Economic update : the state of the economy and the markets leading up to the Federal Budget

The budget is coming.  With just two weeks to go it looks like, the Government will deliver a budget with a strong long term outlook and an amount of short-term pain including the introduction of a debt levy. Not surprising really given the state of the domestic economy and the sheer number of baby boomers that will leave the workforce in coming years.  

Over the last three months, our economy has behaved with relative stability.

The last quarter, and in particular, the last month has seen the Australian dollar rise adding more pressure to rebalance the domestic economy. On the flip side, housing prices have continued to rise over the quarter combined with an increasing level of building approvals showing confidence is certainly in place.

Interest rates have remained unchanged throughout the quarter at 2.50% and RBA Governor, Glenn Stevens has commented that further rate cuts are unlikely in the short term. The board appear more comfortable with the global outlook and are predicting a reasonable pick-up this year. In Australia, the housing market has rallied in recent months and household spending has continued to increase, encouraged by our historically low interest rates.

In international markets, the US and Euro Regions have shown improvements in recent months. The US Federal Reserve made the announcement in March to reduce asset purchases by a further $10 billion a month to $55 billion. Following on from this announcement, US 3-year and 10-year Government Bond Yields rose by 0.07% and 0.32% respectively.

Overall International Bonds outperformed global equities in March, with the Barclays Global Aggregate (Hedged) $A Index increasing by 0.31%. Treasury stocks and corporate bonds gained by 0.35% and 0.36% respectively for the month.

Australian equities posted modest gains in March, with the ASX 300 rising 0.21% for the month. Commodity prices declined by 2.0% for the month in terms of Australian dollar terms, largely coming from the fall of iron ore, coking coal and steaming coal. On a market capitalisation basis, large company stocks performed better than smaller companies. The S&P / ASX 50 Leaders Index increased by 0.33% in March, while the S&P/ASX Small Ordinaries Index posted a loss of 1.16%.

On a sector basis, Financials (ex-Property) was the best performing and gained 2.92% in March. All the big four banks also recorded another round of strong gains in March. Materials and Healthcare were the weakest sectors declining by -2.89% and -2.07% respectively.

While residential dwelling investments continue to expand, commercial properties (office buildings and large shopping centre investments) declined over the month. The Australian Listed Property Market posted a loss of -1.58%.

In international equities, the Fed’s further decision to taper and indication that quantitative easing could end earlier (possibly within the next 6 months) has resulted in a more optimistic growth outlook. The MSCI North America (Local Currency) Index posted a small return of 0.68% in March.

The best performing region was India with 4.75% over the month due to political optimism. Japan was one of the worst performers losing -7.51% in the first quarter of 2014 due to the sudden 3% sales tax threatening to endanger their recovery.

China lost -1.74% and Europe reversed its previous months strong position and lost -0.65% in March.

Global resources performed poorly in the month with the FTSE Gold Mines Index and HSBC Global Mining Index declining by -11.14% and -5.42% respectively.

Over the coming three months we expect, if there are no sudden changes to the global environment….

1. A Federal Budget that takes some positive steps to reduce the deficit, cutting welfare payments to those not working and incentivising mothers into the workforce; and

2. A stable interest rate environment that is supportive of business and consumer confidence.

Superannuation earnings tax announced – good investment performance punished

“Stockholm syndrome is the psychological phenomenon where hostages express empathy and sympathy and have positive feelings toward their captors.  These feelings are generally considered irrational in light of the danger or risk endured by the victims, who essentially mistake a lack of abuse from their captors for an act of kindness” (Wikipedia).

As I read through today’s superannuation announcements I experienced a moment of deep gratitude that the Federal Government had been generous enough not to proceed with the most medieval of the options that had been on the table.  I then began to calculate the material disadvantage that will affect families to which these rules apply.  I realised that in my momentary relief, I had forgotten that surely every family in our democracy is entitled to have certainty of outcome under the set of rules that were represented by the Government of the day to apply to their self-funded retirement.  The more I considered the rules, the more I realised how poorly these rules will operate in practice.  Many other ordinary people will innocently get caught in the clutches of these rules at some point.  Make no mistake, as the compulsory Superannuation Guarantee charge increases from 9% to 12% some ordinary individuals will become hostage to these rules.

Superannuation pension earnings tax

From 1 July 2014, future earnings (such as dividends and interest) on assets supporting income streams will be tax free up to $100,000 a year (indexed in $10,000 increments), the balance of earnings will be taxed at 15%.  Remarkably, these rules punish good investment performance.  For example, the Government announcement points out that “(a)assuming a conservative estimated rate of return of 5%, earnings of $100,000 would be derived from individuals with around $2 million in superannuation.  Ergo, if my fund earns 10%, I will be subject to tax once my assets are at the $1 million level.  While the announcement is silent on this point, heaven help me if after 1 July 2014 I buy a capital asset and sit on it for 10 years and then realise a $1 million gain to fund my pension as a one-off.  How does this get taxed?  Will we be averaging over 10 years to $100,000 per year (safe) or is $900,000 of that gain fair game in the year of sale for the higher tax rate.  What about the small business owners that the Government encourages to put their business property into superannuation.  Is that an extra 10% clip of the ticket now when you make a gain on the sale of your warehouse?  Small business already has it hard enough.  If I held that business asset for 15 years outside of superannuation I would pay no tax.  Surely it was not intended that the superannuation system would be an inferior option.

