With just a couple of weeks until federal treasurer Jim Chalmers brings down his “reform” Budget, it is worth looking at some of the major proposed changes and how they might change the investment environment.
While we obviously don’t exactly know what is in the Budget until Dr Chalmers gets on his feet and reads it out in Parliament on May 12, there have been enough kites flown to have a rough idea of what changes have been proposed and what they might mean.
Perhaps the main change looks like being a less generous way of taxing capital gains on property as part of a way of getting better intergenerational equity in the tax system
There could be some specific limits around how many investment properties can be owned but the more general change looks set to be reduction in the current 50% discount on capital gains for assets held for more than a year.
In with the Old?
The strongest tip seems to be reverting to the original way of taxing capital gains on property under the Hawke and Keating governments, which uses the actual inflation rate over the time the asset is held—in other words, CGT would only apply to the “real” or post inflation gain in the asset price.
This method was ditched by the Howard/Costello government in 1999 in favour of the 50% discount, which was designed to simplify the tax and to attract more investment capital.
If the previous CGT system is restored, it would be expected to dampen demand for capital growth assets such as property and shares as a way of putting property prices back in the ballpark for younger buyers.
However, while only “real” gains would be taxed, that wouldn’t wipe out demand for assets such as shares and property because they would still provide a useful hedge against inflation over time.
Other alternatives that have been examined by Treasury include reducing the CGT discount to 33% or 25%.
Grandfathering or Not?
The key thing to watch for with this CGT change is whether existing investments will be shielded from the changes through a process known as grandfathering.
If existing investments remain under the old tax system that would reduce the likelihood of a rash of sales but would add further complications to an already complex CGT system and reduce the amount of extra revenue to the Government.
Allied to the CGT change might be some changes to the way the negative gearing rules apply to investment properties.
Negative gearing allows investors to reduce their overall tax rate by allowing investment losses to be used against other income.
Usually if loan interest on an investment property exceeds the rent, that “loss” can be used to offset earned income.
Negative Gearing + Generous CGT = Increased Demand
It is the combination of negative gearing with the CGT discount that many economists claim has crowded the market for lower priced homes and units—the very properties that lower income young buyers are interested in.
If this price boosting market crowding can be eased by discouraging investors, in theory more lower income young people will find it easier to get their foot on the first rung of the property ladder.
Treasury has been examining ways to do this by limiting the number of properties that can be negatively geared, potentially to a couple of homes per person.
Will the Gas Tax Finally Arrive?
Another area to watch out for on Budget night is whether the notoriously reform-shy Albanese Government bites the bullet and imposes extra taxes on oil and gas exports.
There have been some whispers that this reform will be a step too far at a time when Mr Albanese has been negotiating with Asian governments to keep fuel supplies flowing.
While the Petroleum Resource Rent Tax (PRRT) is meant to put a tax of up to 40% on gas exporters, in practice the amount of tax they are paying to the actual owners of the resources – the Australian public – is very much lower due to generous deductions for previous losses and investments.
Changes to the PRRT have been looked at, as have a 25% levy on all gas exports or a cash flow tax that would allow lower taxes at times when petroleum prices are low.
Family Trusts to Be Taxed?
Another potential change that has flown under the radar but would be highly controversial if introduced would be a tax on trusts.
Under the current system, the more than a million trusts in Australia don’t pay any tax directly but their distributions are taxable in the hands of the people getting the distribution.
While family trusts that control assets on behalf of beneficiaries are used for a number of reasons including estate planning, asset protection and philanthropy, they are also a popular vehicle for reducing personal taxation.
Among those those tax minimisation strategies is the popular process of income splitting.
In the case of a family in which one beneficiary is on a high income and the other three have much lower incomes, distributing trust returns to the lower income members greatly reduces the amount of tax paid compared to if it was all paid to the high-income earner.
Tax Minimisation Crackdown
The Australian Tax Office (ATO) has already been cracking down on these and other tax minimisation strategies that involve trusts but a change to introduce a tax of 25% or 30% on all trust distributions would greatly curtail the attractiveness of using trusts to minimise taxation.
A Treasury report by tax academic Miranda Stewart recommended imposing a minimum tax rate on trust distributions of 25% to 30% to line up closer to the company tax rate.
Given the highly volatile state of the world economy and share markets at the moment due to the Iran war, it will be very interesting to see how much bravery the notoriously conservative Albanese government is going to commit to and how the public reacts to the changes.
