What would you think if we told you that there is a special type of tax that people are always happy to pay? Would you think we had dropped the ball? You shouldn’t. Read on…
Capital gains tax is a special type of tax that you only pay when you sell an asset for more than you bought it for. So, capital gains tax is a tax that you only pay when you have made a profit from your investment. That’s why everybody should be happy when they find themselves with a capital gains tax bill. It is a lovely problem to have!
In strict terms, capital gains tax is payable whenever a capital gains tax event takes place. The standard capital gains tax events are when investment assets such as property or shares are sold. However, there are some less standard events, such as when an asset is given away or transferred in specie from one investment vehicle to another.
Capital gains are often taxed favourably. If an asset is owned by an individual or a family trust, and the investor holds the asset for more than 12 months, then 50% of any subsequent capital gains are not subject to capital gains tax. To give a simple example: if you spend $100,000 buying a parcel of shares on 1 January 2018, and sell that parcel of shares for $110,000 on 2 January 2019, the capital gain is $10,000. However, because you owned the investment for more than 12 months, only $5000 will be subject to capital gains tax.
The amount subject to capital gains tax is added to the investor’s other taxable income in the year in which the capital gains tax event occurs. This means that an investor can also time the disposal of an asset in a way that minimises tax. For example, if you know that an asset has a large unrealised capital gain, you might defer selling that asset to a financial year in which you do not have any other income. This will reduce the amount of tax payable.
Let’s return to the above example where you sell a parcel of shares such that $5000 is subject to capital gains tax. If your other income for that year is $80,000, then the $5000 will be added to this and you will pay tax on $85,000. This means that the marginal rate of tax that applies to the $5000 will be 32.5%. You will pay $1625 in tax.
However, if you do not have any other income for that year, then the $5000 of capital gains will be your only income. You do not pay tax on the first $19,000 of income each year, meaning that you will not pay any tax on the $5000 capital gain.
So you can see that deferring the realisation of a capital gain to a year in which your income is otherwise low can reduce the amount payable as capital gains tax.
Private companies do not receive the 50% capital gains discount even if they hold assets for more than 12 months. However, self-managed superannuation funds do receive a discount. In their case, the discount is 33.3% of the capital gain – once again, provided that the asset was owned for more than 12 months. Self-managed superannuation funds pay a flat tax 15% on all income. When the 33.3% discount is applied to this, the tax payable on a capital gain becomes 10%.
That said, if a self-managed super fund has commenced paying an income stream, then the fund will not pay tax on assets used to finance that income stream. This is the case regardless of when the asset was first purchased. That means that a self-managed super fund can completely negate capital gains tax by deferring the disposal of relevant assets until after the fund has commenced paying an income stream.
This is an example of the superior flexibility of capital gains. This flexibility is why many investors prefer to receive the bulk of their investment return as a capital gain. Frequently, less tax is paid on capital gains and would be paid on a similar amount of income return.
If you’d like to learn more about how you can invest in a tax advantaged way, please do not hesitate to contact us.