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Most seasoned accountants will remember using the indexation method to calculate capital gain tax (CGT), back in the day.
Many of us were unhappy with the switch to the 50% discount method on 1 October 1999, believing that our clients would be worse off.
Now that we’re switching back to the indexation method we originally had, the same disgruntled sentiments are rising. Which may go to show, change is the real challenge.
Happily, we can use mathematics as a means to test the validity of those sentiments. So, we conducted an analysis to compare taxpayer outcomes when using the different systems for calculating CGT. Would our clients be better off or worse off? We also wanted to study the difference between an individual owning property versus a company owning it. For the purposes of this study, our model makes the following assumptions:
- We ignore the small business CGT discounts.
- The individual taxpayer is already in the top marginal tax bracket.
- If a company owns the property, an individual owns the shares in the company and receives the proceeds from the sale as a dividend, resulting in the individual paying tax at 47%. This allows us to compare individual and company ownership on an equivalent basis.
CGT calculations
Calculating CGT under the discount method is straightforward: work out the gain by subtracting the original cost from the selling price, then halve the result if the owner held the property for more than 12 months.
The indexation method is different, as the cost base of the property moves up or down with inflation. Under indexation, we calculate the gain by taking the selling price and subtracting the cost, adjusted for inflation.
CGT calculation method | Formula: Capital gain = |
Discount method | 50% x (Selling price - Original cost) |
Indexation method | Selling price - Original cost x CPI factor |
Each of the scenarios below shows the tax that individual A would pay over a 20-year period under both the indexed method and the discounting method. The last two columns show the amount of tax payable where an individual owns shares in a company which makes a capital gain, and pays that gain to the individual as a dividend, with the individual paying tax at 47%
Base scenario assumptions:
- The property is held for at least 12 months.
- The CPI factor = (1 + inflation rate %).
- For the indexation formula, where the selling price is less than the (original cost x CPI factor), no capital gains arise.
- Initial property cost in 2027: $1m
Property | New CGT method (indexed) | Old 50% CGT discount | Company CGT | |||||||
Year of | Property sale price | Property | Gain on | A's tax @ | Gain on | Less 50% | Taxable | A's tax @ | Gain for | Tax for A @ |
2028 | 1,030,000 | 1,030,000 | 0 | 0- | 30,000 | (15,000) | 15,000 | 7,050 | 30,000 | 14,100 |
2029 | 1,060,900 | 1,060,900 | 0 | 0- | 60,900 | (30,450) | 30,450 | 14,312 | 60,900 | 28,623 |
2030 | 1,092,727 | 1,092,727 | 0 | 0- | 92,727 | (46,364) | 46,364 | 21,791 | 92,727 | 43,582 |
