The concept of capital gains, and losses
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The Throne speech delivered last week to Bermuda Islanders was chock full of plans in new financial strategies for protections for unemployed and seniors, prospective new homeowners, a more competitive banking industry, new capital taxation, calls for unity and more.
The capital gains taxation paragraph states, “to achieve greater equity by reducing taxes for those at the bottom of the pyramid while extending taxes for those with significant capital income or assets”.
Let’s focus on the term “capital income,” that to Moneywise encompasses a very broad range of taxable items.
Ordinary income is earned by salaries, wages, sale of products or services.
Capital income is generated from the use of capital assets, say rents, leases of large equipment, loans against such assets – interest generation and so on.
Capital assets (ownership) can increase or decrease in value, but are static until they are – as the Brits love to say, “rationalised” – into a realised actual gain. Show me the cash!
Literally, capital gains are the result of an actual sale of an asset for more than the original purchase price.
Bermuda, currently, has little “capital income/asset” legalese, so Moneywise will use United States tax policy on capital gains (losses). UK and Canada have similar tax legislation just as complex as their North Atlantic neighbour.
The generic term gain is divided into two components:
• Realised gains result exactly as stated – upon the sale of an asset at a profit.
• Unrealised gains are also as exactly stated. These are merely statements on a piece of paper, or seen trailing across a stock exchange ticker tape. Unrealised gains cannot be taxed because no effective tax transaction has taken place to either effect a gain (or a loss). Further, unrealised gains(losses) can change value in a nano-second completely removing the ability to assess tax on such a moving target.
Gains for taxation purposes are divided into short-term and long-term gains.
• Short-term gains are defined as less than one year, are treated as ordinary income under US tax regulations, assessed at a higher tax rate that is triggered by the individual or business’ other income and are a nightmare for day-traders due to the amount, trading frequencies and tax reporting.
• Long-term gains are assets held/owned for more than a year and are taxed at a lower rate.
The dividing line between short and long-term gains is a very significant determinant of the kind of tax, and the amount of tax.
CATEGORISATION. In the United States and other international investment markets, the assets below can all trigger certain types of gains upon sale. The challenge for any revenue collection authority staff is to determine the category(s) to be taxed based upon the jurisdiction’s federal governmental current tax legislation. To blur the reality even more, US states tax differently, the same in Canadian provinces and so on.
Categorisation is the easier part.
THE PROCESS. How each individual, corporation, trust, foundation, partnership, and non-profit (yes, they are taxed, too, on moneymaking propositions) will be tax assessed in a timely, cost-effective, efficient process is an incredibly challenging situation – needing expertise, experience, algorithm modelling, and subjective judgment.
Thus, building a structure to be able to monitor, calculate and assess tax on just these two factors alone demands precision, knowledge of security bases, access to personal and business information, and detailing to assess a tax on a timely basis.
Plus, a defined tax court is absolutely necessary for prosecutable actions.
PROCURING THE EVIDENCE. Almost all capital market investment transactions have fully automated tax reporting to US IRS and investment asset holders. Real property sales have similar requirements.
Domestically, what kinds of investment assets may be subject to taxation?
3. Mutual funds, owned individually and in retirement pensions
4. Commercial paper and money market mutual funds
5. Exchange Traded Funds
6. Structured notes
7. Options – index options at a percentage of capital gains; ordinary options taxes at short-term gain thresholds
10. Currency trading
11. Private placements
12. Private equity
13. ETNs, Forwards, other derivative-types have complex tax categories
14. Oil, and related industries partnerships owning capital assets. One annual tax report from just one investment (from tax practitioner experiences) alone was 15 pages long.
15. Notional principal(swaps) termination contracts
16. Life insurance cash value – may be taxable
17. Antiques, valuable art, cars and other type-collections
18. Real property: possible family home, investment property, etc
20. Business corporations, partnerships sales, etc.
Commentators to the Throne Speech speculated on whether the capital gains tax on foreign investments would allow for a credit on Bermuda-sourced investments. Moneywise can only state that the individual/other entity would have to disclose domestic investments in order to capitalise (pardon the pun) on any foreign tax credits.
Generally, United States situs intangible security investments held by foreign residents are not subject to capital gains taxation, while a withholding tax is assessed at source on dividends.
Tangible real property owned by foreigners is a different matter altogether. Legal/real estate/closing agents are required by US FIRPTA tax law to withhold (currently) 15 per cent of sales price, whether or not a profit was rationalised.
Biggest question for Bermuda
What does this new form of taxation mean: who will be taxed, where are the assets (domestic, and/or international) that will be subject to taxation held, how will taxation be reported and by whom, and on what investment assets would these taxes apply.
Stay tuned for more information on this topic.
Disclaimer caution: Taxation is incredibly complex. This is general information only, not tax advice, nor can it, or should it, be used or relied upon to make any personal or entity financial decisions. Moneywise is not your tax adviser. You must consult with experienced qualified international financial/legal professionals for advice on your personal financial situation.
Martha Harris Myron, CPA JSM, a native Bermudian, is creator of Pondstraddler Life™ Financial Perspectives www.pondstraddler.com, international financial consultant to the Olderhood Group Ltd Bermuda, and financial columnist (since 2000) to The Royal Gazette, Bermuda. All proceeds from these articles are donated by The Royal Gazette to the Salvation Army, Bermuda.