As I approach 50 years in the Tax industry, I reflect on the latest Federal Budget: small business, CGT, negative gearing, Tax Reform and unintended consequences.
I’ve had a number of conversations recently about the tax changes announced in the Federal Budget, particularly as they relate to small business, aspiring investors and entrepreneurs.
I completely understand the intent behind many of these measures. However, my analysis — and that of many others — is that they have not been properly thought through, especially in terms of their real‑world impact on small business.
I believe the Government has been poorly served by Treasury in how these measures have been framed. There seems to be an underlying mindset that tax reform must always create “winners and losers”. I use the term tax reform here in the pejorative sense — good reform should create winners without demonising people who have lawfully benefited from existing rules, which are often misunderstood.
I’m also concerned by the apparent desire to move quickly to enact these changes, simply because the numbers may be there, rather than taking the time to get the policy settings right.
A few big‑picture observations worth considering.
1. CGT reform and the small business reality
Most people operating in the small business space are capital poor but value rich. They often build businesses from scratch through effort and risk taking, not by purchasing assets with a cost base.
Under the proposed CGT changes, many small business owners will be subject to CGT on a sale of their business at their top marginal rate (up to 47%), often well above the proposed 30% minimum, simply because they have a zero or low cost base and the interaction of the top marginal tax rate applying from $190K. By contrast, large businesses operating through corporate structures often have a “purchased” or a high cost base and even when they don’t, can effectively cap CGT at 30%, the corporate tax rate.
If the policy goal is to level the playing field, this outcome appears to do the opposite.
2. Trusts, profit retention and reinvestment
Small businesses commonly operate through trusts and partnerships, which require all profits to be distributed each year, and are then subject to the personal tax rates. Unlike large corporates, they cannot retain profits in the business unless they use a “bucket company” which allows tax on profits to be capped at the corporate tax rate of 30%, the same rate available to large businesses.
The proposed trust tax changes effectively remove this levelling mechanism. Conceptually, if large businesses can retain profits after a 30% tax, why should small businesses be denied the same opportunity?
Additionally, under current law, “bucket company” funds cannot easily be reinvested back into the operating business to build its cost base because of Division 7A loan rules. Small business is already constrained — these proposals tighten the screws further.
3. The real issue is franking refunds — not bucket companies
The real structural issue with corporate tax is the refundability of franking credits, which places pressure on the tax base, not small businesses using bucket companies to manage cash flow and reinvestment.
Targeting bucket companies with an effective tax rate of over 50% misses the real issue and risks significant collateral damage to small business.
4. A more equitable approach to negative gearing
Negative gearing is often raised as part of the housing and tax equity debate, but again, the issue should be symmetry, not demonisation.
Currently, investors:
- receive immediate tax deductions for losses at their marginal tax rate (often 47%), and
- later pay CGT on the gain at a 50% discounted rate.
The inequity is clear. Losses are deducted at full rates, while gains are taxed at half rates.
A simple and fair reform would be this:
- Tax capital gains, up to the amount of prior negative gearing deductions, at the taxpayer’s marginal rate at the time of sale.
- Only the excess gain above those deductions would receive the 50% CGT discount.
This creates symmetry, could be applied across all asset classes and encourages risk taking by aspiring investors. The 50% CGT discount is a completely separate issue.
5. Preserve the CGT discount — but introduce lifetime caps
The debate around simply reducing or abolishing the 50% CGT discount overlooks an opportunity for more nuanced reform.
While the discount is generous, some allowance for inflation and long‑term risk is appropriate. A better approach would be:
- Lifetime caps on access to the 50% discount.
- This would support the aspirations of: small business owners, property investors (who are critical to rental supply), entrepreneurs and “mum and dad” investors. Gen X investors creating their entry into the housing market
- Very large capital gains beyond the cap to be taxed at: the corporate rate (30%) if structured through a company, or top marginal rates (45%+) if held personally.
This approach improves equity, targets very large gains, preserves incentives to invest and build, and is likely to be far more acceptable to aspirational Australians.
Final thought
Good tax reform should be careful, principled and proportionate. It should promote initiative, not punish it. There are better ways to improve equity and raise revenue without undermining small business confidence or aspiration.
This is a conversation worth having and I would encourage others to contribute. What do you think?
Mike
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