2031 | 1,125,509 | 1,125,509 | 0 | 0- | 125,509 | (62,754) | 62,754 | 29,495 | 125,509 | 58,989 |
2032 | 1,159,274 | 1,159,274 | 0 | 0- | 159,274 | (79,637) | 79,637 | 37,429 | 159,274 | 74,859 |
2033 | 1,194,052 | 1,194,052 | 0 | 0- | 194,052 | (97,026) | 97,026 | 45,602 | 194,052 | 91,205 |
2034 | 1,229,874 | 1,229,874 | 0 | 0- | 229,874 | (114,937) | 114,937 | 54,020 | 229,874 | 108,041 |
2035 | 1,266,770 | 1,266,770 | 0 | 0- | 266,770 | (133,385) | 133,385 | 62,691 | 266,770 | 125,382 |
2036 | 1,304,773 | 1,304,773 | 0- | 0- | 304,773 | (152,387) | 152,387 | 71,622 | 304,773 | 143,243 |
2037 | 1,343,916 | 1,343,916 | 0- | 0- | 343,916 | (171,958) | 171,958 | 80,820 | 343,916 | 161,641 |
2038 | 1,384,234 | 1,384,234 | 0- | 0- | 384,234 | (192,117) | 192,117 | 90,295 | 384,234 | 180,590 |
2039 | 1,425,761 | 1,425,761 | 0- | 0- | 425,761 | (212,880) | 212,880 | 100,054 | 425,761 | 200,108 |
2040 | 1,468,534 | 1,468,534 | 0- | 0- | 468,534 | (234,267) | 234,267 | 110,105 | 468,534 | 220,211 |
2041 | 1,512,590 | 1,512,590 | 0- | 0- | 512,590 | (256,295) | 256,295 | 120,459 | 512,590 | 240,917 |
2042 | 1,557,967 | 1,557,967 | 0- | 0- | 557,967 | (278,984) | 278,984 | 131,122 | 557,967 | 262,245 |
2043 | 1,604,706 | 1,604,706 | 0 | 0- | 604,706 | (302,353) | 302,353 | 142,106 | 604,706 | 284,212 |
2044 | 1,652,848 | 1,652,848 | 0- | 0- | 652,848 | (326,424) | 326,424 | 153,419 | 652,848 | 306,838 |
2045 | 1,702,433 | 1,702,433 | 0- | 0- | 702,433 | (351,217) | 351,217 | 165,072 | 702,433 | 330,144 |
2046 | 1,753,506 | 1,753,506 | 0- | 0- | 753,506 | (376,753) | 376,753 | 177,074 | 753,506 | 354,148 |
2047 | 1,806,111 | 1,806,111 | 0- | 0- | 806,111 | (403,056) | 403,056 | 189,436 | 806,111 | 378,872 |
Scenario one: 3% inflation, 3% property value increase
This table assumes inflation runs at 3% and the property price increases at the same 3% rate each year. Under indexation, the gain is nil. Under the discount method a gain arises because the selling price exceeds the original cost of the property
In this scenario, owning the property through a company results in the highest tax bill.
Property | New CGT method | Old 50% CGT discount | Company CGT | |||||||
Year of | Property sale price | Property | Gain on | A's tax @ | Gain on | Less 50% | Taxable | A's tax @ | Gain for | Tax for A @ |
2028 | 1,050,000 | 1,030,000 | 20,000 | 9,400 | 50,000 | (25,000) | 25,000 | 11,750 | 50,000 | 23,500 |
2029 | 1,102,500 | 1,060,900 | 41,600 | 19,552 | 102,500 | (51,250) | 51,250 | 24,088 | 102,500 | 48,175 |
2030 | 1,157,625 | 1,092,727 | 64,898 | 30,502 | 157,625 | (78,813) | 78,813 | 37,042 | 157,625 | 74,084 |
2031 | 1,215,506 | 1,125,509 | 89,997 | 42,299 | 215,506 | (107,753) | 107,753 | 50,644 | 215,506 | 101,288 |
2032 | 1,276,282 | 1,159,274 | 117,007 | 54,994 | 276,282 | (138,141) | 138,141 | 64,926 | 276,282 | 129,852 |
2033 | 1,340,096 | 1,194,052 | 146,043 | 68,640 | 340,096 | (170,048) | 170,048 | 79,922 | 340,096 | 159,845 |
2034 | 1,407,100 | 1,229,874 | 177,227 | 83,296 | 407,100 | (203,550) | 203,550 | 95,669 | 407,100 | 191,337 |
