Are you Growth Grace, Dividend Dave or ETF Emma? Find out how Labor's new tax rules reshape your returns

Dividend Dave is an income-focused investor on a 32% marginal tax rate who prefers mature Australian companies paying fully franked dividends. Ten years ago, he invested $10,000 into each of 10 established ASX-listed income stocks and listed investment companies that generally pay fully imputed dividends.

Unlike Growth Grace, Dave is not relying on explosive capital growth. His portfolio produced modest share price gains but delivered a strong stream of fully franked dividends along the way.

• Under the current 50% CGT discount, Dave would still pay capital gains tax. 
• Under the new regime, however, he pays none (in this specific scenario) because the modest gains from Westpac, Argo Investments, GWA and Woodside are eliminated by indexation - and as a bonus, he still carries forward nominal capital losses to offset future gains.

Under our modelling, Dave’s after-tax return improves under indexation!

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VERDICTs

Chris Brycki: WINNER

"Dave is generally a winner (or neutral) because more of his total return comes from fully franked dividends rather than capital gains, while any modest capital appreciation is more likely to be offset by cost base indexation."

Daniel Kelly: WINNER

"In the model, Dave still has a positive nominal capital gain across the portfolio, but the indexed real gains are much lower and are fully offset by the recognised capital losses. 

As a result, the portfolio has no taxable capital gain under the new regime, with a small capital loss available to carry forward. His estimated after-tax return increases slightly from 8.2% p.a. under the current system to 8.4% p.a. under indexation. 

This is a good example that income-focused investors are likely to be relatively better placed than investors relying heavily on capital appreciation, particularly where the income stream is sustainable and tax-effective."

#3 - ETF Emma

ETF Emma is a young passive investor on a 0% marginal tax rate who invests through broad market ETFs to build wealth over the long term. Ten years ago, she invested $1,000 into each of five diversified ETFs covering Australian shares, global equities, emerging markets, bonds and gold.

Like many younger investors, Emma plans to realise her investments for a major life event. For the sake of this example, let's assume she has finished studying, worked casual jobs while building her portfolio, and now wants to sell her investments to buy a car she needs for her career.

Under the current system, that strategy works well. Emma can structure her affairs so she realises her capital gains while earning little or no income, potentially paying no capital gains tax at all.

Under the new regime, however, Emma is effectively checkmated by the taxman.

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VERDICTs

Chris Brycki: LOSER

"If Emma sells while she's still on a tax rate below 30%, she'll generally be worse off because she can't benefit from a lower marginal tax rate on her capital gains."

Daniel Kelly: LOSER

"Under the current system, the taxable capital gain created after the 50% CGT discount does not result in tax being payable because her marginal tax rate is assumed to be 0%. The new regime changes that outcome because the 30% minimum tax can capture real capital gains even where the investor’s marginal tax rate is otherwise low. 

In the model, Emma’s estimated after-tax return falls from 9.2% p.a. to 7.6% p.a. This is a meaningful reduction for a young or low-income investor using ETFs to build long-term wealth outside super and feels particularly harsh given Emma has a low income, likely a low net worth and is doing what she can to try and improve her position."

#4 - Property Pratik

Property Pratik is a property investor on the highest marginal tax rate weighing up two common strategies: a high-growth property in a blue-chip suburb or a higher-yielding property in a more affordable location.

Under the current system, the decision largely comes down to investment objectives. Growth investors benefit from the 50% CGT discount when they eventually sell, while income investors rely on rental income and slower capital appreciation.

Under the new regime, however, that calculus changes. The modelling suggests lower-growth, higher-income properties become relatively more attractive, while investors relying on large capital gains would face a higher tax bill when they eventually exit.

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VERDICTs

Chris Brycki: NEUTRAL

"The new regime creates an incentive to favour higher yielding, lower growth property over lower yielding, higher growth property because capital gains become relatively less attractive."

Daniel Kelly: NEUTRAL

"On the CGT side, a high-growth property is disadvantaged because the loss of the 50% CGT discount more than offsets the benefit of indexation. In the model, the growth property’s after-tax return falls from 6.40% p.a. to 6.26% p.a. 

The income property, however, comes out ahead in the model, with the after-tax return rising from 5.76% p.a. to 6.05% p.a. because less of the total return comes from capital growth and more comes from rental income. 

This highlights the broader point that the new regime does not treat all property investors equally. Low-yield, high-growth property is more exposed to the removal of the 50% CGT discount, while higher-yielding property with more modest capital growth can look relatively better under indexation. 

The important extra nuance is negative gearing, although it is separate from the modelled example above. Existing residential properties held before the Budget announcement are grandfathered from the negative gearing changes, while new builds retain access to negative gearing and can choose between the current 50% CGT discount and the new indexation treatment. 

Established residential property bought after the relevant date is less attractive where the investment relies on deductible rental losses against non-property income."

#5 - Trader Terry

Trader Terry is an active investor who selectively trades stocks and ETFs with good momentum to generate extra income throughout the year. He isn't carrying on a business - he simply trades alongside his day job.

