Capital Gains Tax

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Last Updated:December 6, 2023

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What Is the Capital Gains Tax?

Capital gains tax is levied on profits from selling a non-inventory capital asset (such as shares, bonds, precious metals, property, and real estate).

When shares or other investment assets are sold in the market, the profit that arises from the difference between the selling price and the price at which the asset was purchased is known as a capital gain and is subject to CGT.

However, this type of tax does not apply to unsold investments.

Capital Gains can be classified into short-term and long-term capital gains.

Short-term capital gain refers to the gains made from the sale of an asset held for less than one year, whereas long-term capital gain refers to the profit realized from the sale of an asset held for a period longer than one year.

Short-term capital gains are taxed as ordinary income, whereas long-term capital gains must be taxed according to the prevailing rates.

Capital Gains Tax across different countries

Capital gains tax is payable on profits from selling valuable items and assets such as shares and bonds. The tax rate primarily depends on the money made from the investment and the money earned by the individual in that financial year.

Although every country has a different way of imposing this tax, some countries, like Singapore, New Zealand, Bahrain, Jamaica, etc., do not impose this.

For example, under the current United States Federal Policy, different capital gains tax rates are applicable per the status (whether a corporation or an individual). The CGT rate levied on corporations is 20%, whereas the rate suitable for individual investors is 20%.

On the other hand, the CGT rate in the U.K. was 10% of the profit if the individual’s net income was below 20% and 20% of the profits if the income was above the limit.

Moreover, an additional tax added 8% to the current tax rate if the profit comes from residential property.

Calculating Your Capital Gains

The different ways to compute capital gains tax are explained as follows:

1. Discount Method

Australia is one of the countries using the discount method to determine the CGT incurred by an individual. This method of calculating gains tax is based on discounting the initial capital gain made from the sale of an asset held for more than a year.

This discount is known as the capital gains tax (CGT) discount. The discounted value is multiplied by the taxpayer’s marginal tax rate to calculate the exact tax amount owed by the individual.

Moreover, the individual is entitled to the discount only if the asset has been purchased after 1 September 1999. In Australia, trusts are entitled to such tax discounts, by companies are not entitled.

Let us consider that an asset was purchased for $10,000. We sold it for $30,000 on 15 October 2019. Consider the marginal tax rate to be 30%. Then, calculate the CGT using the discount method.

The nominal capital gain is $30,000 - 10,000 = $20,000
Assessable capital gain after a 50% discount is $10,000
The tax payable would be $10,000 * 0.30 = $3,000

However, the CGT discount is exempted from the following circumstances:

Home has now started being used for rental and business purposes in the past 12 months.
Foreign or temporary residents are not entitled to discounts.
CGT discount is not applicable on events that create a new asset and a capital gain.

2. The Indexation method

Indexation refers to reducing the individual investor’s capital gain using the ratio of market index value on the date of sale to the index value on the date of purchase multiplied by the total capital gain.

This method only applies to assets that are purchased before 21 September 1999.

Let us consider the same asset we used in the previous example: purchased for $10,000 and sold for $30,000.

Assuming that the asset was purchased on 1 October 1989, the index in 1989 was 99.2, whereas the index fixed on September 1999 is 123.4; the indexation method calculates CGT in the following way:

December 1989 = 99.2

September 1999 = 123.4 (the index is fixed since Sep 1999)

Indexed cost base = $10,000 x 123.4 / 99.2 = $12,440

Assessable gain is $30,000 -$12,440 = $17,560

Capital Gains Tax = 0.30 x $17560 = $5,268

Capital Gains Exemptions

Certain forms of income are exempt from this tax. The different states of income that are exempted are explained as follows:

Gambling Income

Gambling income includes the windfall gains made from betting on sports or other activities, casino winnings, and other kinds of activities. Gambling is illegal in many countries; thus, no tax is levied on such gains.

However, taxes on gambling income exist, and many countries do not impose a capital gains tax on gambling winnings. For example, the USA and France have imposed taxes on gambling income, but Australia hasn’t.

Australia is one of the countries which is considered to have one of the most enthusiastic gamblers in the world.

Statistics suggest that Australians accounted for spending around A$209 billion during 2016-2017 at bookmakers and betting agencies, on lotteries, casinos, and poker machines, and roughly 35% of Australians aged 18 overspend money on betting.