2035 | 1,477,455 | 1,266,770 | 210,685 | 99,022 | 477,455 | (238,728) | 238,728 | 112,202 | 477,455 | 224,404 |
2036 | 1,551,328 | 1,304,773 | 246,555 | 115,881 | 551,328 | (275,664) | 275,664 | 129,562 | 551,328 | 259,124 |
2037 | 1,628,895 | 1,343,916 | 284,978 | 133,940 | 628,895 | (314,447) | 314,447 | 147,790 | 628,895 | 295,580 |
2038 | 1,710,339 | 1,384,234 | 326,105 | 153,270 | 710,339 | (355,170) | 355,170 | 166,930 | 710,339 | 333,859 |
2039 | 1,795,856 | 1,425,761 | 370,095 | 173,945 | 795,856 | (397,928) | 397,928 | 187,026 | 795,856 | 374,052 |
2040 | 1,885,649 | 1,468,534 | 417,115 | 196,044 | 885,649 | (442,825) | 442,825 | 208,128 | 885,649 | 416,255 |
2041 | 1,979,932 | 1,512,590 | 467,342 | 219,651 | 979,932 | (489,966) | 489,966 | 230,284 | 979,932 | 460,568 |
2042 | 2,078,928 | 1,557,967 | 520,961 | 244,852 | 1,078,928 | (539,464) | 539,464 | 253,548 | 1,078,928 | 507,096 |
2043 | 2,182,875 | 1,604,706 | 578,168 | 271,739 | 1,182,875 | (591,437) | 591,437 | 277,976 | 1,182,875 | 555,951 |
2044 | 2,292,018 | 1,652,848 | 639,171 | 300,410 | 1,292,018 | (646,009) | 646,009 | 303,624 | 1,292,018 | 607,249 |
2045 | 2,406,619 | 1,702,433 | 704,186 | 330,968 | 1,406,619 | (703,310) | 703,310 | 330,556 | 1,406,619 | 661,111 |
2046 | 2,526,950 | 1,753,506 | 773,444 | 363,519 | 1,526,950 | (763,475) | 763,475 | 358,833 | 1,526,950 | 717,667 |
2047 | 2,653,298 | 1,806,111 | 847,186 | 398,178 | 1,653,298 | (826,649) | 826,649 | 388,525 | 1,653,298 | 777,050 |
The lower tax outcome method is highlighted in green, followed by amber and red.
Scenario two: 3% inflation, 5% property price increase
So what happens if we assume indexation runs at 3% and property prices increase at 5% pa? In this scenario, taxpayer A is better off under indexation for the next 17 years compared with the discount method. Thereafter, the discounted CGT method results in a lower tax amount payable. Again, the company owning the property results in higher tax.
Property | New CGT method | Old CGT discounting method | Company CGT | |||||||
Year of | Property sale price | Property | Gain on | A's tax @ | Gain on | Less 50% | Taxable | A's tax @ | Gain for | Tax for A @ |
2028 | 1,030,000 | 1,050,000 | (20,000) | 0- | 30,000 | (15,000) | 15,000 | 7,050 | 30,000 | 14,100 |
2029 | 1,060,900 | 1,102,500 | (41,600) | 0- | 60,900 | (30,450) | 30,450 | 14,312 | 60,900 | 28,623 |
2030 | 1,092,727 | 1,157,625 | (64,898) | 0- | 92,727 | (46,364) | 46,364 | 21,791 | 92,727 | 43,582 |
2031 | 1,125,509 | 1,215,506 | (89,997) | 0- | 125,509 | (62,754) | 62,754 | 29,495 | 125,509 | 58,989 |
2032 | 1,159,274 | 1,276,282 | (117,007) | 0- | 159,274 | (79,637) | 79,637 | 37,429 | 159,274 | 74,859 |
2033 | 1,194,052 | 1,340,096 | (146,043) | 0- | 194,052 | (97,026) | 97,026 | 45,602 | 194,052 | 91,205 |
2034 | 1,229,874 | 1,407,100 | (177,227) | 0- | 229,874 | (114,937) | 114,937 | 54,020 | 229,874 | 108,041 |
2035 | 1,266,770 | 1,477,455 | (210,685) | 0- | 266,770 | (133,385) | 133,385 | 62,691 | 266,770 | 125,382 |
