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Bunching and Spreading

23.35. Since capital gains will usually have accrued over a period of years, it is considered excessively harsh to tax the gain as if it were ordinary income by simply adding half the gain to the other income of the taxpayer in the year of receipt of the gain. With a progressive tax structure this would often mean that the taxpayer would move into a higher tax bracket and the gain be taxed at a higher rate than if it had been subject to tax as it accrued. There are several ways of mitigating such bunching. These include averaging the gain and reopening past assessments, spreading the gain over the period of ownership, and spreading all gains over a fixed period. The Committee recommends that the third method be used and that all gains be spread over a fixed term of years, say five. It is recognised that the choice of an arbitrary period will be generous in the case of assets held for shorter periods and harsh in the case of assets held for longer periods. Nonetheless these inequities are outweighed by the advantages of a fixed period as far as ease of understanding and administration are concerned.

23.36. As an example of how spreading over a five-year period will work, consider three taxpayers A, B and C who earn taxable income (other than capital gains) of $25,000, $15,000 and $5,000 respectively. Assume that in the income year in question each taxpayer sells an asset at an actual gain of $40,000, thus producing a taxable gain of $20,000 (i.e. half the actual gain). Instead of simply adding this $20,000 to the taxpayer's other taxable income, it is divided by five and $4,000 is added to give taxable incomes of $29,000, $19,000 and $9,000 respectively. The additional tax attributable in each case to the addition of the $4,000 is then calculated and multiplied by five to give the total additional tax payable in respect of the capital gain. The results are summarised in Table 23.B on the basis of 1974–75 tax rates.




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TABLE 23.B: SPREADING OF CAPITAL GAINS

                     
Taxpayer A   Taxpayer B   Taxpayer C  
(1) Taxable income (before capital gain)  25,000  15,000  5,000 
(2) Tax payable on (1)  11,620  5,470  680 
(3) Taxable income plus one-fifth of taxable gain  29,000  19,000  9,000 
(4) Tax payable on (3)  14,180  7,820  2,300 
(5) Difference between (4) and (2)  2,560  2,350  1,670 
(6) Tax payable on taxable gain: 5 × (5)  12,800  11,750  8,100 
(7) Total tax payable: (2) + (6)  24,420  17,220  8,780 
(8) Rate of tax on gain: (6) as percentage of $40,000  32  29.4  20.3 
(9) Marginal tax rate on top bracket of income including taxable gain (per cent)  64  60  48 

23.37. By way of comparison, the tax payable by the three taxpayers if the whole $20,000 of taxable gain were treated as ordinary income is shown in Table 23.C. It can be seen, by comparing line 8 of Table 23.B with line 4 of Table 23.C, that spreading makes little difference to the tax liability of someone who already has a high taxable income; however, the difference is quite marked for anybody on a lower taxable income.

TABLE 23.C: NON-SPREADING OF CAPITAL GAINS

           
Taxpayer A   Taxpayer B   Taxpayer C  
(1) Taxable income (before capital gain)  25,000  15,000  5,000 
(2) Taxable income plus taxable gain  45,000  35,000  25,000 
(3) Tax payable on (2)  24,570  18,020  11,620 
(4) Rate of tax on gain (per cent)  32.4  31.6  27.4 

23.38. The Committee notes that the Budget proposals for a capital gains tax contain no reference to any form of spreading provisions. While such provisions involve a degree of administrative complexity, they are well justified. The differential effect of spreading provisions on high- and low-income earners in particular is to be noted: the absence of such provisions operates harshly in the case of low-income taxpayers who may realise one or perhaps two large capital gains during their lifetimes. Many taxpayers, especially those of fairly modest means, may not realise any capital gains during life but may have substantial accrued gains at death which will be brought to tax as notionally realised. The absence of spreading provisions is particularly harsh in these circumstances.

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