CGT Federal Budget chaos: The tax change that could reshape your portfolio

Australian share investors could face one of the most impactful Federal Budgets in years, with looming changes to capital gains tax expected to reshape portfolios in unexpected ways.

The 50 per cent capital gains tax discount, in place for almost three decades, is expected to be replaced in Tuesday night’s Budget by an indexation system that adjusts taxable gains for inflation.

About 7.7 million Australians hold on-exchange investments, making the proposed changes far more than a niche concern.

Australian Shareholders Association chief executive Rachel Waterhouse said the reform should not disadvantage younger Australians using shares and exchange-traded funds to build wealth or long-term investors who have planned around existing rules.

“Any reform should be prospective, simple, properly consulted on and fair across life stages,” Ms Waterhouse said.

“Existing investments and accrued gains should be protected.”

Under the current system, an investor who sells an asset held for more than 12 months is generally taxed on only half the capital gain.

Moving back to indexation would change the calculation and could increase the taxable amount for many long-term investors, particularly where returns have significantly outpaced inflation.

ASA modelled the impact of a $20,000 share investment earning 8 per cent a year over 10 years. The investment would grow to about $43,178, producing a capital gain of $23,178.

Under the current 50 per cent CGT discount, $11,589 would be included in taxable income. If the discount were cut to 25 per cent, the taxable amount would rise to $17,384. If the discount were removed entirely, the full $23,178 would be taxable.

Under an indexation model, assuming inflation of 3 per cent a year, the taxable gain would be about $16,300.

The final tax bill would depend on the investor’s marginal tax rate, but ASA said the example showed how a change to CGT rules could materially lift the tax burden when investors sell.

That change could also alter how investors think about their portfolio.

UBS strategists Richard Schellbach and Lily Huang said Budgets usually had limited impact on equities but this one could be different, altering incentives and shifting flows across the share market.

UBS said changes to negative gearing could make shares more competitive against property by reducing one of the tax advantages that has helped support Australia’s long housing boom.

From that perspective, limiting negative gearing could “level the playing field” between property and other asset classes, including equities.

UBS said replacing the 50 per cent discount with inflation indexation would make investments driven mainly by capital gains less attractive. That could hurt high-growth stocks (see table below) where investors are often paying for future earnings rather than current income.

The relative winners may be income stocks, including companies with steadier dividend streams.

Ms Waterhouse urged shareholders not to make rushed decisions based on speculation and headlines.

“They should wait for the final details, including commencement dates, grandfathering, treatment of existing holdings and treatment of accrued gains.”

She said tax should not be the only reason to buy or sell an investment.

“Selling may crystallise a gain, reduce income, affect diversification and create costs,” she said.

The property market remains central to the debate. Since 1999, home prices have risen far faster than wages, while the median home price has climbed from 4.4 times median income in 2001 to 8.6 times.

If negative gearing changes cool investor demand for property, UBS said equities could look more attractive in relative terms.

But UBS warned the hit may not stop at property.

Similar policies weighed on listed real estate stocks before the 2019 Federal election, and any renewed pressure on house prices could add another headwind to a sector UBS already views negatively.

And if the changes did weaken property prices, UBS said it would worry how homeowners experiencing their property price fall would translate to domestic consumer-facing companies.

Ms Waterhouse said the key test was whether reform was fair across assets and investor types.

“A well-designed system should support diversification, so investors are not pushed toward or away from particular asset classes because of tax settings alone,” she said.