Never mind negative gearing. Australians pushed $67b through this tax vehicle
Capital gains benefit spikes to $22.7b as property investors sell out
Treasury is forecasting a spike in people claiming investment tax breaks this financial year as experts said higher interest rates and more onerous costs on landlords imposed by some state governments were pushing investors to offload properties.
The department’s latest tax expenditure statement estimates forgone taxes from the capital gains tax discount will hit $22.7 billion in 2024-25, up from $9.2 billion four years earlier. The figure for this year is more than double the Treasury forecast published in February last year.
In 2021-22, the most recent granular data available, the 50 per cent capital gains tax discount overwhelmingly benefited the country’s highest earners. About 300,000 people in the top decile of income earners accrued 80 per cent of the benefit in that year. This cohort also pays the most tax and therefore has more to gain from the concession.
Treasurer Jim Chalmers on Tuesday emphasised the statement – an annual exercise in which Treasury compiles the budget value of various tax concessions and exemptions – should not be regarded as a sign the government was about to target any of these concessions.
In September, it emerged that Labor, under pressure from voters about the housing affordability crisis, had asked Treasury to model potential changes to tax breaks paid to property investors, including negative gearing and the capital gains tax discount.
But Dr Chalmers on Tuesday said he was primarily focused on ensuring multinationals and people with high balance superannuation funds pay more tax.
“It is an important piece of analysis, not a statement of policy intent,” he said of the tax expenditure statement. “You already know that we’ve got a substantial agenda when it comes to tax reform.”
Capital gains have been discounted in some form since then-treasurer Paul Keating introduced the tax in 1985 to ensure people did not pay tax on increases in asset values caused by inflation. But the discount is also controversial, with many economists saying the 50 per cent reduction introduced by Peter Costello overcompensated investors for rising prices.
Investors who own an asset for more than 12 months only pay tax on half the capital gain after selling it, with the tax levied at their marginal income rate. For example, a person who makes $500,000 on an investment property will only have to pay tax on $250,000 of the windfall if they have held it for more than a year.
KPMG chief economist Brendan Rynne said the CGT claims spike reflected increases in asset values and the volumes of properties being sold. He said sales were being driven by a range of factors including growth in interest costs far outpacing growth in rental income, as well as increased state-levied taxes.
The cost of holding investments “has become disproportionately higher than during the pandemic,” he said.
The Victorian government in 2023 hit property investors with $4.7 billion in new taxes over four years. The changes cut the tax-free threshold for land tax from $300,000 to $50,000 and imposed new yearly flat fees and lifted the rate of tax payable on properties over $300,000 by 0.1 percentage point.
In June 2024, the NSW government revealed a $1.5 billion increase in land taxes on landlords, holiday homes and businesses.
The latest Treasury forecasts predict $23 billion more in lost tax revenue from the capital gains discount between 2023-24 and 2025-26 than the forecasts released in February 2023. The difference is $12.4 billion this year alone.
Tax concessions on superannuation earnings will cost the budget about $22 billion this financial year, up from $13 billion four years ago. It is forecast to be the fastest-growing source of lost revenue over the next four years, hitting $26 billion by 2027-28 with an annual growth of 13 per cent.
The annual cost to the budget of negative gearing will also rise sharply in coming years after slumping during the pandemic when the Reserve Bank of Australia cut the official interest rate to a record low 0.1 per cent.
After keeping the cash rate on hold at 1.5 per cent for a record 30 meetings between September 2016 and May 2019, the RBA began cutting rates in June that year, taking it to 0.25 per cent by May 2020. It then cut the rate again in November 2020 to a record low 0.1 per cent.
As lower interest rates filtered through to property investors, the amount they could claim on interest deductions also fell. Tax benefits from rental losses cost about $3.6 billion in 2019-20, according to Treasury, and then fell to $2.7 billion in 2020-21 and $2.2 billion in 2021-22.
But next year’s statement will show a sharp reversal, which will reflect the RBA’s push to lift the official interest rate from 0.1 per cent to 4.35 per cent.
The revenue lost to rental deductions, which includes expenses such as strata, council rates and interest costs for both positively and negatively geared properties, is forecast to rise from $26.5 billion this year to $32 billion in 2027-28.
Figures from the Australian Tax Office show the proportion of taxpayers declaring rental income has been falling gradually since 2017, hitting a 12-year low of 19.4 per cent in 2022.
The absolute number of property investors is also declining, dropping to 2.29 million in 2021-22 from a peak of 2.39 million in 2019-20.
Experts said the decline in property investors partly reflected tougher lending rules imposed by the Australian Prudential Regulation Authority.
