Common Tax Planning Common Tax Planning Strategies Explained: Strategies Explained:

A holistic approach to tax efficient wealth A holistic approach to tax efficient wealth building.building.

Travis Morien Travis Morien Compass Financial Planners Pty Compass Financial Planners Pty

LtdLtd08 9332 054408 9332 0544

http://www.travismorien.comhttp://www.travismorien.com

Basic principlesBasic principles There are many perfectly legal and socially There are many perfectly legal and socially

acceptable ways to increase your wealth in a acceptable ways to increase your wealth in a tax efficient manner. Some of these methods tax efficient manner. Some of these methods are very powerful. Legitimate methods of are very powerful. Legitimate methods of increasing your tax efficiency are called “tax increasing your tax efficiency are called “tax planning”.planning”.

Methods that are unlawful are Methods that are unlawful are categorisedcategorised under two different labels:under two different labels: ““Tax avoidance” is where you set up contrived Tax avoidance” is where you set up contrived

accounting structures and strategies that abuse a accounting structures and strategies that abuse a loophole so you can claim large tax deductions or loophole so you can claim large tax deductions or take advantage of some benefit that was never take advantage of some benefit that was never intended to be used in such a way.intended to be used in such a way.

““Tax evasion” is where you deliberately try to hide Tax evasion” is where you deliberately try to hide income from the Tax Office, by various methods income from the Tax Office, by various methods including secret bank accounts, not recording cash including secret bank accounts, not recording cash transactions, “cooking the books” etc.transactions, “cooking the books” etc.

The focus of tax planningThe focus of tax planning Tax planning should only ever be done with a view Tax planning should only ever be done with a view

to increasing your total wealth.to increasing your total wealth. There are some people that enter into all sorts of There are some people that enter into all sorts of

dubious arrangements in order to obtain a tax dubious arrangements in order to obtain a tax deduction, including trying to minimise their income.deduction, including trying to minimise their income.

Minimising your income is silly, what you want to do Minimising your income is silly, what you want to do is is increase your assets and/or after tax incomeincrease your assets and/or after tax income. .

Some popular tax planning strategies are highly Some popular tax planning strategies are highly effective at reducing your tax, but produce little effective at reducing your tax, but produce little benefit in terms of wealth creation. Some strategies benefit in terms of wealth creation. Some strategies actually make you worse off, either immediately or actually make you worse off, either immediately or in the long term.in the long term.

Hence, tax planning is just a subset of overall Hence, tax planning is just a subset of overall financial planning, which needs to take into account financial planning, which needs to take into account investment strategy, retirement planning, wealth investment strategy, retirement planning, wealth building etc.building etc.

Legality and ethicsLegality and ethics There is always a grey area between tax planning, tax There is always a grey area between tax planning, tax

avoidance and tax evasion, and the Australian Tax Office avoidance and tax evasion, and the Australian Tax Office has a surprising amount of discretion to decide where has a surprising amount of discretion to decide where the boundaries lie.the boundaries lie.

It should be remembered that just because some It should be remembered that just because some “expert” says it is ok, doesn’t mean that it is ok. Also “expert” says it is ok, doesn’t mean that it is ok. Also remember that just because a tax adviser openly remember that just because a tax adviser openly advertises the strategy in a newspaper doesn’t mean the advertises the strategy in a newspaper doesn’t mean the Australian Tax Office has approved the scheme. There Australian Tax Office has approved the scheme. There have been many high profile prosecutions over the years have been many high profile prosecutions over the years and the fact that “everyone does it” makes the ATO and the fact that “everyone does it” makes the ATO moremore likely to shut it down. likely to shut it down.

In other words, be careful about listening to advisers that In other words, be careful about listening to advisers that seem to recommend “too good to be true” strategies like seem to recommend “too good to be true” strategies like clever loopholes and novel types of trust that are clever loopholes and novel types of trust that are supposedly a closely guarded secret of “the rich”.supposedly a closely guarded secret of “the rich”.

Serious penalties including huge fines and jail terms may Serious penalties including huge fines and jail terms may apply if you do something illegal. Blaming your advisor apply if you do something illegal. Blaming your advisor usually won’t get you off the hook.usually won’t get you off the hook.

““The Secrets of the Super The Secrets of the Super Rich”Rich”

Contrary to what many “poor” and “middle class” Contrary to what many “poor” and “middle class” people have been led to believe, there really are no people have been led to believe, there really are no secret techniques used by the wealthy that enable secret techniques used by the wealthy that enable them to get through life paying little or no tax.them to get through life paying little or no tax.

Wealthy people often employ very good advisors but Wealthy people often employ very good advisors but strategies used by the wealthy are almost always the strategies used by the wealthy are almost always the same simple strategies mentioned in this presentation. same simple strategies mentioned in this presentation. The difference is that a skilled advisor knows how to The difference is that a skilled advisor knows how to best combine these strategies for overall results.best combine these strategies for overall results.

People generally get wealthy not by using some flashy People generally get wealthy not by using some flashy “secret” technique, but because they were good at “secret” technique, but because they were good at building a business or investing wisely. building a business or investing wisely.

Gurus promoting the idea of “secrets” are usually Gurus promoting the idea of “secrets” are usually conmen seeking to dupe the poor and middle class, you conmen seeking to dupe the poor and middle class, you generally don’t find millionaires lining up to attend generally don’t find millionaires lining up to attend $10,000 seminars advertised in the newspaper. Most $10,000 seminars advertised in the newspaper. Most wealthy people that I know scoff at such seminars.wealthy people that I know scoff at such seminars.

There are many different types There are many different types of tax planning strategies:of tax planning strategies:

Strategies for obtaining tax deductionsStrategies for obtaining tax deductions Strategies for obtaining tax offsets (credits)Strategies for obtaining tax offsets (credits) Strategies for moving income away from an Strategies for moving income away from an

entity paying a high rate of tax to an entity entity paying a high rate of tax to an entity paying a lower rate of tax.paying a lower rate of tax.

Strategies for moving profits and losses Strategies for moving profits and losses between tax years, either to defer tax or take between tax years, either to defer tax or take advantage of a more advantage of a more favourablefavourable tax rate. tax rate.

Strategies for reducing the amount of Strategies for reducing the amount of assessable capital gains from an investment assessable capital gains from an investment sold at a profit.sold at a profit.

