transaction.
A couple of boundary pegs to commence with – my sole focus is on the individual investor (so not investments made through companies or trusts, although most of the principles are identical for these ownership vehicles as well), and we’ll just stick with shares in New Zealand owned companies for now (as shares in foreign companies have their own set of rules, which you are more than welcome to contact me directly to talk about).
When it comes to asserting that a gain arising upon the disposal of a share should be taxable, Inland Revenue has three weapons within its armory, and I’ve included the legislative reference (to the Income Tax Act 2007) just for those of you who like that sort of stuff:
- You acquired the share with a purpose of disposing it (section CB 4);
- Your level of share-trading activity is suggestive of you actually carrying on a business of ‘dealing’ in shares (section CB 5); and,
- You derived the gain on the disposal of the share from carrying on or carrying out an undertaking or scheme entered into or devised for the purpose of making a profit (section CB 3).
As a final boundary peg, with the intended purpose that you’ll actually make it through to the end of my article, I am only going to focus on weapon number one, as arguably with two and three, most prudent investors would consider any returns from the investment are likely to be taxable and have factored this outcome into their buying/selling decisions.
It is the greyness that surrounds this first weapon, that some would say makes it the most difficult for Inland Revenue to apply, simply because the tax provision is focussed on what was the taxpayer’s subjective reason for buying the relevant share, as at the date they acquired it. I relay this suggestion with caution however, because as with the land tax rules which have their own intention and/or purpose of disposal provision, the onus to prove the subjective intention does not rest with Inland Revenue, but with the taxpayer themselves.
So while Inland Revenue can accept a position taken by you that a certain share was acquired to generate dividend income and perhaps some capital growth over time, if they can see (and they will always have the benefit of hindsight), that special circumstances exist in relation to a particular share, which makes it clear that the share was acquired with a purpose of resale, then they will expect you to pay tax on any disposal gain.
When it comes to having a ‘purpose of resale’, the critical date for you to appreciate, is the date that you are deemed to have acquired the shares – legislatively. This is the date a contract of purchase becomes binding. Also critical for you to understand, is that it is your subjective mind on this date and on no other date which is important.
So applying this principle in practice, when I click on the proceed button within the ASB Securities portal to execute a buy order for a particular parcel of shares, if I’m thinking I’m buying these shares in a pharmaceutical company because the rumour is that they are on the verge of developing a Covid vaccine, so I’ll be selling within nine months to cash-in on tripling my investment post release of the drug, then I have now triggered the taxing provision. It does not matter what happens next. If the drug fails and I end up holding the shares for five years instead, eventually selling for a modest gain on my original investment, that gain is still taxable.
Equally, however, if I had acquired those same shares just because I had a thing for pharmaceutical companies, investing in them long-term with no definitive plan to sell anytime soon, then they out-of-the-blue release a wonder drug which has the consequence that the share price skyrockets, and being the nervous investor I am, I cash-in on the unexpected windfall, then the same taxing provision should be of no application to me.
Clearly you can also have more than one ‘purpose’ on the date you acquire the shares. If this is the case, then it is the dominant purpose that will prevail from a taxing perspective. It has been accepted by the Court, the fact that the taxpayer did not expect to retain the property forever and actually contemplated the possibility of sale does not satisfy the purpose of resale provisions.
You should also be mindful that often as is the case with most things in life, actions will speak louder than words. Inland Revenue will always consider the nature of the share, your vocation (what you do in your day to day), the purchase circumstances (including connections with an existing investment), the number of similar transactions, the length of time the shares were held and the circumstances that ultimately led to the shares disposal. In this regard, it may be the totality of your circumstances which may negate the asserted purpose of the purchase by you.
Finally, when it comes to having any dispute with Inland Revenue, you must remember that their powers of information collection are extremely wide. Consequently, if you are aware that you have made statements to other parties as to your purchase intentions, which may have been recorded, then it is prudent not to try and hide your head in the sand and think that those statements will not be discovered – particularly if you are now taking a position which will be contradicted by those statements you made at the date of acquisition.
At this time, I will close the article, with hope that I have however, opened your eyes to the potential for Inland Revenue to want a piece of your disposal-gain-pie, in scenarios where historically you may have considered you had no exposure.
If in doubt, please feel free to reach out to me.