2036 | 1,304,773 | 1,551,328 | (246,555) | 0- | 304,773 | (152,387) | 152,387 | 71,622 | 304,773 | 143,243 |
2037 | 1,343,916 | 1,628,895 | (284,978) | 0- | 343,916 | (171,958) | 171,958 | 80,820 | 343,916 | 161,641 |
2038 | 1,384,234 | 1,710,339 | (326,105) | 0- | 384,234 | (192,117) | 192,117 | 90,295 | 384,234 | 180,590 |
2039 | 1,425,761 | 1,795,856 | (370,095) | 0- | 425,761 | (212,880) | 212,880 | 100,054 | 425,761 | 200,108 |
2040 | 1,468,534 | 1,885,649 | (417,115) | 0- | 468,534 | (234,267) | 234,267 | 110,105 | 468,534 | 220,211 |
2041 | 1,512,590 | 1,979,932 | (467,342) | 0- | 512,590 | (256,295) | 256,295 | 120,459 | 512,590 | 240,917 |
2042 | 1,557,967 | 2,078,928 | (520,961) | 0- | 557,967 | (278,984) | 278,984 | 131,122 | 557,967 | 262,245 |
2043 | 1,604,706 | 2,182,875 | (578,168) | 0- | 604,706 | (302,353) | 302,353 | 142,106 | 604,706 | 284,212 |
2044 | 1,652,848 | 2,292,018 | (639,171) | 0- | 652,848 | (326,424) | 326,424 | 153,419 | 652,848 | 306,838 |
2045 | 1,702,433 | 2,406,619 | (704,186) | 0- | 702,433 | (351,217) | 351,217 | 165,072 | 702,433 | 330,144 |
2046 | 1,753,506 | 2,526,950 | (773,444) | 0- | 753,506 | (376,753) | 376,753 | 177,074 | 753,506 | 354,148 |
2047 | 1,806,111 | 2,653,298 | (847,186) | 0- | 806,111 | (403,056) | 403,056 | 189,436 | 806,111 | 378,872 |
Scenario three: 5% inflation, 3% property price increase
Assuming inflation runs at 5% and the property increases at 3%. As before, indexation yields the lowest tax bill and creates a capital loss. The discount method results in tax payable because the property has gone up in value, even though the real value of money has not. This shows that under the discounting method, whilst people make a gain, the gain after adjusting for inflation may not even exist, and substantial tax is paid on something which may not even be real.
Property | New CGT method | Old CGT discounting method | Company CGT | |||||||
Year of | Property sale price | Property | Gain on | A's tax @ | Gain on | Less 50% | Taxable | A's tax @ | Gain for | Tax for A @ |
2028 | 1,030,000 | 1,050,000 | (20,000) | 0- | 30,000 | (15,000) | 15,000 | 7,050 | 30,000 | 14,100 |
2029 | 1,060,900 | 1,102,500 | (41,600) | 0- | 60,900 | (30,450) | 30,450 | 14,312 | 60,900 | 28,623 |
2030 | 1,092,727 | 1,157,625 | (64,898) | 0- | 92,727 | (46,364) | 46,364 | 21,791 | 92,727 | 43,582 |
2031 | 1,125,509 | 1,215,506 | (89,997) | 0- | 125,509 | (62,754) | 62,754 | 29,495 | 125,509 | 58,989 |
2032 | 1,159,274 | 1,276,282 | (117,007) | 0- | 159,274 | (79,637) | 79,637 | 37,429 | 159,274 | 74,859 |
2033 | 1,194,052 | 1,340,096 | (146,043) | 0- | 194,052 | (97,026) | 97,026 | 45,602 | 194,052 | 91,205 |
2034 | 1,229,874 | 1,407,100 | (177,227) | 0- | 229,874 | (114,937) | 114,937 | 54,020 | 229,874 | 108,041 |
2035 | 1,266,770 | 1,477,455 | (210,685) | 0- | 266,770 | (133,385) | 133,385 | 62,691 | 266,770 | 125,382 |
2036 | 1,304,773 | 1,551,328 | (246,555) | 0- | 304,773 | (152,387) | 152,387 | 71,622 | 304,773 | 143,243 |
