Be ready for capital gains change

Last week’s political turmoil has increased the likelihood of a change in government and major changes in taxation arrangements for investors. Significant possible changes are stopping cash refunds of franking credits for pension funds and low-income non-pensioner taxpayers, abolishing negative gearing tax refunds for future purchasers of existing properties and a 50 per cent increase in the capital gains tax liability when newly purchased assets are sold.

Negative gearing and investment in residential property is widely used as a savings strategy to reduce current income tax bills and receive preferentially taxed future capital gains. Capital gains is payable only when the asset is sold but at that time the gains accumulated over many years are subject to tax in one year. This wasn’t as important an issue in earlier years when only gains above the rate of inflation were subject to tax.

This reduces the amount of gains subject to tax in the one tax year helping to reduce the applicable tax rate. The current capital gains tax rules subject only 50 per cent of the gains on assets owned 12 months or more to tax and provide many investors with inflation protection.

Under the 50 per cent exemption, if the total gain is 4 per cent annually and inflation 2 per cent a year, only the real capital gain is subject to tax. If 75 per cent of the gain is taxable, only 1 per cent annually is exempt from tax meaning part of the gain required tomatch inflation is taxed.

If enacted into legislation, this change will add to pressures facing property markets. New investors won’t receive negative gearing tax benefits from purchasing existing properties and will face higher capital gains tax on the new rules. If they can’t be certain the gains required to match inflation will be tax-free, their incentive to make long term property and other investments will be reduced.

Even when negative gearing benefits are available on newly constructed property, the higher capital gains liabilities will still apply. The tougher tax arrangements for new property investors were developed when the property markets were much stronger than today. There’s always the possibility the proposals could be amended before the rules are changed but property investors need to be aware of the possibility of major change.

Similarly, low-income non-pensioner taxpayers and pension fund investors face the prospect of substantially lower returns from investing in franked, dividend shares. One option is to consider alternative investments including trusts where income is distributed without any company tax deducted. Now is the time to consider possible future action to minimise the adverse impact of proposed tax changes.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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