Deductions vs offsetsDeductions vs offsets When you claim a tax deduction for When you claim a tax deduction for

something, you obtain a tax benefit equal to something, you obtain a tax benefit equal to the amount of tax you would the amount of tax you would havehave paid on paid on that income at your tax rate. For example, if that income at your tax rate. For example, if you are on the top marginal tax rate of you are on the top marginal tax rate of 48.5%, claiming a $100 Tax deduction will 48.5%, claiming a $100 Tax deduction will produce a tax benefit of $48.50.produce a tax benefit of $48.50.

An offset is a credit against tax payable. If An offset is a credit against tax payable. If you are entitled to a $100 tax offset, your you are entitled to a $100 tax offset, your total tax bill will be reduced by the full $100.total tax bill will be reduced by the full $100.

Moving income between Moving income between entities on different tax ratesentities on different tax rates

The term “entity” has a very broad meaning The term “entity” has a very broad meaning and can include different people, companies and can include different people, companies and superannuation funds.and superannuation funds.

A common and very simple example of this is A common and very simple example of this is when a couple make income producing when a couple make income producing investments in the name of the partner on the investments in the name of the partner on the lower tax rate, often a non-employed spouse.lower tax rate, often a non-employed spouse.

More complex strategies may involve More complex strategies may involve structures like a discretionary trust, the structures like a discretionary trust, the trustee may be able to choose the best way to trustee may be able to choose the best way to distribute income between several distribute income between several beneficiaries which may include people or beneficiaries which may include people or companies.companies.

Moving income between tax Moving income between tax yearsyears There are many ways to move income between There are many ways to move income between

tax years. If you are working now but likely not tax years. If you are working now but likely not to be working in a few years (retired, holiday, ill to be working in a few years (retired, holiday, ill etc), then you may be on a lower tax rate then. etc), then you may be on a lower tax rate then. It might be sensible to defer the sale of any It might be sensible to defer the sale of any assets trading at a capital gain until the lower assets trading at a capital gain until the lower income year.income year.

Other times, people may wish to bring forward Other times, people may wish to bring forward income if they expect a substantial increase in income if they expect a substantial increase in taxable income in the future.taxable income in the future.

A powerful way to move income from this tax A powerful way to move income from this tax year into a tax year that may be many years year into a tax year that may be many years from now is to invest in an agribusiness scheme.from now is to invest in an agribusiness scheme.

More tax efficient investingMore tax efficient investing One of the biggest expenses to a successful One of the biggest expenses to a successful

investor is capital gains tax (CGT). investor is capital gains tax (CGT). Every time you sell an eligible asset at a Every time you sell an eligible asset at a

profit, you need to remit part of that gain to profit, you need to remit part of that gain to the Australian Tax Office as CGT.the Australian Tax Office as CGT.

A discount of 50% applies if you hold the A discount of 50% applies if you hold the asset for more than one year, so medium to asset for more than one year, so medium to long term investments are vastly more tax long term investments are vastly more tax efficient than shorter term trades.efficient than shorter term trades.

Many people overlook the fact that if you Many people overlook the fact that if you defer the defer the realisationrealisation of a capital gain you get of a capital gain you get to keep your to keep your unrealisedunrealised tax debt in the tax debt in the market earning you dividends. There is market earning you dividends. There is actually a small but significant increase in actually a small but significant increase in your effective rate of return if you can keep your effective rate of return if you can keep portfolio turnover down.portfolio turnover down.

Managed funds and tax Managed funds and tax efficiencyefficiency It pays to check on the tax efficiency of any It pays to check on the tax efficiency of any

managed fund you are thinking of investing in. managed fund you are thinking of investing in. Some funds have a relatively low portfolio Some funds have a relatively low portfolio

turnover and tend to actively manage their turnover and tend to actively manage their taxable distributions to reduce the tax burden taxable distributions to reduce the tax burden to their investors. to their investors.

Other funds trade excessively, and make huge Other funds trade excessively, and make huge distributions every year, much of it non-distributions every year, much of it non-discountable short term capital gains.discountable short term capital gains.

Obtaining such information isn’t easy if you are Obtaining such information isn’t easy if you are a general member of the public, this is where a a general member of the public, this is where a good financial advisor can be of assistance.good financial advisor can be of assistance.

Tax offsetsTax offsets There are so many different tax offsets that There are so many different tax offsets that

you should talk to an accountant to see you should talk to an accountant to see which ones you can claim.which ones you can claim.

Common ones include franking credits on Common ones include franking credits on share dividends, low income tax offset, share dividends, low income tax offset, Senior Australian’s Tax Offset, spouse Senior Australian’s Tax Offset, spouse superannuation contributions offset, superannuation contributions offset, personal super contributions offset, personal super contributions offset, dependent spouse offset, family tax benefits dependent spouse offset, family tax benefits part A and B, baby bonus and many more. part A and B, baby bonus and many more.

The three tax systems of The three tax systems of AustraliaAustralia

Personal income is taxed in Australia on a Personal income is taxed in Australia on a marginal tax rate system. The higher your marginal tax rate system. The higher your income, the higher the average rate of tax you income, the higher the average rate of tax you pay. Capital gains on assets held more than one pay. Capital gains on assets held more than one year are taxed at half of your marginal tax rate.year are taxed at half of your marginal tax rate.

Corporations in Australia pay a flat rate of tax on Corporations in Australia pay a flat rate of tax on income of 30%. No discounts apply to capital income of 30%. No discounts apply to capital gains.gains.

Superannuation funds pay tax of 15% on income Superannuation funds pay tax of 15% on income and 10% on long term capital gains. A and 10% on long term capital gains. A surcharge may also apply for contributions for surcharge may also apply for contributions for high income earners. high income earners.

Arguably GST is counted as a fourth tax system, Arguably GST is counted as a fourth tax system, but is outside the scope of this discussion as it but is outside the scope of this discussion as it has limited applicability to investment has limited applicability to investment strategies.strategies.