With the housing market looking overly frothy, APRA told banks in December 2014 to keep growth in loans to property investors below 10 per cent a year. Property price growth soon recovered, and the regulator followed up with a new edict in March 2017, forcing banks to make sure that interest-only loans were no more than 30 per cent of all new loans issued.
While the rules have been lifted, lending standards remain far tighter than was the case before 2014, making it much harder for investors to significantly leverage into the market.
ATO warnings will send shivers down the spines of private companies
The ATO has released its first two taxpayer alerts for the 2024 calendar year. Each of them is a warning in its own different way to private groups.
Mark MolesworthTax adviserEvery generation must find out for itself that the stove is hot. Recent Australian Tax Office (ATO) guidance indicates some wealthy individuals and the groups of entities they control are in the process of finding that out all over again.
The ATO has released its first two taxpayer alerts for the 2024 calendar year. Each of them is a warning in its own different way to private groups.
The first relates to tax incentives for investing in early-stage companies which was an initiative of the Turnbull government’s innovation agenda.
The offsets can reduce individuals’ tax bills by up to 20 per cent of the amount invested in eligible early-stage innovation companies. The offset is subject to caps of $10,000 per year for “unsophisticated” investors or $200,000 per year for “sophisticated” investors.
What concerns the ATO is taxpayers using circular financing arrangements to access the offsets – and that some in the community are promoting these arrangements to investors.
Under the arrangement described in the taxpayer alert, the investor borrows the vast majority of their investment amount from an entity related to the promoter of the scheme.
LAlmost all of this is then returned to the lender (after a fee has been subtracted by the promoter). Unsurprisingly, the ATO considers that the circular financing arrangement is only entered for the purpose of obtaining the offset, and the offset is therefore not available.
If this all sounds hauntingly familiar, it is because such financing arrangements were a key part of many of the late 1990s and early 2000s mass marketed tax schemes. These involved tree plantations, emu farms and vineyards, among other “investments”, and led to the failure of Great Southern Group and Timbercorp. They also caused a lot of tax pain for investors caught up in them.
While those older schemes proliferated and were eventually the subject of widely applicable settlement processes, the ATO has learned its lessons and is flagging its concerns early.
The second taxpayer alert is concerned with private companies giving guarantees. In the arrangement the ATO is concerned about, a profitable company guarantees a loan taken out by another private company that is not profitable.
The unprofitable company then lends the funds borrowed to an individual or trust associated with the group. This potentially allows the stored wealth of the profitable company to be accessed by other related entities via a bank loan.
In the ATO’s view, the loan made by the unprofitable company under the arrangement can be deemed to be a dividend because it offends a particular provision in Division 7A.
This is the case even where the borrowing guaranteed is from an arm’s length bank or other financial institution. It also applies immediately upon the guarantee being given.
This conclusion is likely to come as a surprise to many private groups. The giving of guarantees by profitable companies to secure borrowings by other members of the group is common.
Further, where the loan that is the subject of a guarantee is directly made by the bank to the ultimate recipient individual or trust, there is a separate provision in Division 7A that deems a dividend to be paid only when the borrower defaults and the guarantee is called on.
There is no rational reason why having another company interposed in the lending chain should make a difference to the timing of the tax outcome, but that is what the law appears to require.
Apparently in acknowledgment of the shivers this approach will send through the spines of private groups, the ATO has issued a related draft tax determination that promises the law will only be strictly applied “to high-risk arrangements that display clearly artificial or contrived elements”.
The issue tax professionals have with this kind of approach is that whether an arrangement is “high risk” or demonstrates steps that are “clearly artificial or contrived” can be a matter of perception.
While it is helpful to know how the ATO is likely to interpret the law, it should not be the case that enforcement relies on divining whether a particular arrangement meets, or could be perceived as meeting, such indistinct criteria.
This is not to be critical of the ATO or the Commissioner of Taxation. He and his officers have to make do with the law as it is, rather than the law as it might be wished to be. It is much better that the ATO’s interpretation is plainly outlined and available for taxpayers to consider.
Private groups and their advisers are on notice – the ATO is concerned about artificial and contrived arrangements that attempt to circumvent tax laws. Experience says being in the ATO’s sights is not a pleasant experience.
Those who have participated in these types of activities should consider their options for making voluntary disclosures.
However, the social contract also requires the government should commit to reviews of important components of the tax system and timely implementation of recommendations from those reviews.
There appears to be little political appetite to properly reform the tax system on a holistic level, but that is not what is required here. Nor is it a case of minor tinkering being enough.
What is required is maintenance of important components of the tax system to ensure that they are internally consistent and not creating unintended consequences.
Otherwise, those taxpayers inappropriately captured by the provisions might rightfully complain about their burned hands.