Countries such as the United States, France, and Spain impose taxes on income from gambling, raising the question of whether all governments worldwide should also take the initiative to impose taxes on windfall gains.

Even within the same jurisdiction, different types of gambling are taxed in different ways and at various rates.

States and territories tax poker machines based on player losses or net revenue; in contrast, table games like roulette and blackjack are taxed based on turnover or profit, with some jurisdictions taxing them only for the goods and services tax.

It is a complex process to impose taxes on gambling as it solely relies on people who declare their winnings faithfully, and at times can be unfair for those who claim their winnings faithfully and others to pocket their money.

But if the right measures are in place, if taxes on gambling are imposed in different countries, considering the amount of money involved in the industry, it can be a major revenue boost for the government.

However, many economists believe that gambling income should not be taxed as they believe gambling is not a reliable income stream. Furthermore, it is practicable and impossible to rely solely on gambling as an income stream to support oneself, although this is possible for skilled individuals.

It would not make sense to tax the earnings on gambling as the companies that operate these gambling methods are already taxed, leading to a similar ideal of Franklin credits and double-dipping in tax revenue.

Finally, if gambling winnings are taxable, the issue of gambling losses being tax-deductible would also have to be made, raising further issues. Moreover, it is also believed that gambling can lead to addiction, causing many social and cultural problems in the economy.

But, one of the strongest arguments against taxing gambling winnings is that gambling is most often a hobby and not an income source for individuals. However, this argument is flawed.

According to Per Kee, the foundation of our progressive tax system is that 'people should be taxed according to their ability to pay. Therefore, why should tax only be limited to income? Furthermore, if individuals acquire winnings, they have a greater capacity to pay and should be taxed higher.

Otherwise, equality is undermined because individuals in similar economic positions will be taxed differently.

Main Residence

Australia does not impose this tax on the primary residence, sometimes referred to as the main residence. This suggests that the government won't impose taxes on the asset's profit-making sale.

This is referred to as the "Main Residence Exemption," and a person is qualified if they meet the following criteria and are an Australian resident:

If the owner, spouse, or dependents have lived in the home continuously while it has been theirs.
It hasn't been utilized to generate income, which means you haven't used it to run a business, rent it out, or "flipped" it (bought it to renovate and sell at a profit)
It is located on a plot of land no more than 2 hectares.

Other Forms of Income

Other activities exempted from incurring capital gains tax are the sale of personal assets or collectibles, the sale of small businesses used to support retirement, and the sale of motor vehicles not used for business purposes.

How to Avoid Capital Gains Taxes

Taxpayer can decrease their capital gains tax the easiest way possible by delaying the sale of assets.

Individuals may, however, postpone paying their taxes using the following methods, depending on the laws and regulations of various countries:

Gains on investments in preferred industries or sectors, like small firms, may be subject to a lower tax rate in a given country.
When property ownership is passed to a family member who is in the low-income category, taxes may be lowered. In the United States, a family member may completely avoid the capital gains tax if they fall between the 10% to 12% ordinary income tax rate in the year of selling the property.
There can be accounts that qualify for tax benefits. The best strategy is to let gains build up in the account tax-free, but once the payor takes money out of the account, taxes may also be due.
By selling a plus at a loss, you could generate a "tax loss" that you could use to offset gains you could make in the future and possibly reduce or avoid paying taxes on those gains.
Even though Tax losses are a valuable asset for businesses, they should avoid "Sham" Transactions, which refer to selling to oneself or a subsidiary without a justifiable reason to create a tax loss.
Tax can also be avoided if the surplus is donated to a charity.
Tax may be postponed if the remunerator sells the asset but receives payment from the client over several years. However, at that time, the taxpayer is exposed to the possibility of a buyer default.
One option to postpone taxes might be to buy or sell an associate's degree in a structured fashion.
The asset's idea (initial cost) is adjusted in inbound transactions. A transmissible asset's basis in the United States is its value at the moment of inheritance.
Tax may also be delayed if the seller of the associate degree plus invests the cash in purchasing a "like-kind" asset. This is commonly available only for land and physical property tied to business in the U.S. and is known as a 1031 Exchange.
Tax may be delayed if the financial gain is reinvested into bound geographic locations.

The Chance Zone program was established in the U.S. to "bring investment and development to lower-income areas that don't otherwise receive an excellent deal of attention" and "recycle capital into the economy that will preferably be 'frozen.'