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Chapter 12: Indexation, averaging and quarantining of losses

A case for reform

The current realisation-based capital gains tax system includes indexation and averaging features. Indexation contributes to tax law complexity and certain design deficiencies of averaging need to be reformed.

Capital losses are quarantined against capital gains. The quarantining of capital losses introduces a bias against some forms of investment.

A strategy for reform

To develop a simplified, fairer and less distortionary system for taxing capital gains.

Key policy issues Indexation How could the tax law treatment of gains and losses for both appreciating and depreciating assets be made more uniform? Averaging arrangements How could the current investment distortions and scope for tax minimisation be addressed? Capital loss quarantining How might reformed arrangements reflect an appropriate balance between the arguments for and against quarantining?
Reform options Option
Removal of indexation.
Modify averaging arrangements by removing the effect of multiplying the tax-free threshold and taxing capital gains above the threshold under a 1/5 (existing) or 1/2 rule.
Option 1
Allow carry-forward at an appropriate interest rate.

Option 2
Carry-back of capital losses to offset earlier capital gains.

Option 3
Remove quarantining of capital losses where gains on assets are assessed on an annual basis.

Option 4
Limit quarantining of past and future losses to shares and units in trusts. This option would allow other capital losses to be offset against ordinary income.