2037 | 1,343,916 | 1,628,895 | (284,978) | 0- | 343,916 | (171,958) | 171,958 | 80,820 | 343,916 | 161,641 |
2038 | 1,384,234 | 1,710,339 | (326,105) | 0- | 384,234 | (192,117) | 192,117 | 90,295 | 384,234 | 180,590 |
2039 | 1,425,761 | 1,795,856 | (370,095) | 0- | 425,761 | (212,880) | 212,880 | 100,054 | 425,761 | 200,108 |
2040 | 1,468,534 | 1,885,649 | (417,115) | 0- | 468,534 | (234,267) | 234,267 | 110,105 | 468,534 | 220,211 |
2041 | 1,512,590 | 1,979,932 | (467,342) | 0- | 512,590 | (256,295) | 256,295 | 120,459 | 512,590 | 240,917 |
2042 | 1,557,967 | 2,078,928 | (520,961) | 0- | 557,967 | (278,984) | 278,984 | 131,122 | 557,967 | 262,245 |
2043 | 1,604,706 | 2,182,875 | (578,168) | 0- | 604,706 | (302,353) | 302,353 | 142,106 | 604,706 | 284,212 |
2044 | 1,652,848 | 2,292,018 | (639,171) | 0- | 652,848 | (326,424) | 326,424 | 153,419 | 652,848 | 306,838 |
2045 | 1,702,433 | 2,406,619 | (704,186) | 0- | 702,433 | (351,217) | 351,217 | 165,072 | 702,433 | 330,144 |
2046 | 1,753,506 | 2,526,950 | (773,444) | 0- | 753,506 | (376,753) | 376,753 | 177,074 | 753,506 | 354,148 |
2047 | 1,806,111 | 2,653,298 | (847,186) | 0- | 806,111 | (403,056) | 403,056 | 189,436 | 806,111 | 378,872 |
Scenario four: 3% inflation, 7% property price increase
Finally, we assume inflation runs at 3% and the property market increases by 7% each year. In this case, the discount method results in a lower tax outcome than indexation.
Property | New CGT method | Old CGT discounting method | Company CGT | ||||||||
Year of | Property sale price | Property | Gain on | A's tax @ | Gain on | Less 50% | Taxable | A's tax @ | Gain for | Tax for A @ | |
| |||||||||||
2027 | 1,000,000 | 1,000,000 | - | - | - | - | - | - | - | - |
|
2028 | 1,070,000 | 1,030,000 | 40,000 | 18,800 | 70,000 | (35,000) | 35,000 | 16,450 | 70,000 | 32,900 |
|
2029 | 1,144,900 | 1,060,900 | 84,000 | 39,480 | 144,900 | (72,450) | 72,450 | 34,052 | 144,900 | 68,103 |
|
2030 | 1,225,043 | 1,092,727 | 132,316 | 62,189 | 225,043 | (112,522) | 112,522 | 52,885 | 225,043 | 105,770 |
|
2031 | 1,310,796 | 1,125,509 | 185,287 | 87,085 | 310,796 | (155,398) | 155,398 | 73,037 | 310,796 | 146,074 |
|
2032 | 1,402,552 | 1,159,274 | 243,278 | 114,340 | 402,552 | (201,276) | 201,276 | 94,600 | 402,552 | 189,199 |
|
2033 | 1,500,730 | 1,194,052 | 306,678 | 144,139 | 500,730 | (250,365) | 250,365 | 117,672 | 500,730 | 235,343 |
|
2034 | 1,605,781 | 1,229,874 | 375,908 | 176,677 | 605,781 | (302,891) | 302,891 | 142,359 | 605,781 | 284,717 |
|
2035 | 1,718,186 | 1,266,770 | 451,416 | 212,166 | 718,186 | (359,093) | 359,093 | 168,774 | 718,186 | 337,548 |
|
2036 | 1,838,459 | 1,304,773 | 533,686 | 250,832 | 838,459 | (419,230) | 419,230 | 197,038 | 838,459 | 394,076 |
|
2037 | 1,967,151 | 1,343,916 | 623,235 | 292,920 | 967,151 | (483,576) | 483,576 | 227,281 | 967,151 | 454,561 |
|
2038 | 2,104,852 | 1,384,234 | 720,618 | 338,690 | 1,104,852 | (552,426) | 552,426 | 259,640 | 1,104,852 | 519,280 |
|
2039 | 2,252,192 | 1,425,761 | 826,431 | 388,422 | 1,252,192 | (626,096) | 626,096 | 294,265 | 1,252,192 | 588,530 |
