Capital gain is an economic concept defined as the profit earned on the sale of an asset that has increased in value over the holding period. An asset may be tangible property, a car, a business, or intangible property such as shares.
A capital gain is when the selling price of the asset is greater than the original purchase price. In the event that the purchase price exceeds the sale price, a capital loss occurs. Capital gains are often subject to taxation, of which rates and exemptions differ between countries. The history of capital gain originates at the birth of the modern economic system and its evolution has been described as complex and multidimensional by a variety of economic thinkers. The concept of capital gain may be considered comparable with other key economic concepts such as profit and rate of return, however, its distinguishing feature is that individuals, not just businesses, can accrue capital gains through everyday acquisition and disposal of assets.
History
The history of capital gain in human development includes conceptualizations from pre-1865 slave capital in the United States, to the development of property rights in France in 1789, and even other developments much earlier.[1] The official beginning of a practical application of capital gain occurred with the development of the Babylonian's financial system circa 2000 B.C.[2] This system introduced treasuries where citizens could deposit silver and gold for safekeeping, and also transact with other members of the economy.[2] As such, this allowed the Babylonians to calculate costs, sale prices and profits, and hence capital gains.
Calculation
Capital gain is generally calculated through taking the sale price of an asset and subtracting its base cost and any incurred expenses.[3] The resulting value will be the capital gain, or capital loss if negative. In reality, many governments provide supplementary methods of calculating capital gains for both individuals and businesses. These methods can provide taxation relief through lowering the calculated capital gain value.
Australia
The Australian Taxation Office (ATO) lists three methods of calculating capital gain for Australian citizens and businesses, each one designed to lower the final resulting value of the eligible party's gain.[4] The first is the discount method, whereby eligible individuals or super funds may reduce their stated capital gain value by 50% or 33.33% respectively.[5] The second is the indexation method, which allows individuals and firms to apply an index factor to increase the base cost of the asset, thereby decreasing the final capital gain value.[6]
Taxation of gains
There are typically significant differences in the taxation of capital gains earned by individuals and corporations, and the OECD recognizes three simple categories of individual capital income which are taxed by its member nations around the world. These include dividend income, interest income, and capital gains realized through property and shares.[19] The OECD average dividend tax rate is 41.8%, whereby dividends are often taxed at both the corporate and individual level and categorized as corporate income first and personal income second.[19] However, certain countries such as Australia, Chile, Mexico, and New Zealand employ imputation tax systems which allow corporations to redeem imputation credits for tax paid at the corporate level, thus reducing their tax burden.[19] The OECD average interest income tax rate is 27%, and almost all OECD countries excluding Chile, Estonia, Israel, and Mexico tax an individual's total nominal interest income.[19]
Eligible assets
Capital gain can only be earned on the profitable sale of assets. A former Chief Accountant of the Securities Exchange Commission defined an asset as: “Cash, contractual claims to cash or services, and items that can be sold separately for cash”.[20] Practical applications of this definition primarily include stocks and real estate.
Stocks
A capital gain may be earned through the sale of financial assets such as stocks. When one sells a stock, they would subtract the cost price from the sale price to calculate their capital gain or loss.
Disposition effect
The disposition effect is a theory which links human psychology to capital gain in stocks and examines how humans make choices under the threat of a potential capital loss.[21] It reveals a pattern of irrationality within human behaviour, in which stocks which have potential to accrue a capital gain are sold too early, while stocks which are clear losers are held on for too long, thus creating greater capital losses than necessary.
See also
- Cash flow
- Investment
- Passive income
- Property income
- Profit
- Share repurchase
- Unearned income
Further reading
References
- Thomas Piketty. Capital in the Twenty-First Century: A multidimensional approach to the history of capital and social classes The British Journal of Sociology, 2014^
- Jeremy C. Jenks. Chapters on the History of Money: Chapter I Financial Analysts Journal, 1964^
- Calculating and paying capital gains tax www.nab.com.au, retrieved 2023-08-24^