Capital gains snakes and ladders
This week Noel Whittaker shares his thoughts on the impact of changes to the tax treatment of capital gains.
Weeks have passed since budget night, and criticism continues to mount. Hardly a day goes by without someone uncovering another quirk buried deep in the Budget papers. Much of the proposed legislation is so vaguely drafted that even tax experts are waiting for further details before giving advice.
The government presents these measures as a solution to "intergenerational inequality" and a way to make housing more affordable for first-home buyers. In my view, there are only three ways to improve affordability: cut personal income tax, reduce interest rates, or allow house prices to fall. The first two are off the table. While softer prices may help buyers, they spell trouble for people already in the housing market, including young people who purchased with deposits as low as 5 per cent.
The Treasurer claims the billions of dollars of extra revenue raised by increasing taxes will fund an automatic $1,000 tax deduction for ordinary Australians. For a worker on average earnings, it's worth only $300. The government has also made much of the $250 Working Australians Tax Offset, but that is of no benefit to people who have no taxable income. Even taken together, these two measures are worth only about $11 a week to the average worker. That's a drop in the bucket when set against Budget estimates that show the major tax measures announced will raise about $77 billion over the forward estimates and beyond. Yet there is barely a mention of some of the most disadvantaged people in our society: single pensioners who rent and who are heavily penalised if they try to supplement their income through part-time work.
I am deeply concerned about the changes to the tax treatment of capital gains and their impact on everyday investors, after these were hastily passed through the parliament.
The government claims that replacing the 50% capital gains tax discount with indexation is simply a return to the Paul Keating model introduced in 1985. It fails to mention the original system also included averaging, which spread capital gains over several years for tax purposes and prevented taxpayers from being pushed into higher tax brackets by a one-off sale.
Consider John, who earns $125,000 a year and makes a net capital gain of $50,000. Under the Keating system, averaging would see the entire gain taxed at 30 per cent. Under the proposed model, most of the gain is taxed at 37 per cent because it pushes him into a higher tax bracket. That's not a return to the Keating model. It's a selective version that keeps the revenue-raising features and drops the taxpayer protections.
The government has even invented a new term: the "minimum tax gap". This is the amount of extra tax you must pay if the tax generated by your capital gain falls short of 30 per cent of the gain. To work it out, the legislation requires you to follow a seven-step process to calculate your minimum tax capital gain, followed by another seven-step process to calculate your minimum tax gap, if one exists. That's 14 steps before you know how much tax you owe. As far as shares are concerned, the complications are mind-boggling.
Case study: Ted and Mavis, both aged 75, have $700,000 in super and a parcel of shares owned by Ted, purchased five years ago for $60,000. They receive a part Age Pension. Ted dies on 30 June 2027 and leaves everything to Mavis. As a result, she loses her Age Pension because her assets exceed the relevant threshold. At Ted's death, the shares are worth $100,000. Two years later, Mavis sells them for $120,000 to help fund travel and home renovations, hoping that reducing her assets may help her regain at least part of the pension. She has no taxable income.
Under the old CGT rules, the capital gain would have been $60,000, reduced to $30,000 after the 50% discount, resulting in little or no tax. Under the proposed system, Mavis is deemed to have acquired the shares for $60,000 on 30 June 2027. That leaves a gain of $55,000 after allowing $5,000 for indexation. The tax bill would be $16,500. But here is the anomaly. If Mavis can reduce her assets enough to qualify for even a small Age Pension, the entire capital gain becomes tax-free. The difference between paying $16,500 and paying nothing may depend solely on whether she qualifies for a few dollars a fortnight of pension.
It's difficult to avoid the conclusion that these measures were rushed and poorly considered and drafted without proper thought for their real-world consequences. As more details emerge, the list of anomalies continues to grow. The question is whether the government is prepared to listen before the damage becomes permanent.
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