Capital Gains Tax

Capital gains tax will be a major topic as we race to the next federal election. Treasurer Josh Frydenberg was on the attack last week, pointing out that if Labor’s capital gains tax (CGT) proposals become law, Australians will be paying CGT at one of the highest rates in the Western world.

Our top marginal income tax rate is 47%, including Medicare. This means a top-rate taxpayer now pays 23.25% CGT when the 50% discount for holding an asset for more than 12 months is applied.

Labor intends to raise the top marginal rate to 49% by reinstating the 2% Budget Repair Levy. And to reduce the 50% CGT discount to 25%.

If Labor succeeds in making both these changes, a top-rate taxpayer will suddenly find themselves paying CGT of 36.75% – an increase of almost 58%.

Labor reckons the tax hike is necessary to bring the budget back into surplus, and they are projecting a saving to the bottom line of around $12 .6 billion over 10 years. But, like many of Labor’s costings, this one seems rather optimistic. Just do the sums.

For starters, they are promising the increased rate of CGT will apply only to assets acquired after the changes become law. If they do get elected in May, it’s almost certain that the legislation will not be enacted until mid-2020. Therefore, it should only affect assets purchased after that date. Next, the discount applies only to assets held for over a year. So no assets would be affected by the proposals for at least three years from today.

Now think about the type of people who buy investment property, which is where the CGT rate is most important. Most are suspicious of superannuation, regard shares as a bit of a punt, and try to secure their long-term future by putting together a stable of investment properties so they can live off the rents when they retire. It’s highly unlikely that they will be cashing them in any time soon.

There has been a lot of speculation about what Labor’s proposed CGT changes would do to the economy in general, and the housing market in particular. There is no obvious answer. Given that Labor has promised the tax status of existing assets will be unaffected, there would be no reason to sell assets now and incur unnecessary CGT. Human nature being what it is, I reckon there will be a rush of buying once it becomes certain that Labor’s tax increases will become law. This may create a minor boom as everybody who can buy an investment property jumps in before the negative gearing rules change and the effective rate of capital gains tax is up.

Certainly, if the rules do change, investors will be reluctant to sell assets purchased after the rule change because the cost of doing so would be much higher. In any event, I have long believed that tax is just one of many factors that influence investment decisions. If you can make a great profit now, and you believe the asset has peaked, it still makes perfect sense to reap the rewards immediately and pay whatever tax is due.

One thing is certain – any changes to CGT will be beneficial to shares. Property and shares are the two major investment assets, but shares have one unique asset – the ability to sell in part. Think of two retirees – one has $1 million in shares, the other has $1 million in two investment properties. The share investor can sell assets at a slow rate as funds are needed, keeping themselves under the tax-free threshold, and will almost certainly pay no CGT. It’s a different matter for the hapless property investor – they can’t sell the back bedroom, so the only way they can release money to live on will be to sell one of the properties and pay a big chunk of CGT.