Personal tax rates for Australian residents Personal tax rates for Australian residents 2004/20052004/2005

Taxable incomeTaxable income Tax payable*Tax payable*

$0 to $6,000$0 to $6,000 NilNil

$6,001 to $6,001 to $21,600$21,600

$0 + 17% of excess over $0 + 17% of excess over $6,000$6,000

$21,601 to $21,601 to $58,000$58,000

$2,652 + 30% of excess $2,652 + 30% of excess over $21,600over $21,600

$58,001 to $58,001 to $70,000$70,000

$13,572 + 42% of excess $13,572 + 42% of excess over $58,000over $58,000

$70,000 plus$70,000 plus $18,612 + 47% of excess $18,612 + 47% of excess over $70,000over $70,000

* Medicare levy of 1.5% may also apply

Personal tax system cont’dPersonal tax system cont’d Contrary to what many people think, your marginal tax Contrary to what many people think, your marginal tax

rate is not equal to your average tax rate.rate is not equal to your average tax rate. For example, if your income is $80,000, you will be on For example, if your income is $80,000, you will be on

the top marginal tax rate. Including Medicare Levy, the top marginal tax rate. Including Medicare Levy, the marginal tax rate of such a taxpayer is 48.5%.the marginal tax rate of such a taxpayer is 48.5%.

The amount of tax actually paid by someone earning The amount of tax actually paid by someone earning $80,000 is $24,512 including Medicare Levy. This $80,000 is $24,512 including Medicare Levy. This works out to an works out to an effectiveeffective tax rate of about 31%. The tax rate of about 31%. The top marginal tax rate only applies on the last $10,000 top marginal tax rate only applies on the last $10,000 of income, though of course any additional income of income, though of course any additional income would be taxed at 48.5% and most tax planning that would be taxed at 48.5% and most tax planning that we do will be on dollars that would be taxed at the we do will be on dollars that would be taxed at the highest rate.highest rate.

For long term capital gains (asset held more than one For long term capital gains (asset held more than one year), the capital gain profit is first discounted by 50% year), the capital gain profit is first discounted by 50% and then added to assessable income at marginal tax and then added to assessable income at marginal tax rates.rates.

CompaniesCompanies Companies pay tax at a flat rate of 30%. This applies to Companies pay tax at a flat rate of 30%. This applies to

both income and capital gains.both income and capital gains. High income investors often buy investments in the High income investors often buy investments in the

name of a Pty Ltd company so they will be taxed at a name of a Pty Ltd company so they will be taxed at a maximum 30% on income, though investors need to maximum 30% on income, though investors need to take account of the fact that capital gains will always be take account of the fact that capital gains will always be taxed at 30%, rather than the effective top rate of taxed at 30%, rather than the effective top rate of 24.25% paid on long term gains earned in the name of 24.25% paid on long term gains earned in the name of a person.a person.

Companies are distinct tax entities recognised by the Companies are distinct tax entities recognised by the Tax Office, and can retain income and assets in their Tax Office, and can retain income and assets in their own name and need to lodge their own tax returns.own name and need to lodge their own tax returns.

A common tax planning strategy is to retain and A common tax planning strategy is to retain and reinvest income in a company, only drawing a dividend reinvest income in a company, only drawing a dividend when the shareholder’s tax bracket equals 30% or less. when the shareholder’s tax bracket equals 30% or less.

Companies can be used as an efficient “parking” Companies can be used as an efficient “parking” vehicle to defer personal income tax.vehicle to defer personal income tax.

Trusts and other structuresTrusts and other structures Unlike a person, company or a superannuation fund, Unlike a person, company or a superannuation fund,

trusts are not entities that pay tax. A trust is a trusts are not entities that pay tax. A trust is a “fiduciarial obligation” between a trustee and the “fiduciarial obligation” between a trustee and the beneficiaries.beneficiaries.

Investments can be made in the name of a trust, but Investments can be made in the name of a trust, but all income and capital gains must be distributed to all income and capital gains must be distributed to beneficiaries every year or the trustee will pay tax at beneficiaries every year or the trustee will pay tax at the top marginal tax rate on undistributed income.the top marginal tax rate on undistributed income.

A “fixed” trust is set up so that all beneficiaries get a A “fixed” trust is set up so that all beneficiaries get a fixed entitlement to the income, capital gains and fixed entitlement to the income, capital gains and capital of the trust. “Discretionary” trusts give the capital of the trust. “Discretionary” trusts give the trustee a lot of flexibility in determining how to make trustee a lot of flexibility in determining how to make distributions and offer significant tax planning distributions and offer significant tax planning opportunities.opportunities.

Beneficiaries of trusts can be people, companies, Beneficiaries of trusts can be people, companies, partnerships and other trusts.partnerships and other trusts.

SuperannuationSuperannuation Although the superannuation system is Although the superannuation system is

complicated and many people do not trust it, complicated and many people do not trust it, super is still one of the most tax efficient ways super is still one of the most tax efficient ways to build wealth.to build wealth.

You only pay 15% tax on income in a super You only pay 15% tax on income in a super fund and the capital gains tax rate on assets fund and the capital gains tax rate on assets held for more than a year is 10%.held for more than a year is 10%.

Another advantage of super is that this is one Another advantage of super is that this is one of the most difficult assets for a creditor to get of the most difficult assets for a creditor to get his hands on, so superannuation is ideally his hands on, so superannuation is ideally suited to business owners and professionals suited to business owners and professionals wanting a protected place to store their long wanting a protected place to store their long term savings.term savings.

Reasonable benefits limitsReasonable benefits limits Superannuation is an excellent savings vehicle for long Superannuation is an excellent savings vehicle for long

term retirement savings. The tax efficiency and the asset term retirement savings. The tax efficiency and the asset protection characteristics are so good that limits have protection characteristics are so good that limits have been introduced that stop very wealthy people from been introduced that stop very wealthy people from taking too much advantage of it.taking too much advantage of it.

A “reasonable benefits limit” (RBL) is the most one can A “reasonable benefits limit” (RBL) is the most one can take out of super while still obtaining maximum tax take out of super while still obtaining maximum tax concessions.concessions.

The lump sum RBL is $619,223 in the 2004/05 tax year. The lump sum RBL is $619,223 in the 2004/05 tax year. This figure is indexed each year with inflation.This figure is indexed each year with inflation.