Let's suppose Terry made some good calls this financial year and realised $45,000 in capital gains on top of his employment income.

While Terry is working full-time and earning above the 30% tax threshold, the new rules make little difference because his capital gains are already taxed above the minimum rate.

The picture changes dramatically if Terry cuts back his hours, takes a career break or steps away from work while continuing to trade.

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VERDICTs

Chris Brycki: NEUTRAL

"Like Emma, Terry is exposed to the 30% minimum tax. But given the shorter term nature of his investing activities, he won't have any meaningful benefit from indexation."

Daniel Kelly: MIXED

"Terry is the profile that requires the most thought as it is not quite as straightforward as the others. If he is genuinely a short-term trader, or carrying on a business of trading shares, the example may not be a clean application of the new CGT regime. Short-term gains do not currently benefit from the 50% CGT discount, and genuine trading profits may be treated as ordinary income rather than capital gains. 

On that basis, it would be too broad to say that every trader is automatically worse off under the proposed CGT changes. The more important thing to focus on here is that the 30% minimum tax hurts investors who realise eligible capital gains in low-income years. In the model, the full-time worker scenario is broadly neutral because their capital gains are already taxed at or above 30%. 

The part-time and no-income examples are losers because the minimum tax removes the benefit of realising gains while sitting in a low tax bracket. So, Terry is not necessarily a loser because he trades frequently. He is a loser where the strategy relies on realising eligible capital gains at a very low marginal tax rate."

#6 - Start-up Sam

Start-up Sam is an entrepreneur who builds a successful business over many years, hoping one day to achieve a life-changing exit. For this example, let's assume he invested $200,000 into his business and, after 15 years, sold it for $20 million.

Unlike most other investors, almost all of Sam's return comes from one enormous capital gain. While cost base indexation provides a small uplift to his original investment, it's insignificant relative to the size of the gain. The result is a substantially larger taxable gain than under the current 50% CGT discount.

To make matters worse, founders who have built their businesses over more than 10 years may not qualify for the government's separate start-up concessions, leaving many long-term entrepreneurs fully exposed to the new regime.

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VERDICTs

Chris Brycki: LOSER

"Startup founders like Startup Sam are among the biggest losers under these changes. They spend years taking extraordinary risks to build a business, often for little or no income, in the hope of one day creating something valuable. Yet when that success finally comes, the reward is taxed at almost double the rate.

It's hard to see how Australia can remain globally competitive for startups and high growth entrepreneurship under these settings. The government says it wants to encourage innovation and productive risk taking. Instead, it's made one of Australia's most important wealth creation journeys significantly less attractive."

Daniel Kelly: LOSER

"In this scenario, Sam invests $200,000 and ultimately exits for $20 million, creating a nominal gain of $19.8 million. Under the current 50% CGT discount, the taxable gain is $9.9 million which would then be taxed at his marginal tax rate. 

Under the indexation approach, assuming 3% inflation, the indexed cost base only rises a small amount (especially pronounced because the cost base of the capital was only $200,000) and the taxable real gain is still $19.71 million, a shocking 99% higher than under the current system. 

That highlights the core issue for venture and start-up investors. Indexation works best where a meaningful part of the nominal return is simply inflation. It is far less valuable where the outcome is a high-multiple, high-risk capital gain which is expected with VC investing. 

The important caveat is that the Government is proposing a targeted concession for qualifying innovative start-ups, which may allow some founders, employees and early-stage investors to retain access to a 50% discount. 

The final point I would make on this profile is timing. The cleanest way to present this scenario is as a forward-looking example under the new regime. If Sam made the investment 15 years ago and exits before 1 July 2027, the new CGT rules do not apply. If he already holds the investment and exits after 1 July 2027, only the gain accruing after that date is exposed to the new rules."

A new era for Australian investors?

The new regime appears to reward some behaviours and penalise others. Investors focused on fully franked dividends, income and modest capital growth generally fare better than those whose wealth is created through large capital gains.

Indeed, Geoff Wilson made a similar point in my recent interview, suggesting investors may be better off looking for an investment offering 3% capital growth and a 7% fully franked yield (providing cash flow for the proverbial avocado on toast!) in order to optimise the tax payable.

That doesn't mean Growth Grace, ETF Emma or Start-up Sam suddenly become bad strategies. Far from it. Over the long run, total returns still matter most. 

But the hurdle they need to clear has become noticeably higher, while the relative attractiveness of income-producing investments and certain property strategies appears to have improved.

If nothing else, we hope this exercise has encouraged you to think about your own portfolio through a different lens. It also highlights the importance of understanding how the new 30% minimum tax on capital gains interacts with your employment income - something that can materially change your after-tax outcome.

Notes: The tools we used in this exercise include Stockspot's CGT Calculator, Sharesight's Share Checker, Bank of Canada's inflation-adjusted returns calculator, and capitalgainscalculator.com.au.

Now it's over to you. Which of our six investor personalities best describes your portfolio? Vote in the poll below and join the discussion in the comments.