Imposing a capital gains tax on investment in New Zealand shares runs the risk of discouraging direct retail investment, damaging the nation’s capital markets.

It could also create an unlevel playing field between direct investment and investment through Portfolio Investment Entities or PIEs.

That’s the gist of a joint NZX and Securities Industry Association (SIA) submission to the Tax Working Group.

“We are concerned that extending capital income taxation to investments in New Zealand shares … has the capacity to discourage direct investment and damage our capital markets,” the two organisations say.

This could push retail investors away from buying shares directly to either investing through PIEs or “even away from the capital markets entirely.”

NZX data shows retail investors account for 26 percent of all trades by number and 13 percent by value, as well as 41 percent of price-setting trades by number and 23 percent by value.

As well, SIA member data shows they work with more than 300,000 New Zealand retail investors with total assets of more than $80 billion, including $40 billion held in custodial accounts.

“Without these investors, the secondary market would be in the hands of a relatively small number of fund managers, many of whom are passive investors,” the submission said.

“It is clear from the activity data above that this would result in significantly reduced on-market activity, price discovery and liquidity. In turn, this would affect the attractiveness of NZX’s market to offshore investors,” it said.

Concentrated ownership of competing companies can have adverse effects on competition in the markets where those companies compete, which would be negative for the economy as a whole.

“Capital raisings would also be affected: the combination of weakened secondary markets and the concentrated nature of the investor market would likely result in increased costs of capital for New Zealand companies.”

That would likely drive companies wanting to raise capital to grow to choose to list in Australia rather than at home and “perhaps even being encouraged to move head office or operations offshore.”

The submission says the floating of the state-owned electricity generators and retailers in 2013 and 2014 would have been more difficult without retail investors and that the government, investment funds and retail investors have all experienced “a very positive outcome from both capital appreciation and dividend income” as a result of those floats.

A capital gains tax (CGT) on direct retail investment in shares would encourage those investors to switch to alternative investments that aren’t so-taxed.

“For example, international shares would become relatively more attractive if their taxation did not change,” the submission said.

“More particularly, it appears from the Tax Working Group’s interim report that a different CGT treatment is contemplated” for Australasian shares held by investors directly compared to those held through PIEs, it said.

“It is mentioned in the report that, given the practical difficulties that arise in applying a CGT to PIEs, one option is for Australasian shares to remain CGT for PIEs,” it said.

More favourable tax treatment of PIEs would tend to discourage direct investment. The administration burden of a CGT would also tend to favour indirect investment through PIEs.

But it seems NZX and SIA aren’t certain their arguments against a CGT on retail investment in shares will fall on receptive ears.

“If the above is not accepted, we suggest that at the very least there should be a level playing field between owning New Zealand shares directly and owning them indirectly via PIEs,” their submission said.

“Without parity of treatment for direct and indirect investment, there is a risk that we see a return to the tax-driven structures and behaviours of yesteryear that, through sensible policy choices, have now largely disappeared.”

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