You can access a higher RBL, the “pension RBL” by You can access a higher RBL, the “pension RBL” by putting at least half your benefit into certain “complying” putting at least half your benefit into certain “complying” income streams. The pension RBL is $1,238,440 in income streams. The pension RBL is $1,238,440 in 2004/05. The pension RBL is higher to encourage people 2004/05. The pension RBL is higher to encourage people to convert their super into pensions that will last at least to convert their super into pensions that will last at least for their life expectancy, rather than withdrawing it and for their life expectancy, rather than withdrawing it and spending it in a short period of time.spending it in a short period of time.

Withdrawing from super – lump Withdrawing from super – lump sumssums

There are various components of super which are all taxed There are various components of super which are all taxed differently (we’ll gloss over the complexities in this differently (we’ll gloss over the complexities in this presentation), the most common components are “Pre 83”, presentation), the most common components are “Pre 83”, “Post 83” and “Undeducted”.“Post 83” and “Undeducted”.

5% of Pre 83 money withdrawn from a super fund is taxed at 5% of Pre 83 money withdrawn from a super fund is taxed at marginal tax rates. 95% is tax free.marginal tax rates. 95% is tax free.

In the 2004/05 tax year, you can withdraw $123,808 of “post In the 2004/05 tax year, you can withdraw $123,808 of “post 83” money from a superannuation fund before having to pay 83” money from a superannuation fund before having to pay any tax on this lump sum. This figure is indexed upwards any tax on this lump sum. This figure is indexed upwards every year. The balance of lump sum withdrawals is taxed every year. The balance of lump sum withdrawals is taxed at 15% (+ 1.5% Medicare), subject to reasonable benefits at 15% (+ 1.5% Medicare), subject to reasonable benefits limits.limits.

Undeducted components can be withdrawn from super tax Undeducted components can be withdrawn from super tax free.free.

Pre and Post 83 untaxed amounts withdrawn in excess of Pre and Post 83 untaxed amounts withdrawn in excess of your reasonable benefit limit are taxed at 47% plus your reasonable benefit limit are taxed at 47% plus Medicare, post 83 taxed amounts drawn as a lump sum in Medicare, post 83 taxed amounts drawn as a lump sum in excess of your RBL are taxed at 38%.excess of your RBL are taxed at 38%.

Withdrawing from super – income Withdrawing from super – income streamsstreams

Income streams are taxed at marginal tax rates, Income streams are taxed at marginal tax rates, minus a 15% superannuation pension tax offset. minus a 15% superannuation pension tax offset. The earnings within the fund itself are tax free The earnings within the fund itself are tax free once the fund begins paying an income stream.once the fund begins paying an income stream.

Undeducted components create a “deductible” Undeducted components create a “deductible” amount of the income stream that is tax exempt. amount of the income stream that is tax exempt. The size of the deductible component varies The size of the deductible component varies depending on the type of income stream, the term depending on the type of income stream, the term of the payments and your life expectancy.of the payments and your life expectancy.

Pre and Post 83 money withdrawn in the form of an Pre and Post 83 money withdrawn in the form of an income stream that is in excess of the Reasonable income stream that is in excess of the Reasonable Benefits Limit is taxed at normal marginal tax Benefits Limit is taxed at normal marginal tax rates, but doesn’t attract the 15% pension tax rates, but doesn’t attract the 15% pension tax offset.offset.

Superannuation contributions Superannuation contributions surchargesurcharge

If your “adjusted taxable income” (ATI) exceeds If your “adjusted taxable income” (ATI) exceeds certain thresholds, an additional tax is paid on certain thresholds, an additional tax is paid on contributions to superannuation. This tax does contributions to superannuation. This tax does not affect earnings, just contributions.not affect earnings, just contributions.

Adjusted taxable income is your total Adjusted taxable income is your total remuneration, which includes salary, remuneration, which includes salary, superannuation contributions and fringe superannuation contributions and fringe benefits.benefits.

If your ATI exceeds $99,710 (2004/05 tax year, If your ATI exceeds $99,710 (2004/05 tax year, figure is indexed annually), you may be liable to figure is indexed annually), you may be liable to pay some surcharge on your contributions. This pay some surcharge on your contributions. This surcharge rate increases from 0 to 14.5% when surcharge rate increases from 0 to 14.5% when your ATI reaches $121,075. Below $94,691 your ATI reaches $121,075. Below $94,691 surcharge is zero, above $121,075 it is 14.5%. If surcharge is zero, above $121,075 it is 14.5%. If your ATI is inside this range, a formula will apply.your ATI is inside this range, a formula will apply.

Superannuation contributions Superannuation contributions surcharge cont’dsurcharge cont’d

Surcharge rate = (ATI - $99,710)/1,709.2. Surcharge rate = (ATI - $99,710)/1,709.2. (in the 2004/05 tax year)(in the 2004/05 tax year)

For example, if your ATI is $110,000, your For example, if your ATI is $110,000, your surcharge rate will be 6.02036%. Note surcharge rate will be 6.02036%. Note that surcharge rates are always worked that surcharge rates are always worked out to 5 decimal places.out to 5 decimal places.

If your remuneration was $85,000 salary If your remuneration was $85,000 salary plus $25,000 super, you’d pay 6.02036% plus $25,000 super, you’d pay 6.02036% x $25,000 = $1,505.09 in surcharge, in x $25,000 = $1,505.09 in surcharge, in addition to the $3,750 (15% x $25,000) addition to the $3,750 (15% x $25,000) you would have paid anyway in you would have paid anyway in “contributions tax”.“contributions tax”.

Strategies for obtaining tax Strategies for obtaining tax deductions:deductions:

Salary packaging or direct deductions of Salary packaging or direct deductions of business expenses (if eligible).business expenses (if eligible).

Claiming work, transport and some self-Claiming work, transport and some self-education expenses as deductions.education expenses as deductions.

Negative gearing (in fact, any gearing).Negative gearing (in fact, any gearing). Deductions associated with property Deductions associated with property

(depreciation allowances etc).(depreciation allowances etc). Agribusiness.Agribusiness.

Salary packagingSalary packaging A “salary sacrifice” arrangement is a deal A “salary sacrifice” arrangement is a deal

agreed to between an employee and an agreed to between an employee and an employer to swap some cash salary for employer to swap some cash salary for another type of non-cash benefit.another type of non-cash benefit.

You would do this because taking You would do this because taking remuneration in the form of a non-cash remuneration in the form of a non-cash benefit often means you don’t have to pay benefit often means you don’t have to pay income tax on that benefit.income tax on that benefit.

