[Disclaimer: The information contained in this article is not professional legal or accounting advice and should not be relied upon in such a manner. This is a general interest article and for your own information you should seek professional advice from Australian licensed professionals.]
In Australia and throughout the world we are experiencing what the International Monetary Fund (IMF) describes as the ‘great recession’.[1] It is during these times that the catchphrase “the rich get richer and the poor get poorer” becomes most relevant for Australians because of the rapid drop in asset prices here and around the world. In light of this it is of utmost importance that Australian taxpayers have financial literacy, in particular how Australian taxation law affects their investment decisions concerning the most common assets such as property and shares.
The purpose of this paper is to prove that a simple working knowledge of financial literacy about capital gains taxation can help an Australian taxpayer protect their asset wealth during the ‘Global Financial Crisis’, when asset prices are rapidly falling. As this paper will prove, if we didn’t have the ability of carrying capital losses forward to offset future capital gains, society would be susceptible to greater economic inequity.
Financial literacy is a key component in how a person in society can improve their socio-economic status in society. This would be primarily concerned with reducing a person’s tax liability under the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). In regards to asset wealth, when asset prices are rapidly declining the concept of capital gains tax and net capital losses will be of focus.
The fictitious Australian taxpayer model will be conducted with the following assumptions:
- That the person is an Australian resident for tax purposes.[2]
- Their reaction to ‘Global Financial Crisis’ was slow and thus sold their assets on 1 January 2009.
- That derived income is ignored for the purposes of this paper.[3]
- That the taxpayer is asset holds assets that include a property (other than a main residence) bought on 1 July 2004 worth $400,000 and shares worth $40,000.
- That the taxpayer’s assets are worth $300,000 (property) and $10,000 (shares) as of 1 January 2009.
- That the taxpayer sells their assets on 1 January 2009 at a capital loss of $100,000 (property) and $30,000 (shares).
- That the taxpayer on the 1 July 2009 buys a property worth $250,000 and shares worth $5,000.
- That the taxpayer on 1 July 2012 sells the property for $400,000 and shares for $40,000.
Fictitious Australian Taxpayer Model
| CGT Asset |
|
$ |
| Property (Other than a main residence) |
Acquired 1 July 2004 |
$400,000 |
| Shares |
Acquired 1 July 2004 |
$40,000 |
| |
|
|
| CGT Event A1 (Disposal of a CGT Asset) |
| Property (Other than a main residence) |
Disposed on 1 January 2009 |
$300,000 |
| Shares |
Disposed on 1 January 2009 |
$10,000 |
| |
|
|
| Capital Proceeds |
|
$310,000 |
|
|
|
| Net Capital Loss |
|
|
| Property |
|
$100,000 |
| Shares |
|
$30,000 |
| Total |
|
$130,000 |
The hypothetical taxpayer after disposing of the assets on the 1 January 2009; incurs a net capital loss of $300,000 for the property and $30,000 on the shares. The hypothetical taxpayer is able to carry forward the net capital loss incurred to offset future capital gains incurred: ITAA 1997 s 102-10(2). The purpose of that exercise under the law is to not disadvantage the taxpayer because of the fall in value of their assets.
| CGT Asset |
|
$ |
| Property (Other than a main residence) |
Acquired 1 July 2009 |
$250,000 |
| Shares |
Acquired 1 July 2009 |
$5,000 |
| |
|
|
| CGT Event A1 (Disposal of a CGT Asset) |
| Property (Other than a main residence) |
Disposed on 1 January 2012 |
$400,000 |
| Shares |
Disposed on 1 January 2012 |
$40,000 |
| |
|
|
| Capital Proceeds |
|
$440,000 |
| Capital Gains |
|
$185,000 |
| Net Capital Loss (carried) |
|
$130,000 |
| Net Capital Gain |
|
$55,000 |
| 50% Discount (Asset held longer than 12 months) |
|
$27,500 |
| Net Tax Liability |
|
$27,500 |
What the model illustrates is what happens to the capital loss at a future date by offsetting the future capital gains. Whereas, if the operation of the capital gains sections were to not exist the taxpayer would incur not only the capital loss on the first sale of property and shares, but also incur the extra capital gains tax liability from the sale of the future property and shares. This would result in the taxpayer being disadvantages twice in their financial decisions.
The strengths of this model are that it proves that a simple operation of Australian taxation law is effective in preserving a taxpayer’s asset wealth, even when the taxpayer reacts slowly to a rapid decline in asset prices. Such is being experienced currently in Australia and the world in the ‘Global Financial Crisis’. The model illustrates the ‘Global Financial Crisis’ and what occurs to the reduced asset price.
In addition, the other strength of the model in helping people improve their socio-economic status is that it is not reliant on a taxpayer’s income but rather their ability to buy assets such as property or shares. Thus, a person on a low income over a period of years of saving disposable income and at a later date buys an asset, such as property of shares, can take advantage of the capital gains legislation.
However, the weaknesses of the model is that it assumes a taxpayer would have a working knowledge of the concept of capital gains tax and net capital losses under the Income Tax Assessment Act 1997 (Cth). This weakness most represents reality where a large proportion of Australian taxpayer’s use professional services to seek advice and complete their personal taxation forms. Either services cost financially and do not add to that taxpayer’s financial literacy.
This reinforces the argument that financial literacy is important for people in society, so to not lose their socio-economic status through unwise financial decisions. The Honourable Senator Nick Sherry in a keynote address to the National Consumer Congress in Adelaide on the 13 March 2009, highlighted the fact that financial literacy in far North Queensland and in remote areas of the Northern Territory were of an unacceptable standard and should be improved so as to protect their financial independence and secure their financial future. The senator noted that financial literacy was the key to helping people preserve their lifestyles and save them from financial stress, as many are experiencing now during the ‘Global Economic Crisis’.
Conclusion
The aforementioned analysis is only a small example of how a little financial literacy can benefit a taxpayer of any level of income and help minimise economic inequality in Australia. It also shows how the Income Tax Assessment Act (Cth) helps achieve this goal by allowing capital losses to be carried forward to offset future capital gains to reduce a taxpayer’s net tax liability.
The model’s reliance on financial literacy is the key argument of this paper and that society needs to be able to use the law to their best advantage. The Australian tax system has been designed to be progressive, so as to tax more aggressively those on higher incomes and less aggressively for those on low incomes. However, as the model illustrates, a person on a low income can be asset rich and be able to take advantage of the capital gains/losses to protect and grow their wealth, even if they were not experienced to sell earlier (the model illustrates what occurs when a taxpayer sells late).
It is in the best interest of Australians in terms of reducing the economic inequity in society to increase financial literacy, especially for taxpayers that may be making their first investments in assets such as property or shares. Even in times of great economic downturn it is important to protect taxpayer’s assets, as the Income Tax Assessment Act 1997 (Cth) achieves. A little knowledge goes a long way in reducing a person’s tax liability and Australia will go further when all members of society are able to take advantage of what the law allows.
[1] ‘
Tanner won’t speculate on debt limits’, The Age 11 March 2009
www.theage.com.au at 15 March 2009.
[2] Income Tax Assessment Act 1936 (Cth) s 6(1)
[3] Income Tax Assessment Act 1997 (Cth) s 6-5
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