12th April 2019

    Author: Carl Valentine

    With the Federal Election announced for May 18, the differing taxation policies of the Coalition and the Opposition are well and truly in the spotlight.

    The Opposition’s proposals to prospectively limit the taxation benefits available under negative gearing arrangements that have been recognised in our tax laws since 1922 (aside from a brief interlude between 1985 and 1987) are likely to impact more taxpayers than other changes proposed by the Opposition.

    Negative gearing refers to a situation where the income derived from a source is less than the expenses incurred in relation to deriving that income (in a technical sense the allowable deductions are greater than the associated assessable income).

    The loss that arises from that investment is then applied to reduce the other taxable income of the taxpayer and hence reduces their overall tax payable (investment losses are commonly applied against salary income to deliver tax benefits to individual taxpayers). Its also important to note that in most cases negatively geared investments are also cash flow negative and require cash derived from other sources to finance the negatively geared investment (negatively geared assets are generally cash flow hungry).

    Negative gearing is most commonly considered in connection with property investing, especially residential rental properties. It is also widely used in share investing and can be equally applicable in other investments.

    The Opposition is proposing that from 1 January 2020, negative gearing will only be permitted in respect to: 

    • New residential housing (with that term not yet defined for income tax purposes, but is defined for GST purposes – time will tell how this term is defined for these purposes); and
    • Investments made prior to that date (i.e., the changes will be “grandfathered” such that these changes will only be in respect of assets acquired from 1 January 2020).

    That is, from 1 January 2020 losses made on investments, other than those in new residential housing, cannot be applied to reduce the tax payable on a taxpayer’s other sources of income. It is not clear yet if those losses can be carried forward to reduce future tax payable on the asset or if they will form part of the cost base of the asset (or worse, give rise to no future tax benefit at all).

    This proposal inevitably brings additional complexity to our taxation system. There is a risk that this essentially quarantines passive income and losses (other than the specifically excluded new residential housing investments).

    While only time will tell how the Opposition’s proposed changes will be legislated, some areas that need clarification include:

    • Whether this change will apply only to individuals or if it will apply to other entities too.
    • It is not currently clear if investment losses generated that cannot be deducted under the proposed changes simply carry forward to be used against income from that asset (or other investment assets), if they form part of the cost base of the asset or, in the worst outcome, are simply disregarded and give rise to no future tax benefits.
    • There is also clear need for greater clarity as to whether the Opposition’s proposed changes will apply on an asset by asset basis or by taxpayer. That is, are the investment losses on say one property only available to be applied against future income from that property or will they apply at an entity level such that losses from one investment can be applied against the investment income derived from another asset by the same entity? The Tax Institute has discussed this with the Opposition, and it has been suggested the rules will apply at an entity level rather than at an asset level.
    • Where negative gearing is permitted into the future, the overall attractiveness of it will likely be reduced where the Opposition is also successful in reducing the CGT discount from 50% to 25% (that change, all other things being equal) reducing the after-tax returns generated on sale of an asset.
    • Subject to the above point, taxpayers may need to review how they hold investments to avoid a situation whereby one entity holds only negatively geared assets that generate losses and another holds positively geared assets that generate income. Similarly, how and to whom, discretionary trusts distribute investment income may also need to be reviewed if such income could not be reduced by other losses incurred by the beneficiary. Of course, tax is just one aspect of investment structuring and it would be unwise to make significant changes to holding structures until such time as full details on the proposed changes are available.
    • There could be cause to reconsider the tax profile of future investments from a revenue and capital perspective. If investment losses become quarantined and can’t be utilised a taxpayer may generate better after-tax returns from realising capital gains rather than revenue returns (this could be seen in practice by a preference to invest equity in projects rather than debt, however the proposed changes to the CGT discount might be a counterforce in this regard).
    • There will be a heightened need to accurately account for the deductions arising in connection with investment assets, particularly around the allocation of deductions where an expense wasn’t incurred directly in connection to a particular asset.
    • Traditional investment loans, like margin loans, may no longer generate the same level of tax benefits (especially when considered in combination with the proposed denial of the refund of surplus imputation credits). While less prevalent now than in the past, managed investment schemes that generated negative gearing based tax benefits for investors would likely be even less popular under the proposed changes.
    • The ongoing ability to negatively gear new residential housing investments will be welcomed by the property sector, however investors will need to keep in mind that when on-selling these properties those purchasers won’t then necessarily be able to benefit from any corresponding investment losses. This could impact the pricing for existing housing relative to new housing (that is, a market distortion could arise).
    • Unintended consequences could arise where businesses derive some of their income from renting or leasing activities (e.g., equipment hire businesses). An unintended consequence could include where a business owns its premises and has borrowed to buy those premises, but no rent is paid because the activities are all within the same entity (or uses part of the property in a business and partly for rental purposes). Subject to how any changes are implemented, there could be a situation where businesses are denied the ability to offset losses or claim deductions incurred from part of their business against the income generated by another part of their businesses. This would run counter to all well-established taxation principals and reverses a component of our tax laws first introduced back in 1922.

    It should also be kept in mind that the changes to negative gearing are but one of a suite of measures, including reducing the general CGT discount for individuals from 50% to 25% and the denial of refund for surplus imputation credits. If introduced collectively, the combination will have a more magnified impact on taxpayers than any one of these changes in isolation would have.

    PVW Partners will look at other tax policy proposals ahead of the May 18 election. 

    Please note: The Opposition’s taxation policy announcements are relatively low on detail and require legislative change for them to be implemented. The final form of any taxation changes will of course be dependent on the outcome of the May 2019 Federal Election and the composition of both the House of Representatives and the Senate. The above comments are general in nature and do not constitute financial advice in any form. You should consult with your specialist advisor for advice on these matters specific to your circumstances.


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