When you negotiate a remuneration When you negotiate a remuneration scheme with an employer that includes scheme with an employer that includes salary sacrifice, this is called a “salary salary sacrifice, this is called a “salary package”.package”.

Salary packaging cont’dSalary packaging cont’d You can salary package virtually anything, You can salary package virtually anything,

but to stop abusive arrangements there is but to stop abusive arrangements there is an extra tax paid by the an extra tax paid by the employeremployer called called Fringe Benefits Tax. (FBT)Fringe Benefits Tax. (FBT)

The amount of FBT paid on items that The amount of FBT paid on items that attract the full rate of FBT is calculated such attract the full rate of FBT is calculated such that the employer pays the same amount of that the employer pays the same amount of tax as if you had received it yourself and tax as if you had received it yourself and paid the top marginal tax rate (48.5%). paid the top marginal tax rate (48.5%). Naturally, the employer will have to pass Naturally, the employer will have to pass this cost on to you and so you would gain no this cost on to you and so you would gain no benefit on many packaged items.benefit on many packaged items.

Salary packaging cont’dSalary packaging cont’d Some benefits attract no FBT, some attract a Some benefits attract no FBT, some attract a

partial amount of FBT and some the full rate of partial amount of FBT and some the full rate of FBT. There is a tax saving if you take FBT FBT. There is a tax saving if you take FBT exempt items or items that attract FBT at a exempt items or items that attract FBT at a concessional rate.concessional rate.

Common FBT exempt benefits: Common FBT exempt benefits: superannuation, employee share schemes, superannuation, employee share schemes, laptop computers, mobile phones and many laptop computers, mobile phones and many benefits that would be “otherwise deductible”. benefits that would be “otherwise deductible”.

The most commonly packaged benefit that The most commonly packaged benefit that attracts a concessional rate of FBT is a car. attracts a concessional rate of FBT is a car. Depending on what you use the car for and Depending on what you use the car for and how far you drive it every year, there can be a how far you drive it every year, there can be a substantial tax saving for salary packaging a substantial tax saving for salary packaging a car, usually with some sort of lease car, usually with some sort of lease arrangement.arrangement.

Maximum deductible Maximum deductible contributionscontributions

An employer can only An employer can only package a limited package a limited amount of income into amount of income into superannuation and superannuation and claim a tax deduction on claim a tax deduction on it. This limit is called the it. This limit is called the Age Based Limit, and the Age Based Limit, and the maximum contribution maximum contribution on which deductions can on which deductions can be claimed is called a be claimed is called a Maximum Deductible Maximum Deductible Contribution (MDC).Contribution (MDC).

AgeAge ABLABL MDC*MDC*< 35< 35 $13,934$13,934 $16,912$16,91235 – 35 – 4949

$38,702$38,702 $49,936$49,936

5050 $94,980$94,980 $126,30$126,3066

* Self employed and unsupported people can claim a tax deduction on 100% of the first $5,000 contributed and 75% of the balance. Employers can claim a 100% tax deduction on all contributions for their employees up to the employee’s age based limit.

Income splittingIncome splitting Income splitting is a very common strategy and is Income splitting is a very common strategy and is

often quite easy to implement.often quite easy to implement. If you can make investments in the name of a If you can make investments in the name of a

spouse on a lower marginal tax rate (for example, spouse on a lower marginal tax rate (for example, buy shares, managed funds or invest in term buy shares, managed funds or invest in term deposits) then obviously less tax will be paid than if deposits) then obviously less tax will be paid than if investments are made in the name of the person on investments are made in the name of the person on the higher tax rate.the higher tax rate.

Discretionary trusts allow a trustee to split income in Discretionary trusts allow a trustee to split income in a very flexible manner, being able to potentially a very flexible manner, being able to potentially choose from a number of beneficiaries.choose from a number of beneficiaries.

Note that there are special high tax rates for minors Note that there are special high tax rates for minors that receive “unearned income”, these tax rates run that receive “unearned income”, these tax rates run as high as 66%. The tax free threshold for a person as high as 66%. The tax free threshold for a person under 18 years is only $416, but with the low income under 18 years is only $416, but with the low income tax offset it effectively rises to about $643.tax offset it effectively rises to about $643.

Income splitting continuedIncome splitting continuedYou can income split by investing in the You can income split by investing in the name of a person on a lower marginal name of a person on a lower marginal tax rate or, provided you have sufficient tax rate or, provided you have sufficient investment income to make paying the investment income to make paying the extra accounting costs worthwhile, you extra accounting costs worthwhile, you can invest via a discretionary trust that can invest via a discretionary trust that allows you to decide every year who gets allows you to decide every year who gets income and capital gains distributions.income and capital gains distributions.

Negative gearingNegative gearing ““Gearing” is the practice of borrowing money for Gearing” is the practice of borrowing money for

investments like shares or property. “Negative investments like shares or property. “Negative gearing” is where the amount of income received gearing” is where the amount of income received from the investment is less than the interest from the investment is less than the interest expense. You claim the shortfall as a tax deduction. expense. You claim the shortfall as a tax deduction. You can also do “positive gearing” where the income You can also do “positive gearing” where the income exceeds the interest and if you are able to balance exceeds the interest and if you are able to balance the cost it would be called “neutral gearing”.the cost it would be called “neutral gearing”.

Negative gearing is particularly tax efficient because Negative gearing is particularly tax efficient because while the interest shortfall is 100% tax deductible, while the interest shortfall is 100% tax deductible, the capital gain (assuming there is one) will only the capital gain (assuming there is one) will only ever be taxed at half your marginal tax rate if you ever be taxed at half your marginal tax rate if you hold for more than one year. When you run the hold for more than one year. When you run the numbers on this, the amount of return you need on numbers on this, the amount of return you need on your growth investments is less in a simple your growth investments is less in a simple percentage term than the interest rate on your loan.percentage term than the interest rate on your loan.

Negative gearing continuedNegative gearing continued Negative gearing is not a tax planning strategy Negative gearing is not a tax planning strategy

as such, it is a tax efficient wealth building as such, it is a tax efficient wealth building strategy. strategy.

