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I. The General Issue

23.7. A capital gains tax is essentially a tax upon gains from the realisation of property where the realisation is not an aspect of the carrying on of a business or the carrying out of a business deal. At present, subject to the Budget proposals, such gains are not taxed in Australia unless they come within sections 26 (a) or 26AAA of the Act (see paragraphs 23.73–23.74). Where such a gain is taxed it is taxed as ordinary income of the taxpayer. A capital gains tax seeks to tax gains that at present escape levy.

23.8. A tax on capital gains is levied today by a number of countries including Canada, France, West Germany, Japan, the Netherlands, the United Kingdom and the United States. In addition Ireland has recently announced its intention of introducing such a tax. Thus most countries comparable with Australia in terms of social background and economic development have the tax and, while this in itself is not a justification for its introduction in Australia, it is an indication that Australia is somewhat out of the mainstream of current thought and practice on this matter.

23.9. The general arguments for and against a capital gains tax can be set out succinctly by testing the tax by the three main criteria of equity, simplicity and efficiency employed in earlier chapters.

23.10. It is a tax which, in any administrable form, must be complex and difficult, and produce some anomalies and inequities of its own. There is no doubt whatever that any revenue it raises could be more cheaply and easily raised in other ways. By the criterion of simplicity it fails.

23.11. The arguments over its consequences for the efficient use of resources are somewhat less easy to assess. In a number of submissions received by the Committee its deleterious effect upon the investment of risk-capital is referred to. But the deterrent effect of a tax on realised gains would be matched by the encouraging effect of an allowance of losses in capital gains assessments, and the Committee doubts whether there is much substance in this argument. The converse argument has also been put that in the absence of a capital gains tax there will be excessive investment in assets which, though they yield relatively little taxable income, are especially likely to appreciate in capital value. There may be truth in this proposition. If so, it is possible that a capital gains tax might deflect investible funds from this area into areas where more risk has to be accepted. On balance, while recognising that a capital gains tax, by the complexity of the calculations it inevitably involves, must be troublesome to investors, the Committee believes that there is a case for it on efficiency grounds.

23.12. It is on grounds of equity that, in the Committee's view, the arguments for a capital gains tax may reasonably be held to be so strong as to overwhelm the admittedly strong case against it on grounds of simplicity.

23.13. The fundamental argument here is that in a taxation system in which ability to pay is a primary test of liability, capital gains, whether accrued or realised, constitute an increase in ability to pay in so much the same way as receipts of wages,


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salaries, interest, dividends and rents as to make it inequitable for them not to be brought to tax. Failure to tax them gives rise to inequity of both the kinds earlier distinguished:

  • (a) Horizontal inequity occurs because individuals in similar economic circumstances are treated unequally in that those who derive their accretions to market power in the form of non-taxable capital gains pay less tax than those deriving more conventional income.
  • (b) Vertical inequity occurs between individuals in dissimilar economic circumstances in that the failure to tax capital gains will usually favour those who are more well-to-do rather than those who are less, since the former own more capital per head than the latter and are more likely to make investments that realise capital gains.

23.14. Before the validity of this central proposition is examined, two points need to be made:

  • (a) The impracticability of taxing capital gains as they accrue is universally recognised: the tax can only attempt to deal with realised gains. Where these gains are in effect the receipts at one moment of several years of accrued gains, to tax them, under a progressive tax system, as if they were one year's income would be inequitable. This is the phenomenon of ‘bunching’ and its treatment requires special consideration.
  • (b) In inflationary conditions a part, and possibly a large part, of capital gains will be ‘purely monetary’ rather than ‘real’. Though this is a complication that to some extent also affects other categories of income, it is essential to make allowances for it in the taxation of capital gains.

23.15. While these points are, in the Committee's view, sufficient to make it wrong wholly to equate all realised gains with ordinary income, they are peripheral to the question of whether they should be regarded as income at all.

23.16. It is sometimes argued that their present non-taxation is anomalous primarily because many of them are virtually certain, as for example in the case of urban land and works of art. This, pushed to extremes, would not make a very satisfactory case. For if both buyers and sellers were equally well informed, the non-taxation of appreciation would already have been reflected in the relative current prices of the assets so that over time their future returns net of tax to their holders would be the same. Hence the introduction of a capital gains tax would principally create a crop of capital losses among holders of such assets as land, and a parallel crop of capital gains among owners of assets the main yield of which was in taxable income form. The substantive situation here is, however, that no market is ever ideally well informed and that, in relation to such assets as land and works of art, capital gains are mainly achieved by those buyers who have a better knowledge than sellers of market trends. Thus their gains are rightly judged akin to income because most are the fruit of skill and effort.

23.17. The corresponding case against taxing capital gains is sometimes made by suggesting that they are too uncertain, too irregular to be treated as income and should for that reason be left with the non-taxable status now accorded to ‘windfalls’. The temporal irregularity of some realised capital gains has already been conceded as a valid argument for special treatment in a progressive taxation system. But in the Committee's view the other considerations are not persuasive. Uncertainty attaches in greater or less degree to all income, and intermittent earnings are properly brought to


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tax at present. However, pure windfall gains and payment of compensation for physical injuries and injury to reputation should be exempt from taxation. This favourable treatment is in the former case due partly to public tolerance towards good luck but in the latter to the administrative difficulties in bringing the income element in such receipts within the income base.

23.18. The Committee does not believe that the purposes of a capital gains tax can be adequately served by any other taxes. The land taxes currently levied by all State governments do not seem to be adaptable: they only tax one of many vehicles for these gains and they tax the whole value of land and not changes in it. Estate duties impose a tax at only rare intervals and do not impinge on capital gains devoted to consumption during lifetime. A wealth tax would tax them but only incidentally; however, for reasons explained in Chapter 26, this tax is not recommended.

23.19. Hence the Committee concludes that the taxation of capital gains should be introduced in Australia at an appropriate time, and in the next section examines the main provisions new legislation should contain. It is not feasible to do more than set out a broad outline of the coverage and mode of a tax on capital gains that appears suitable for Australian conditions. In particular, certain matters such as the jurisdictional base of the tax and the treatment of lease transactions and part-disposals of assets are not considered here. The Committee has, in general, not attempted to deal with aspects of the tax beyond those covered in the preliminary report and the proposals announced by the Government.

23.20. Complex legislation would be required and much explanatory material would need to be prepared and circulated. The pamphlet giving general information about capital gains tax, issued in the United Kingdom by the Board of Inland Revenue, runs to 112 pages. In preparing the summary suggestions that follow, the Committee has studied with considerable interest the provisions relating to the similar tax introduced in the United Kingdom in 1965 and Canada in 1971.

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