Key points:
- The issue of negative gearing continues to get airplay in political discussions and media in the housing affordability & supply space, but by history remains unpopular and probable political suicide to implement.
- Although the ATO may have existing powers to push back on this and the tax arbitrage with CGT concessions, in practice this is difficult for them to do.
- An alternate approach with legislative changes not at odds with the tax and commercial landscape could be undertaken without causing political backlash.
- It’s a different discussion as to whether to retain or modify CGT discount concessions and capital allowances for buildings, with various options on the table.
The prospect of legislative reform on the issue most often referred to as negative gearing is quite remote heading into a Federal election, particularly following the ill-fated and perhaps too blunt Labor Party proposals in 2019. For clarity those proposals were to simply disallow negative gearing – i.e. the shortfall between rent and interest costs – and to also reduce the CGT discount from 50% to 25%.
Pitted as fundamental change against a key principle in tax law that one ought to be able to claim genuine interest costs incurred against taxable income received without carve out or nuance, it was perhaps doomed to fail. Bona fide long-term investors are unfairly treated and it perhaps affronted an electorate that has a long tradition of affection for acquiring property and “getting ahead”.
But the issue and the tension with CGT concessions will not go away amongst the press, politics and economists, particularly in the context of housing affordability and fairness. Interestingly, no party is proposing any changes to building write off deductions (Division 43 – capital allowances) which are so highly prized by property investors and certainly exacerbate the negative gearing “mischief”.
To be clear the perceived mischief is not “negative gearing” in its own right or “CGT concessions” alone, but rather the ability to claim negative gearing losses against other income, providing a tax saving of up to 47%, and then being taxed at half the normal rate on the gain that recovers that loss.
However, to simply remove negative gearing, puts those genuine investors who intend to hold long term and not avail themselves of this tax arbitrage at a material disadvantage. Some would say “I’ve got no intention of selling, so this is a permanent tax cost & impact for me.” Most of us would have sympathy for the view.
Might there be a better way to approach the issue? It’s something I have given a lot of thought to and written about over the years, but even I have moved from stridently rejecting any changes to accepting that the issue will not go away, and something will eventually be done.
The thing that sticks in my mind, are comments made at my request some 10 years ago at a tax conference, by a then QC who I consider to be one of Australia’s greatest tax minds. Not in any paper, I recall the comments as follows:
“I have been asked to talk about negative gearing. Frankly, I don’t see the point. I would however observe that if someone acquires an income producing property which year on year makes a shortfall, and the only way to recover that shortfall is sale for a gain, then that gain may be on revenue account”.
Stunned silence pervaded the room, yet nothing has emerged from that, despite that person’s opinion being one that you would be unwise to ignore.
The Proposition
That where a single negatively geared property carries a cumulative tax loss year on year, any gain made on sale will be:
- Taxed as ordinary income to the extent of the remaining unrecovered tax loss on that property, then
- Afforded the concessional CGT treatment (50% discount) on the balance of that gain.
Funnily the initial response from a range of property investors canvassed has been “that’s not unreasonable. If not particularly preferred”.
It has the advantage of not unreasonably penalising genuine property investors and matching deductions to cash costs in accordance with established tax principles. However, it moderates those who attempt to game the system to take advantage of the tax arbitrage between full deductions at up to 47% tax benefit and recovering gains taxed at half that.
Alternate ideas?
If we accept that restricting negative gearing deductions across the board is politically “difficult” and restricting those changes just to just property investments somewhat nonsensical, this raises the question as to what the ATO may viably do under current legislation to moderate abuse of the tax arbitrage.
There is a sleeping provision in Section 51AAA of the Income Tax Assessment Act 1936, the purpose of which is to deny full tax deductions in respect of making capital gains that arguably may be used to moderate some negative gearing claims.
The counter argument is that s51AAA was only intended to be an anti-overlap provision and that there is a well-established principle out of C of T v Janmor Nominees Pty Ltd [1987] FCA 317, that full deductions may be claimed.
My simple response to that is “read the section” and by the way Janmor Nomineees applies to a period prior to the introduction of CGT and the enactment of s51AAA!
The bigger issue is the impracticality of tracking and dealing with each property owners’ individual circumstances to apply this as there is certainly no one-size-fits-all and the ultimate “correct” result does not emerge until eventual sale of the property.
It is suggested that the Proposition above is far more practical and palatable to all.
How might the proposition above work in practice?
Arguably the Australian Taxation Office (ATO) could make a policy decision based on the view above to simply commence taxing as income the recovery of cumulative revenue losses on a property by property basis. I did not get the opportunity to question the indicated QC on the basis of his view, but am inclined to think that it simply falls out of the established cases – in particular the issues set out and summarised in FCT v The Myer Emporium Ltd [1987] ATC 4363 and Westfield Ltd v FCT [1991] ATC 4234.
Noting the apparent intention to make a gain on sale (who doesn’t acquire a property to later sell at a profit) combined with the commercial undertaking (but not perhaps a “business”) involved in heavily gearing and funding a property, it is not perhaps a stretch to get there.
The Australian Taxation Office (ATO) already has at its fingertips much of the detail of income and expenditure & capital allowances through the required data provided on leased properties in furnishing tax returns. It is not a great step to increase these information requirements as required and/or also place the onus on taxpayers to provide the calculation, with false statements carrying the obvious penalties if reviewed.
It is accepted however that valid arguments for this approach exists both ways and the ATO would need to commit to a strong and sustained policy approach, seeing it through to the Full Federal Court.
Legislative reform?
If the push from the Greens and independents continues for some form of reform on negative gearing the approach noted above may be a very good solution to placate those seeking more radical change and not perhaps cause political suicide.
Are we ready for that conversation? I invite your views and comments!
But what about the other issues being discussed?
- Whether we should retain or reduce the CGT discount concessions or (my preferred view) have them on a sliding scale over a longer period of time?
- The retention of generous capital allowances for buildings (building cost write-off) over 25 or 40 years?
I will leave those remaining elephants in the room for another article.