It is important to note that when you borrow to It is important to note that when you borrow to invest you introduce extra risks related to your invest you introduce extra risks related to your ability to service the debt and a greater level ability to service the debt and a greater level of exposure to market risk due to the larger of exposure to market risk due to the larger portfolio. Some forms of borrowing introduce portfolio. Some forms of borrowing introduce other risks as well, like the risk of margin calls.other risks as well, like the risk of margin calls.

Unless you borrow vast amounts of money it is Unless you borrow vast amounts of money it is unlikely that the size of the tax deductions will unlikely that the size of the tax deductions will be large enough to make a serious dent on be large enough to make a serious dent on your assessable income. That is why I don’t your assessable income. That is why I don’t classify this as a pure tax planning strategy.classify this as a pure tax planning strategy.

Gearing and riskGearing and risk Although the profits can be fantastic, the risks of Although the profits can be fantastic, the risks of

gearing should not be ignored.gearing should not be ignored. Borrowing $100,000 to invest means you have Borrowing $100,000 to invest means you have

$100,000 at risk in the market. If there is a $100,000 at risk in the market. If there is a decline of 30%, and declines of this size are decline of 30%, and declines of this size are common in both shares and property, you would common in both shares and property, you would lose $30,000. If you need to sell the investment lose $30,000. If you need to sell the investment you may end up with a debt you can’t afford to you may end up with a debt you can’t afford to pay back.pay back.

There is also interest rate risk, if rates rise There is also interest rate risk, if rates rise significantly people can get themselves in lots of significantly people can get themselves in lots of trouble if they have borrowed too much.trouble if they have borrowed too much.

It is important to always consider whether you It is important to always consider whether you are in any position to accept the chance of are in any position to accept the chance of losses before you invest.losses before you invest.

Pre-paying interestPre-paying interest It is legal to claim a tax deduction on expenses It is legal to claim a tax deduction on expenses

for interest as much as 13 months ahead. for interest as much as 13 months ahead. A common strategy that people use toward the A common strategy that people use toward the

end of the financial year is to pre-pay interest to end of the financial year is to pre-pay interest to a lender. This results in bringing forward tax a lender. This results in bringing forward tax deductions that would otherwise be incurred in deductions that would otherwise be incurred in the next financial year (but since the dividends the next financial year (but since the dividends from the investment haven’t been received they from the investment haven’t been received they won’t add to assessable income until next year).won’t add to assessable income until next year).

Most lenders that allow you to pre-pay interest Most lenders that allow you to pre-pay interest also give a discount on the interest for doing so, also give a discount on the interest for doing so, so not only do you save tax, you also pay less so not only do you save tax, you also pay less interest.interest.

Capitalising interestCapitalising interest Some lenders enable you to “capitalise” Some lenders enable you to “capitalise”

the interest, which means they just keep the interest, which means they just keep adding the interest to the account balance adding the interest to the account balance owing (up to an approved credit limit).owing (up to an approved credit limit).

The loan balance will keep growing, The loan balance will keep growing, increasing your tax deductions. You can increasing your tax deductions. You can use the cash to either buy more assets or use the cash to either buy more assets or to pay off another loan with a higher to pay off another loan with a higher interest rate or a non-deductible personal interest rate or a non-deductible personal loan.loan.

Capitalising interest is sometimes called Capitalising interest is sometimes called “double negative gearing.”“double negative gearing.”

Tax deductible managed Tax deductible managed investment schemes (MISs)investment schemes (MISs)

Some investments in primary Some investments in primary production schemes are tax production schemes are tax deductible. Normally these types of deductible. Normally these types of investment are in the agriculture or investment are in the agriculture or film industries, though there are all film industries, though there are all sorts of other schemes.sorts of other schemes.

You claim a tax deduction of up to You claim a tax deduction of up to 100% of your initial application money, 100% of your initial application money, but when the project matures you’ll be but when the project matures you’ll be taxed on 100% of the return.taxed on 100% of the return.

Example: AgribusinessExample: Agribusiness The most common type of tax deductible The most common type of tax deductible

investment is tree farming (silviculture). investment is tree farming (silviculture). There are many crops available including There are many crops available including eucalyptus hardwood, pine, sandalwood, eucalyptus hardwood, pine, sandalwood, paulownia and a number of other exotic paulownia and a number of other exotic timbers.timbers.

Also popular are horticultural crops Also popular are horticultural crops ranging from citrus and tropical fruits ranging from citrus and tropical fruits through to olives, almonds, grapes and through to olives, almonds, grapes and some other crops like wildflowers, some other crops like wildflowers, ginseng, coffee and truffles.ginseng, coffee and truffles.

Hardwood tree farmingHardwood tree farmingThe most popular type of agribusiness The most popular type of agribusiness scheme, and arguably the least risky, is scheme, and arguably the least risky, is eucalyptus tree farming. There are longer eucalyptus tree farming. There are longer term projects (about 20 years) where the term projects (about 20 years) where the wood is grown for sawlog timber and veneer, wood is grown for sawlog timber and veneer, and medium term projects (just over 10 and medium term projects (just over 10 years), where the wood is grown for chipping years), where the wood is grown for chipping for the production of paper.for the production of paper.

This sector does in fact receive a high degree This sector does in fact receive a high degree of government support, as it presents a more of government support, as it presents a more environmentally friendly alternative to logging environmentally friendly alternative to logging native forests and creates valuable export native forests and creates valuable export revenue and employment in rural areas.revenue and employment in rural areas.

How a typical blue gum project How a typical blue gum project worksworks

Claim a 100% tax deduction for planting expenses Claim a 100% tax deduction for planting expenses (about $5,000 - $8,000 per hectare is common).(about $5,000 - $8,000 per hectare is common).

The blue gums grow for 10 – 12 years, the project The blue gums grow for 10 – 12 years, the project manager looks after the trees and then arranges manager looks after the trees and then arranges the harvest. Depending on the up-front the harvest. Depending on the up-front payments, there may also be deductible ongoing payments, there may also be deductible ongoing management fees.management fees.

When the wood is harvested, you receive the When the wood is harvested, you receive the proceeds as fully taxable income.proceeds as fully taxable income.

Investment characteristics of Investment characteristics of agribusinessagribusiness

No liquidity. You usually have to wait more than ten years No liquidity. You usually have to wait more than ten years for a return (though some projects are shorter term).for a return (though some projects are shorter term).