|
2040 | 2,409,845 | 1,468,534 | 941,311 | 442,416 | 1,409,845 | (704,923) | 704,923 | 331,314 | 1,409,845 | 662,627 |
|
2041 | 2,578,534 | 1,512,590 | 1,065,944 | 500,994 | 1,578,534 | (789,267) | 789,267 | 370,956 | 1,578,534 | 741,911 |
|
2042 | 2,759,032 | 1,557,967 | 1,201,064 | 564,500 | 1,759,032 | (879,516) | 879,516 | 413,372 | 1,759,032 | 826,745 |
|
2043 | 2,952,164 | 1,604,706 | 1,347,457 | 633,305 | 1,952,164 | (976,082) | 976,082 | 458,758 | 1,952,164 | 917,517 |
|
2044 | 3,158,815 | 1,652,848 | 1,505,968 | 707,805 | 2,158,815 | (1,079,408) | 1,079,408 | 507,322 | 2,158,815 | 1,014,643 |
|
2045 | 3,379,932 | 1,702,433 | 1,677,499 | 788,425 | 2,379,932 | (1,189,966) | 1,189,966 | 559,284 | 2,379,932 | 1,118,568 |
|
2046 | 3,616,528 | 1,753,506 | 1,863,021 | 875,620 | 2,616,528 | (1,308,264) | 1,308,264 | 614,884 | 2,616,528 | 1,229,768 |
|
2047 | 3,869,684 | 1,806,111 | 2,063,573 | 969,879 | 2,869,684 | (1,434,842) | 1,434,842 | 674,376 | 2,869,684 | 1,348,752 |
|
Caveats and key takeaways
These models are of course simplifications of the real world, in which inflation and market prices vary from year to year. They do highlight, however, that the indexation method does not always produce a higher tax bill for the taxpayer when compared to the discount method. In summary:
- For a property market rising at least twice as fast as inflation, the discount method is preferable.
- For a property market rising faster than inflation, but less than twice as fast, the lower tax outcome is somewhere between the two methods,
- For a property market rising slower than inflation, the indexation method produces the lower tax outcome.
- Holding a property in a company and paying a dividend always results in a higher tax amount. There are of course other reasons as to why holding property in a company may be preferable.
Ultimately, based on the specific assumptions and scenarios modeled above, we can conclude that the change to indexation does not necessarily place taxpayers in a worse position. Nor, by extension, does it place the government in a better position. Perhaps the government is banking on property prices increasing at twice the inflation rate to put them in the same position as before.
Not factored into the calculation is the minimum 30% tax amount payable on the capital gain under the new CGT rules. The study also does not consider other small business CGT discounts which may be available to individuals and trusts owning farmland.
None of this matters if the property is never sold, but ‘never’ is a really long time and whether it is this generation, the next or the one after, the changes to capital gains tax are impactful and extensive. What was once hallowed as a sacred pre-CGT asset, has changed with the stroke of a pen, and all properties will now need to deal with CGT.
Whilst change is constant, these changes may create the impetus to review succession plans, freshen up old structures holding pre-CGT assets and plan for the future, at least until the next change.
