TAX REFORM OR TAX WARS!
As expected, the Treasurer announced a “Tax Heavy” Federal Budget last night including a raft of proposed tax changes that will impact all SME business owners and investors in one way or the other, but importantly none will apply immediately. The focus is clearly on reducing the tax benefits of investment income and capital gains and certain business structures, but unfortunately it hasn’t really addressed the tax burden of “workers”, rather it has sought to tax capital gains and investment income at rates closer to those paid by most workers.
Whether this is tax reform or creates a tax war between investors & business owners and salaried income earners will be played out during the consultation and debate to come? In short, the key changes are:
• From 1 July 2027, the transitional abolition of the CGT 50% discount in favour of the former CPI indexation methodology.
• From 1 July 2027, a 30% minimum tax rate on capital gains including taxing gains on pre-CGT assets.
• From 1 July 2027, a restriction of negative gearing deductions against other income unless the property is a new build or a property held before Budget night.
• From 1 July 2028, a minimum 30% tax on the income of discretionary trusts.
Although details are limited, given the timeframe until these measures are to apply, including an expected Federal Election in early 2028, there is plenty to consider before we can begin to plan for their introduction.
That said, we have outlined what was announced and our initial thoughts on their impact for you and your clients.
CHANGES TO THE CGT DISCOUNT
In one of the most anticipated changes to the CGT provisions, the Treasurer has taken many of us by surprise in abolishing the 50% CGT Discount from 1 July 2027 and taking us back to the pre 1999 system of CPI based indexation of the cost of an asset to determine its “real” gain, albeit with a minimum 30% CGT tax rate thrown in where the actual tax rate on the gain falls below this rate.
These changes will apply to ALL CGT assets (except “new builds” as below) acquired from 1 July 2027 and held by individuals, partnerships and trusts for at least 12 months. Super Funds will retain access to the 33.33% CGT Discount.
Whilst these changes take effect from 1 July 2027, they will be prospective in that gains accruing on existing investments prior to 1 July 2027 will still retain access to the 50% CGT discount. From 1 July 2027, the “value” of the CGT asset will then be indexed under the CPI indexation model to determine the actual net capital gain on disposal.
The determination of value as at 1 July 2027 can be via two alternative methods:
• seek a valuation of the asset as at 1 July 2027, or
• use a specified apportionment formula that estimates the asset’s value on 1 July 2027, based on its growth rate over the asset’s holding period. The ATO will provide tools to estimate this value for taxpayers.
An example from the Budget Papers that outlines this is:
Jane purchases an asset on 1 July 2022 for $800,000. She sells the asset on 1 July 2032 for $1,600,000 earning a 7.2 per cent annual return. Using ATO tools, Jane determines that the asset was worth $1,131,371 at commencement of the policy (1 July 2027).
Under the transitional rules, Jane calculates her taxable capital gain by adding:
• Taxable capital gains of $165,685 earned before commencement, which is equal to gross capital gains of $331,371 with the 50 per cent CGT discount; plus
• Taxable gains of $319,958 earned after commencement, which is equal to the gain of $468,629 less cost base indexation.
Her total taxable capital gain is $485,643. This is more than the $400,000 that would have been calculated if a 50 per cent discount applied to the gain overall. Assuming a 47 per cent tax rate, the tax on her gain is $228,252 (compared to $188,000 with a 50 per cent discount).
Surprisingly, these transitional measures will also include pre-CGT assets, exempting the unrealised pre-CGT gain as at 1 July 2027 but subjecting any increase in value of the pre-CGT asset, after CPI indexation from this date, to CGT.
A special exemption from these new rules has been proposed for “new builds” of residential properties that “genuinely add to supply”. This will include dwellings constructed on vacant land, or where existing properties are demolished and replaced with a greater number of dwellings.
These properties will remain able to access the 50% CGT Discount, or to choose CPI indexation, whichever is best.
Lastly, the Government will undertake consultation with early stage and start-up businesses given their unique features. This clearly flags issues of “sweat equity” where little or no capital cost is incurred to acquire an asset, rather effort and ideas, such that CPI indexation will not have any positive impact in increasing a CGT cost base, effectively ensuring these capital gains are taxed at full value with no cost base indexation for those incorporated after 1 July 2027.
The CGT 30% Minimum Tax Rate
The other surprising proposal was the minimum tax rate of 30% that will apply to “real” capital gains accruing from 1 July 2027. The Budget Papers state that the introduction of the minimum tax rate reduces the benefit of taxpayers deferring capital gains to years when their marginal tax rates are low.
Further detail on this minimum tax is not available at this point, including how it interacts with tax and capital losses or other tax credits and/or offsets.
The simple example in the Budget Papers states:
Jack has a taxable income before capital gains of $25,000 in 2029–30 and realises a capital gain of $10,000 on an asset that he purchased in 2027–28. Jack does not receive an income support payment so is not exempt from the minimum tax.
• The tax on Jack’s capital gain of $10,000 is $1,400, or a tax rate of 14 per cent (excluding the Medicare levy). As this is lower than 30 per cent, Jack pays an additional $1,600 in tax to bring the tax rate on his capital gain up to 30 per cent. Jack may have tax offsets available to reduce the minimum tax and would be exempt from the minimum tax if he received an income support payment in that year.
MKT Comment:
There is a huge amount to work through here, but with a 1 July 2027 start date, we may have to wait a number of months before any draft legislation is provided for consultation and debate.
We certainly didn’t see the complete abolition of the CGT Discount for all but Super Funds coming, but we are pleased that the transitional rules will quarantine pre-1 July 2027 capital gains. That said, the mechanism around setting that 1 July 2027 value rather than seeking an independent valuation will be vitally important, as will be the detail surrounding the calculation of the 30% minimum tax.
One thing that has definitely become clearer is that acquiring appreciating capital assets within companies from 1 July 2027 (and potentially earlier) is now becoming a serious consideration given the removal of the 50% CGT discount AND the 30% minimum tax on capital gains.
The Coalition has already announced that they will not support any of these changes, so we would recommend a wait and see approach until further detail is announced and debated.
If you would like to discuss any of these proposed Budget Changes please contact our MKT Federal Budget team of Ross Prosper, Mimi Ngo, Chris Schoeman or Sean Pearce.