Moderately high risk: fire, flood, currency movements, Moderately high risk: fire, flood, currency movements, price movements of the commodity.price movements of the commodity.

Return data is often hard to find, but a good agribusiness Return data is often hard to find, but a good agribusiness project should produce returns at least as high as project should produce returns at least as high as equities. equities.

Not really tax efficient if you are on the same or a higher Not really tax efficient if you are on the same or a higher marginal tax rate when you get the harvest. Ideally you marginal tax rate when you get the harvest. Ideally you would want to invest in them while you are earning good would want to invest in them while you are earning good money and paying tax at the top marginal tax rate, but money and paying tax at the top marginal tax rate, but retired in the year of the harvest. This is an example of retired in the year of the harvest. This is an example of moving income from one tax year to another to take moving income from one tax year to another to take advantage of lower marginal tax rates.advantage of lower marginal tax rates.

““Mortgage accelerator” Mortgage accelerator” strategystrategy Interest incurred on a loan to buy into an Interest incurred on a loan to buy into an

agribusiness scheme is usually tax agribusiness scheme is usually tax deductible.deductible.

If you have non-deductible debts their after If you have non-deductible debts their after tax cost can be nearly twice as much as tax cost can be nearly twice as much as deductible debts, for an investor paying the deductible debts, for an investor paying the 48.5% marginal tax rate.48.5% marginal tax rate.

A common strategy is to take out a loan for A common strategy is to take out a loan for an agribusiness investment and use the tax an agribusiness investment and use the tax refund to pay off a non-deductible debt. The refund to pay off a non-deductible debt. The after tax interest bill is basically the same as after tax interest bill is basically the same as before except now you have an agribusiness before except now you have an agribusiness investment and future cash flow advantages.investment and future cash flow advantages.

Dodgy schemes and the ATODodgy schemes and the ATO ““Tax effective” investments have become notorious in the Tax effective” investments have become notorious in the

last few years following a widely last few years following a widely publicisedpublicised crackdown by the crackdown by the Australian Tax Office (ATO).Australian Tax Office (ATO).

Many schemes were put together by accountants and Many schemes were put together by accountants and lawyers purely for the tax deductions. Various “creative” lawyers purely for the tax deductions. Various “creative” accounting tricks were employed so “investors” were able to accounting tricks were employed so “investors” were able to claim tax deductions several times larger than the amount claim tax deductions several times larger than the amount actually invested! actually invested!

As a profit was made just from the tax dodge, the crop was As a profit was made just from the tax dodge, the crop was just a sideshow. Far greater effort was put into finding ways just a sideshow. Far greater effort was put into finding ways to increase the tax deductions than to research the to increase the tax deductions than to research the commercial viability of the crop. Result: too many tea trees commercial viability of the crop. Result: too many tea trees were planted, the price of tea tree oil fell below harvest and were planted, the price of tea tree oil fell below harvest and extraction costs, some blue gum plantations were made on extraction costs, some blue gum plantations were made on cheap marginal land where the trees didn’t grow well. Many cheap marginal land where the trees didn’t grow well. Many other crops simply failed to meet prospectus projections.other crops simply failed to meet prospectus projections.

The ATO cracked down on these, and disallowed tax The ATO cracked down on these, and disallowed tax deductions. There is now a “product ruling” system where deductions. There is now a “product ruling” system where the ATO certify that they will allow the tax deduction on the ATO certify that they will allow the tax deduction on approved projects provided they comply with the ATO’s approved projects provided they comply with the ATO’s conditions.conditions.

How to get out of paying the How to get out of paying the superannuation contributions superannuation contributions

surchargesurcharge High income earners that salary sacrifice a High income earners that salary sacrifice a

significant amount of income to significant amount of income to superannuation will find that they are paying superannuation will find that they are paying a significant amount of superannuation a significant amount of superannuation contributions surcharge.contributions surcharge.

By claiming a few tax deductions they may By claiming a few tax deductions they may be able to reduce their adjusted taxable be able to reduce their adjusted taxable income to below the $99,710 threshold and income to below the $99,710 threshold and thus no longer have to pay surcharge.thus no longer have to pay surcharge.

Common deductions claimed include Common deductions claimed include negative gearing strategies and agribusiness.negative gearing strategies and agribusiness.

When salary packaging a significant amount of When salary packaging a significant amount of money into superannuation, high income investors money into superannuation, high income investors can pay a significant amount of super contributions can pay a significant amount of super contributions surcharge.surcharge.

If your income is not too far above the upper If your income is not too far above the upper surcharge threshold and you are putting a lot of surcharge threshold and you are putting a lot of money into super, the amount of surcharge you money into super, the amount of surcharge you can save by claiming a tax deduction can often can save by claiming a tax deduction can often come close to paying for the agribusiness come close to paying for the agribusiness investment!investment!

For some investors taking maximum advantage of For some investors taking maximum advantage of salary packaging as well as agribusiness extremely salary packaging as well as agribusiness extremely high effective rates of return can be achieved due high effective rates of return can be achieved due to the very small net after tax outlays required to the very small net after tax outlays required after factoring in surcharge and other tax savings.after factoring in surcharge and other tax savings.

Timing and netting of capital Timing and netting of capital gainsgains If you can hold on to your taxable capital If you can hold on to your taxable capital

gains as long as possible, you will obtain gains as long as possible, you will obtain a benefit by having that money invested a benefit by having that money invested in the markets. Effectively an unrealised in the markets. Effectively an unrealised capital gain contains an “interest free capital gain contains an “interest free loan” from the Australian Tax Office.loan” from the Australian Tax Office.

The longer you get to hold on to that The longer you get to hold on to that gain, the longer you’ll be able to earn gain, the longer you’ll be able to earn dividends and further growth on that dividends and further growth on that money.money.

Therefore, methods that delay the Therefore, methods that delay the realisation of capital gains tax can realisation of capital gains tax can produce significant benefits.produce significant benefits.

Netting capital gainsNetting capital gains If you sell an asset at a capital loss, you can only If you sell an asset at a capital loss, you can only

offset that loss against a capital gain. Generally, you offset that loss against a capital gain. Generally, you can’t claim a capital loss as a direct tax deduction. can’t claim a capital loss as a direct tax deduction. Capital loss credits can be carried forward as long as Capital loss credits can be carried forward as long as is necessary for them to be used up.is necessary for them to be used up.

