When David Murray said capital gains tax concessions were a tax subsidy for the wealthy, he really threw the cat among the pigeons.
Speaking after the release of his Financial System Inquiry, he singled out tax breaks for housing, including capital gains tax concessions and negative gearing, saying this “tends to encourage leveraged and speculative investment”.
Since then other voices have also been calling for an examination of investment tax concessions, especially those that apply to superannuation, and investors have been bracing themselves for change.
But for all the talk about capital gains tax, it’s often poorly understood.
How it works
Capital gains tax was introduced by the Hawke/Keating government on 20 September 1985 and applies to all assets acquired on or after that date.
Notable exceptions are the family home and assets held in a super pension, which are exempt from capital gains tax.
Net capital gains must be included in your income tax return for the year in which they were made. You work this out by taking the money you made from selling an asset and subtracting your ‘cost base’. These assets include investments such as property and shares, but also goodwill of your sole trader business.
The cost base includes the price you paid plus any costs incurred in buying and selling such as brokerage or commission and other incidental costs.
Next, take away any capital losses including unused net capital losses brought forward from previous financial years. And finally, apply any discount factor you are eligible for.
Discounts apply
If you hold assets in your name for at least 12 months then any capital gain is discounted by 50 per cent. In other words, you only pay tax on half your profit. So someone on the top marginal tax rate of 47 per cent (including the Medicare levy) pays an effective tax rate of 23.5 per cent on capital gains. If assets are held inside super for more than 12 months the discount is 33.33 per cent before tax is payable at the superannuation rate of 15 per cent.
This results in an effective tax rate of 10 per cent (15 per cent of 66.66 per cent).
While super funds pay capital gains tax at concessional rates on the disposal of assets during the accumulation phase, all income is tax free in pension phase, including income from the sale of investments.
Death and taxes
Confusion over capital gains tax rules and how they are applied when someone dies is also widespread.
When a person dies their assets are distributed according to their will. If shares, property or other investments held outside super are sold and the proceeds distributed in cash to their beneficiaries, then normal capital gains tax rules apply. Realised capital gains must be included in the deceased’s final tax return and tax paid at their marginal rate.
The family home remains tax free provided it is sold within two years.
However, assets such as shares or property can be transferred into the name of a beneficiary with the original cost base intact and capital gains tax deferred until they sell the assets. The one exception is assets purchased before September 1985 where the cost base becomes the market value at the time of death.
Things get more complicated if the assets are held inside a super fund, especially where the fund is in pension phase. A surviving spouse may not be liable for capital gains tax if there is a reversionary pension in place, but this is a complex area and investors should seek professional advice.
For the time being at least, the government shows no sign of acting on Murray’s advice and investors show no sign of deserting the property market. As Sir Humphrey Appleby might say, it would be a brave move by any government to remove capital gains tax concessions for investments inside or outside super.
References
i “Financial System Inquiry: David Murray calls for scrutiny of housing, super tax breaks” by Nassim Khadem, AFR, 7 Dec 2014,
http://www.afr.com/p/business/financial_services/financial_system_inquiry_david_murray_5dHl40DhOh6TgI63mtl3IO
ii Taxpayers Australia, http://www.taxpayer.com.au/KnowledgeBase/10080/Individuals-Tax-Super/Capital_gains