Capital gains tax is a key discussion point in Australia at the moment. It would be fair to say this is largely due to our current debt position and one could also argue, our inability to bring down inflation. Should inflation continue to increase under current Treasurer Jim Chalmers, the Reserve Bank will likely need to hike interest rates, therefore resulting in an increase in the amount of interest we as a country pay on said debt. A slight detour from the original starting point but as debt increases, our politicians in Canberra naturally look for ways to bring in more revenue and higher taxes generally follow suit.
Backtracking for a second, capital gains tax, or CGT as it is more commonly known, was introduced by Bob Hawke and the ALP back in 1985. Hawke’s Treasurer at the time was one Paul Keating who would go on to become the Prime Minister a few years later. Their policy at the time was to tax realized capital gains from investments such as property and tax – just like tax is applied to income (Eg. Salary and wages). In simple, should an asset acquired after 20 September 1985 (the date the policy was implemented) be sold for a profit, the profit would be taxed at an individual’s marginal tax rate. Let’s use an example to explain – should an asset be purchased for $100,000 and sold for $500,000, the capital gain of $400,000 would be taxable. Any assets acquired prior to 20 September 1985 were exempt as to ensure no investors were worse off – a key discussion point to circle back to later on.
In 1999, John Howard and the Liberal Party introduced some key changes to the CGT rules. The key one was to implement a 50% discount for individuals and Trusts, and a 33.33% discount for superannuation funds. Interestingly companies did not receive a discount, something which we will again circle back to later on. The only rule to access this discount was that the asset had to be held for 12 months or longer. Using the example above, this meant the capital gain of $400,000 would actually be reduced to $200,000 once the 50% discount was applied. Assuming the investor in that scenario was on the top marginal tax rate of 47% (45% plus the 2% Medicare levy), the tax saving as a result of the change would be $94,000. Thank you Mr Howard!
While people trying to grow their wealth were still keen to invest prior to the implementation of the discount, this naturally provided a greater opportunity to build wealth due to the lower level of taxation on capital gains. While the discount is naturally applied to all forms of investments, including shares and investment properties, Australian’s love of property is one which we are going to focus on here. Investment properties naturally generate yield and our ability to negatively gear also meant investors could use tax losses associated with the property to offset other forms of income such as salary and wages. The end result here is an investment we love coupled with a “tax saving” and then a discount on the capital gain upon sale. While I am naturally trying to keep this simple, there is no doubt this drove a lot of investors into the property market.
Shifting topic slightly for a second, I am certainly one to feel this change then had a flow on effect and has ultimately led us to a point where the government is continually trying to interfere with our property market. Firstly negative gearing and the CGT discount provided incentives for investors to enter the market and fast forward to now, property prices have skyrocketed to a point where most of our capital cities are amongst the most unaffordable on the planet. In order to counter this, we now have a government trying to mess with this red hot market using incentives such as stamp duty discounts (state level) and the federal governments “first home guarantee scheme” that allows first home buyers to purchase with just a 5% deposit. Traditionally the aim has been to have a 20% deposit to avoid lenders mortgage insurance but this policy prevents this as the government essentially guarantees the 15% gap between 5% and 20%. I know I am jumping around a little bit here but it certainly feels like the governments along the way have created a bit of an issue by introducing a tax, tweaking it, watching property prices soar and then looked for ways to fix this without affecting values. I again should note that CGT applies to all assets not just properties but that is the key asset class being talked about when the notion of tweaking the tax has been raised.
So back to the current day and the potential to change this. Firstly the inept Liberal opposition of the past 2 terms has meant Anthony Albanese and the ALP currently enjoy a healthy margin in the current parliament – not a bad time to start talking about a major change, particularly when the CGT discount was a policy introduced by the Liberal party initially. While they haven’t publicly said anything about making a change as yet, the 2 key question we ponder are this:
- Will they reduce the discount to a lower amount, say 25%, or remove it altogether?
- Will they retrospectively apply this or only apply the change to asset purchased post the date any changes are implemented?
I think it would be very unpopular if they were to remove it altogether and then apply it retrospectively so I would be very surprised if that was the path they took but as mentioned, they do enjoy a very healthy margin in Canberra at the moment. Add to this, Jim Chalmers is copping a lot of heat for his spending being a key driver of higher inflation. Something needs to change to address this internally rather than just making bulk changes to the CGT rules I would think.
For starters any change would be marketed by the ALP as a way to tax the wealthier (traditionally Liberal) voters. Let’s not let the truth get in the way of a good story given stats show us that it is actually the middle class using negative gearing into property investments to help accumulate wealth more than it is the mega-wealthy. It is naturally easy to find a Liberal politician on a healthy salary with 5-10 investment properties however and market them as the key beneficiaries of the CGT discount! Either way, it wouldn’t be a difficult story to sell to an everyday Australian battling with the current cost of living crisis that we should tax people with investment properties more in order to either hold or reduce income taxes for low- and middle-income earners.
From a strategy perspective, removing the CGT discount would naturally impact on those who currently hold assets such as investment properties. This would only impact them if they were wanting to sell however. Without mass sales, which we could only suspect would drive down prices, this doesn’t actually go towards addressing the shortage of properties for first home buyers. Does the government really want to create a cooler property market, essentially making people feel like their wealth is being destroyed? Or do they just want to make future investment a little bit less than enticing than it is today?
A few things come to mind. Those who have the ability to hold assets don’t have to sell. In fact, they can pass these assets on to the next generation without any major implications and the taxable capital gains simply become their problem. Secondly, if the discount was to be reduced significantly or removed altogether, do structures such as companies become more appealing given all forms of tax are capped at 30%. It would be quite bizarre that these structures could become the most tax effective for some people when they were originally not eligible for the CGT discount in the first place.
All in all, my gut feeling is telling me there will be a change. If I have to make a bet, it is that the discount will be reduced down (let’s say to 25%) and applied retrospectively as well. This won’t deter people from investing and still make them feel like they are getting a little bit of a free kick, it just won’t be as much of a free kick as they were getting yesterday. While this will increase up the tax take over time, I still don’t feel this will help the first home buyers too much.
This does however increase up the benefit of structures such as companies in high income earning households. The need for these structures wouldn’t exist in low-medium income households but naturally every situation is different so seek advice if you are uncertain.
Something else to ponder which I started off with. If the governments of the past 30 odd years hadn’t tinkered with things so much and continually interfered with property markets, would we be having this conversation today? It appears they want more tax on capital gains but don’t want to impact the property market too much either. Some people may be willing to take a hit to the value of their property if in turn this provides a benefit to their kids – if this actually happens that is. All in all, I still think plenty of first home buyers are going to need help from the bank of mum and dad to stand a chance in the future…