Capital gains and losses are “netted”. Each year you Capital gains and losses are “netted”. Each year you pay capital gains tax on the total capital gains minus pay capital gains tax on the total capital gains minus the total capital losses.the total capital losses.

While it is sensible to defer the realisation of capital While it is sensible to defer the realisation of capital gains, the same can not be said of capital losses. In gains, the same can not be said of capital losses. In fact, a capital loss is a valuable asset for tax planning fact, a capital loss is a valuable asset for tax planning purposes and if possible should be realised. These purposes and if possible should be realised. These losses can then be used to offset any sales you intend losses can then be used to offset any sales you intend to make at a profit. By being quick to realise losses to make at a profit. By being quick to realise losses and slow to take profits you can delay the ultimate and slow to take profits you can delay the ultimate paying of capital gains tax for a very long time.paying of capital gains tax for a very long time.

If you still like that particular asset, you could buy it If you still like that particular asset, you could buy it back a short time later.back a short time later.

Deductible superannuation Deductible superannuation contributionscontributions

Employees can’t claim a tax deduction on their Employees can’t claim a tax deduction on their personal contributions, they must use salary sacrifice.personal contributions, they must use salary sacrifice.

If you are self employed, or “unsupported”, you may If you are self employed, or “unsupported”, you may be able to claim a tax deduction on some or all of be able to claim a tax deduction on some or all of your superannuation contributions.your superannuation contributions.

A common post-retirement strategy is for people to A common post-retirement strategy is for people to liquidate their ordinary investment portfolio and claim liquidate their ordinary investment portfolio and claim a tax deduction on contributions to superannuation, a tax deduction on contributions to superannuation, to eliminate their capital gains tax liabilities.to eliminate their capital gains tax liabilities.

The same strategy could be employed to reduce the The same strategy could be employed to reduce the tax liability on the harvest from an agribusiness tax liability on the harvest from an agribusiness project.project.

Note that rules apply specifying who can and can not Note that rules apply specifying who can and can not make contributions to superannuation, there are a make contributions to superannuation, there are a variety of tests of age and employment activity.variety of tests of age and employment activity.

Superannuation co-Superannuation co-contributionscontributions This year a new incentive was introduced to encourage This year a new incentive was introduced to encourage

lower income taxpayers to make voluntary contributions to lower income taxpayers to make voluntary contributions to their super.their super.

This scheme is called the “co-contribution”, and involves the This scheme is called the “co-contribution”, and involves the government matching your contributions up to a maximum government matching your contributions up to a maximum of $1,500pa.of $1,500pa.

The amount of the co-contribution depends on your taxable The amount of the co-contribution depends on your taxable income, and is at a maximum for people with income and income, and is at a maximum for people with income and reportable fringe benefits below $28,000, reducing by 5c in reportable fringe benefits below $28,000, reducing by 5c in the dollar as your income exceeds this, cutting out at the dollar as your income exceeds this, cutting out at $58,000. $58,000.

Co-contribution = the lesser of your voluntary contribution Co-contribution = the lesser of your voluntary contribution and $1,500 – 0.05 x ($income&FB - $28,000). If the and $1,500 – 0.05 x ($income&FB - $28,000). If the formula gives rise to a number below $20, the tax office will formula gives rise to a number below $20, the tax office will pay $20.pay $20.

The obvious beneficiaries would be lower income The obvious beneficiaries would be lower income employees, but the main beneficiaries are likely to be part-employees, but the main beneficiaries are likely to be part-time working spouses and semi-retired people.time working spouses and semi-retired people.

Co-contributions replace the old $100 super contributions Co-contributions replace the old $100 super contributions rebate. Obviously this benefit is a lot more generous than rebate. Obviously this benefit is a lot more generous than the one it replaces.the one it replaces.

One possible downside of tax One possible downside of tax planningplanning

Before implementing any tax planning strategy, Before implementing any tax planning strategy, you need to consider the costs of doing so. Such you need to consider the costs of doing so. Such costs include accounting, legal and advisor fees.costs include accounting, legal and advisor fees.

The benefits of implementing a sophisticated The benefits of implementing a sophisticated strategy may not be worth the bother in terms of strategy may not be worth the bother in terms of time and money spent on creating and time and money spent on creating and maintaining the strategy unless you have a fairly maintaining the strategy unless you have a fairly high income and/or a big portfolio. (Especially high income and/or a big portfolio. (Especially when creating tax structures like companies and when creating tax structures like companies and trusts.)trusts.)

On the other hand, there are a number of simple On the other hand, there are a number of simple strategies that can be relatively easily and strategies that can be relatively easily and cheaply implemented.cheaply implemented.

SummarySummary There do exist legal and acceptable methods There do exist legal and acceptable methods

for reducing tax, but tax planning should only for reducing tax, but tax planning should only ever be of secondary importance behind ever be of secondary importance behind wealth/retirement planning.wealth/retirement planning.

Some tax planning methods are very Some tax planning methods are very powerful, a combination of negative gearing, powerful, a combination of negative gearing, salary packaging and agribusiness can reduce salary packaging and agribusiness can reduce the amount of tax paid to very low levels, but the amount of tax paid to very low levels, but sometimes just taking the money and paying sometimes just taking the money and paying income tax on it is the better long term income tax on it is the better long term strategy.strategy.

An accountant and a financial planner can An accountant and a financial planner can assist in implementing all of the strategies assist in implementing all of the strategies mentioned here, plus many others.mentioned here, plus many others.

Disclaimer:Disclaimer:The material in this presentation does not The material in this presentation does not represent a recommendation of any represent a recommendation of any particular security, strategy or investment particular security, strategy or investment product. The author's opinions are subject to product. The author's opinions are subject to change without notice. Information change without notice. Information contained herein has been obtained from contained herein has been obtained from sources believed to be reliable, but is not sources believed to be reliable, but is not guaranteed. This article is distributed for guaranteed. This article is distributed for educational purposes and should not be educational purposes and should not be considered investment advice or an offer of considered investment advice or an offer of any security for sale. Investors should seek any security for sale. Investors should seek the advice of their own qualified advisor the advice of their own qualified advisor before investing in any securities.before investing in any securities.