The new CGT regime announced in the May 2026 Federal budget now sees capital losses treated differently to capital gains in two important ways.
- Gains are taxed, but losses cannot be deducted against other income. Instead, capital losses can only offset capital gains, otherwise they are quarantined to offset against future gains. This has always been a feature of the CGT system. [Note that prior to the Budget, gains were taxed like normal income, but now there is a 30% minimum CGT to contend with.]
- Gains are determined against a cost base indexed for inflation, while losses are not. The result is a new regime that taxes real gains but measures losses only in nominal terms.
Capital gains and capital losses are simply opposite sides of the same investment outcome. Yet the tax system treats them asymmetrically.
Had both simply been termed a ‘capital outcome’ from the outset, the question of treating them differently for tax purposes might never have arisen.
The effect of not indexing capital losses
The following example illustrates the effect of excluding capital losses from indexation.
Assume two investors.
Investor 1 buys shares A and B at a cost of $1,000 each. At the same time, Investor 2 buys shares C and D for $1,000 each.
All the shares are sold at the same time, with the cost base of all four shares indexed for inflation to $1,200 per share.
Investor 1 sells his shares at $500 for share A and $2,500 for share B.
Total portfolio capital gain is $1,000. The nominal gain on share B is $1,500, which after inflation is a real gain of $1,300. However, the real loss of $700 on share A does not count. Only the nominal loss is recognised such that Investor 1 pays tax on a $1,300 gain - $500 loss = $800.
Investor 2 sells shares C and D for $1,500 each.
Total portfolio gain is $1,000 also. And after inflation, the real gain per share is $300. Investor 2 therefore pays tax on $600. Both investors earned the same total nominal gain, yet Investor 1 reports a taxable gain one-third higher than Investor 2.
The asymmetry becomes greater when losses are carried forward. If Investor 1 retains share B therefore there is no capital gain to offset against, the $500 nominal loss must be carried forward. Frozen at $500, that loss would steadily be eroded by inflation over time, ensuring increasing asymmetry with the time taken to use the loss.
When two investors achieve the same economic outcome but face different tax outcomes, the design of the system deserves scrutiny.
If gains and losses are not measured symmetrically, it is reasonable to question both the rules for measuring those outcomes and their differing tax treatment.
Should the tax treatment of an investment portfolio depend on how its return is distributed across individual holdings?
The structure of ownership matters
If the portfolios of Investors 1 and 2 were held inside pooled investments such as ETFs, their investor-level CGT outcomes should be the same, assuming the same unit purchase and sale prices.
An investor owns units of an ETF rather than directly owning underlying shares. The ETF itself is the asset upon which outcomes are determined based on units bought and sold, not the dollar gains or losses of the underlying shares. Identical CGT outcomes assume that the ETFs buy and hold their stocks.
So we have another anomaly. Should the tax treatment of an investment portfolio depend on the structure through which the investments are held?
A potential distortion of investment
The new legislation would therefore seem to penalise direct stock picking and more volatile portfolios. The CGT treatment could influence how people invest their money.
An investor who selects individual shares faces the possibility of unindexed, quarantined capital losses. Yet investing in a pooled portfolio of similar underlying risk could yield more favourable tax outcomes.
And if the investor did choose to stock pick, investing in less volatile stocks theoretically produces steadier gains without oscillating so much between gains and losses. From a tax perspective, smoother return paths may become preferable to more volatile return paths, even where the latter offer higher expected pre-tax returns.
There may also be a bias towards holding underperforming assets rather than realising losses. Why crystallise a loss today if the system reduces its economic value over time? This lock-in effect would be more pronounced if there were no gains to offset against.
A more neutral tax system should reduce distortions around investment decisions. And more broadly, it should encourage more risk-taking and therefore the allocation of capital towards more innovative businesses prepared to invest in technology and take risks in research and development.
That is, tax policy that promotes investment in businesses focused on more productive activities, in an economy crying out for a boost to productivity.
Tony Dillon is a freelance writer and former actuary. This article is general information and does not consider the circumstances of any investor.