CGT reform: Is Australia penalising entrepreneurs?

Australia has always been about the idea of a fair go. The belief that someone can start with nothing, work hard, take risks and build a better future. Yet the Federal Government's proposed changes to Capital Gains Tax (CGT) risk undermining that principle.

Consider Bill*.

Bill is a bus driver. He dreamt of owning his own business. He saved up, developed a business plan and convinced a bank to loan him money to lease a bus.

Bil starts out driving the bus himself. He works long hours, handles the administration, manages the accounts and earns very little. As demand grows, he leases a second bus and hires another driver. Over the next twenty years he reinvests every spare dollar back into growing his business.

Today Bill operates 22 buses, employs 25 people and has built a successful company from the ground up. The business has grown beyond the small business CGT concession thresholds. An investor offers him $6.5 million for the company.

Now consider another example.

Three young software developers create a technology platform. For years they survive on very little income while they develop and refine their product. The business makes losses year after year. Fifteen years later they employ 50 people and have built a successful technology company. They sell the business for $15 million, receiving $5 million each.

A third example is an engineer who starts a consulting practice from scratch. Through years of hard work, reputation building and client relationships, he grows the business to employ 40 engineers. Eventually he decides to sell.

What do these businesses have in common?

They were not purchased. They were created.

The value of each business exists largely because of the effort, skill, risk-taking and sacrifice of the founders. The most valuable asset in each case is the goodwill they personally built over many years.

Under the previous CGT system, when these owners eventually sell their businesses, the 50 per cent CGT discount was available to them.

Under the proposed CGT changes, that discount is replaced with cost base indexation.

At first glance this sounds fair. The Government’s argument is that only real gains should be taxed and that inflation should not increase a taxpayer's liability. However, cost base indexation only benefits taxpayers who have a cost base to index.

Imagine instead that Bill had inherited wealth, purchased an existing bus company for $1 million, and held it for twenty years. Under the new rules that $1 million cost base would be indexed for inflation. Using actual inflation figures from the last 20 years, the indexed cost base would have grown to approximately $1.65 million.

When the business is sold, an investor receives the benefit of an increased cost base.

Bill, by contrast, created the business from scratch. The goodwill he built through twenty years of effort was not purchased. The value he created through hard work receives no equivalent adjustment.

The same issue arises for the software founders and the engineering practice.

The result is a tax system that benefits those with existing capital over entrepreneurial value creation.

The Government describes these reforms as making the tax system fairer. Yet they create a striking contrast. The person who already has money to buy an existing business pays less tax than the person who starts with nothing, takes the risk, works the long hours and builds a business from the ground up.

Australia should encourage investment. But it should also encourage entrepreneurship.

A tax system that rewards the ownership of capital more generously than the creation of value risks weakening one of the fundamental ideas that has long defined Australia: that ordinary people can build something extraordinary through their own effort.

That is why these CGT reforms are unfair. They do not simply change how capital gains are taxed; they change who the tax system rewards.

*Not his real name

Deanne Firth is the director of Tactical Super.