Key takeaways
- Australia’s move from the 50% CGT reduction to base price indexation affects taxpayers differently depending on the initial base price of the asset.
- Real estate investors generally benefit from indexing because their assets typically have large purchase prices that can be adjusted for inflation.
- Startup employees often receive equity with minimal cost bases, leaving most of their capital gains fully exposed to tax despite indexation.
- The different tax outcomes result from the operation of the indexing formula rather than from differences in tax rates or policy intent.
- Subsequent policy exclusions for innovative companies recognize that a uniform tax rule may not produce equitable results for all asset classes.
A single line item in Australia’s 2026-27 federal budget replaced the 50% capital gains tax cut with cost-based indexation and a 30% minimum tax on net capital gains, effective July 1, 2027. Applied to a residential property investor, this swap barely moves the needle. Applied to a start-up employee cashing in on equity, this roughly doubles the tax bill. Same rule, same formula, very different results, and the reason comes down to a single number that most people never think about: cost basis.
Indexing assumes there is something to index
Cost-basis indexing works by adjusting upward what a person initially paid for an asset based on inflation, and then taxing only the gain above that adjusted figure. The logic holds for an asset with a real starting price.
Imagine a homeowner who purchased an investment property for $600,000 ten years ago. Indexed for inflation, this purchase price is now closer to $780,000. Sell the property for $1 million and the tax applies to about $220,000 of actual gain rather than the entire $400,000 of nominal gain. Indexing did exactly its job: it removed inflation from earnings and taxed what was left.
This mechanism is entirely dependent on the asset having a real and substantial cost base from the outset. SBS News reported that the May Budget uniformly applied the same indexation formula to all asset types, replacing the 50% cut for individuals, trusts and partnerships, before later exclusions began to close the gap in how it lands on different types of capital.
Sweat Equity starts from almost nothing
The cost base of a startup employee is nothing like that of an owner. Initial shares are typically issued at cents per share, sometimes fractions of a cent, because the company has no revenue yet, no balance sheet, and no proven value yet. The employee is not purchasing an appreciating asset, but accepting a below-market salary in exchange for a stake that might be worth nothing.
Run the index formula against this starting point and the calculations stop immediately. Multiply a near-zero cost base by any inflation factor and the result is still close to zero. There is no figure worth adjusting upwards, no real purchase price on which inflation can act, no shelter for the resulting gain.
Consider an employee with a 1% stake in a company exiting for $200 million. This stake is worth $2 million. With the old 50% reduction, the effective tax rate on this gain was about 23.5%, generating a tax bill of about $470,000 and leaving the employee with about $1.53 million. Under indexation applied to a near-zero cost base, almost the entire $2 million gain is exposed to maximum marginal rate close to 47%bringing the tax bill to approximately $940,000. Same exit, same participation, almost double the tax.
Same formula, opposite results
The startup owner and employee experience the same political mechanism in opposite ways. For the owner, indexation brings real relief, because there is a real figure to index. For the employee, this brings almost nothing, because there is nothing to inflate. The formula is neutral. The assets to which it applies are not.
Bloomberg reported that even Productivity Commission chair Danielle Wood, while describing the broader budget as a credible package of productivity reform, flagged the risk of unintended consequences for the startup sector in particular, a recognition that the same tool can perform different tasks depending on what it is aimed at.
Mechanical problem, not a political disagreement
This is not a debate over whether startup founders deserve a tax break or whether real estate investors are taxed fairly, but rather a mechanical mismatch between a formula and the asset class to which it was applied without adjustment. Indexation measures relief proportional to the size of the original cost base, and a startup employee with no cost basis speaking is precisely the case for which the formula was never designed.
Subsequent exclusions in favor of innovative companies have closed part of this gap by preserving the old reduction for eligible companies and participations. But the underlying mechanics explain why this conversation was happening: a rule designed to separate inflation from real gains works exactly as expected when there is a real number to start from, and produces a very different result when there isn’t.
FAQs
What is cost-based indexation?
Cost-based indexation is a tax mechanism that adjusts the initial purchase price of an asset to reflect inflation before calculating the taxable capital gain. By increasing the cost base, the system aims to tax only the part of the gain that represents a real increase in value rather than just inflation.
This approach generally provides greater benefits for assets purchased for large amounts and held for long periods of time.
Why does cost-based escalation affect startup employees differently?
Employees of startups often receive company equity at a very low acquisition cost because the company is still in its early stages and has limited market value. Since the initial cost base is minimal, applying inflation adjustments results in only a negligible increase in this figure.
As a result, almost all of the value realized when the shares are ultimately sold may remain subject to capital gains tax, resulting in a much greater tax liability than for assets with a higher purchase price.
Why do residential real estate investors generally benefit more from indexing?
Investment properties generally have substantial purchase prices which can be adjusted upward to reflect inflation over the holding period. This higher indexed cost basis reduces the amount of gain that is ultimately taxable when the property is sold.
Because inflation adjustments are applied to a significant initial investment amount, property owners often receive much larger tax breaks than investors whose assets started with very low cost bases.
Does the different result mean the tax policy is unfair?
The divergent results arise primarily from the mechanics of the formula rather than from different tax rates or explicit policy preferences. Cost-based indexing was designed to eliminate inflationary gains, but its effectiveness depends heavily on the size of the initial acquisition cost.
When applied uniformly to assets with very different cost bases, the same calculation can produce very different practical results.
Have any changes been made to account for the impact on startup equity?
Following concerns about the effect of the reforms on the Australian startup ecosystem, subsequent policy exclusions were introduced for certain innovative companies and eligible equity interests. These measures were designed to reduce some of the unintended consequences for startup founders and employees.
Even with these adjustments, the discussion highlights the importance of considering how tax formulas interact with different asset classes rather than assuming that a single rule will produce similar results for each taxpayer.