Has the Government forgotten the GFC when there were double digit annual declines in return which depressed superannuation balances and for which superannuation pensioners were not compensated by the tax system.  Now if there is a 20-30% surge forward in one year do people who should not be punished by this system suddenly find they are subject to the system just as they earn their losses back?  Surely not.

I see the need for averaging, as well as extension of small business relief, as items that will rapidly get on the drafting agenda.

Pension withdrawals themselves will not be taxed.

Special transitional rules for capital gains

  • Special arrangements will apply for capital gains on assets purchased before 1 July 2014:For assets that were purchased before 5 April 2013, the reform will only apply to capital gains that accrue after 1 July 2024;
  • For assets that are purchased from 5 April 2013 to 30 June 2014, individuals will have the choice of applying the reform to the entire capital gain, or only that part that accrues after 1 July 2014; and
  • For assets that are purchased from 1 July 2014, the reform will apply to the entire capital gain.

Common sense arrives for “excessive contributions”

Many innocent people have been subject to a punitive rate of tax if they accidentally exceed their concessional contributions threshold.  They get taxed at 46.5% even if their personal tax rate is lower.  Moreover, if the excessive contribution was accidental, it has not been possible to withdraw the excess contribution and correct the error.  Pleasingly from 1 July 2013, it will be possible to withdraw the excessive contributions, be taxed at your ordinary rate with an interest charge on the benefit of a tax timing difference that arises because of the different tax payment dates of the superannuation fund.

In closing, the Government’s announced superannuation reforms are “less bad” than expected. Are we grateful that they are less bad?  Yes.  Can they unfairly single out and materially change the expected retirement income projections for taxpayers who have retired and generated asset balances around $1 million?  Yes, but only if they invest well.  Do they potentially punish people who have balances well under $1 million if they have a good year?  Yes.  Is mediocre performance more likely to avoid the tax than good performance?  Yes.  Oh dear.

Superannuation: Moving the goal posts halfway through the game

Feeling frustrated that the Government has put playing with super rules back on the table?  I have been inundated with calls from concerned clients over the last week asking me what to do.  In particular, one theme of exasperation has come through resoundingly:

“That’s the end for super for me – the Government is playing with the rules to basically take back any advantage when I eventually retire.  I don’t trust this or future Governments to treat me fairly.  Super is a honey pot they will go after.  Why would I lock my money away when the Government will keep changing the rules, keep raising the tax rates.  If they don’t get me now, they will get me by the time I’m 60.”I feel the same way too.  Cheated.  But my advice is not to run for the exits yet.  It is a fact of the superannuation system of the last 30+ years that it consistently outperforms other platforms for passive wealth generation for the risks involved.

The proposed new rules produce unequal results for different citizens based on “wealth”, they are manifestly unjust and frustrating because they fly in the face of the policy platform the Government took to the last election.  But hang in there.  Emotional decisions are rarely the best ones.  The law is not changing yet, may affect only a few, and there should be opportunity to take protective steps before any change if necessary.The most important announcement to be aware of is Prime Minister Julia Gillard’s announcement on 6 February 2013 that she wishes to increase the tax rate on superannuation earnings of the top 1% to a tax rate that could be as high as 30%.  Common sense suggests that ultimately it is unlikely to be that high given this is a change that would cripple people’s long term retirement savings plans.  “Absolutes” such as “top 1%” also tend to produce unintended winners and losers – leaving inequities at the margins.  For example, if my fund balance is $X my tax rate might be 15%, but if I have $X + $1 it might be 30%.  Manifestly unjust.

If the announcement is carried through, there may be no more than 100,000 retirees affected.  However the policy dilemma the Government faces is that taxing so few funds is unlikely to deliver the material revenue increases the Government is looking for.  It will involve great pain for modest gain.  For the tax to really deliver solid revenue outcomes, it would need to apply to a wider range of taxpayers.

From 1 July 2012, the Government increased the contributions tax rate to 30% for people with “adjusted incomes” of $300,000+.  That would be one option.  But the number of these taxpayers still remains limited.  So to really raise decent revenue you would need to tax people around or below $200,000 in income.

So where does that leave Prime Minister Gillard’s policy in terms of its value to society?  Are there now a group of ordinary Australians out there who are distrustful of the superannuation system as a result of the Government’s media campaign? Absolutely.  Certainly, if you want to give the rich a kick in the guts, this is a great way to do it.  But what will those top 1% of retirement earners do?  Increasingly they will look offshore at neighbouring jurisdictions that have more reasonable tax rates and take their earnings out of this country with them.  If they don’t leave, their children certainly might.  You only have to pick up the newspaper to read of people such as Gina Rinehart and Nathan Tinkler shifting their footprint to Singapore to realise that punitive taxation of the rich (or even the threat of it) simply motivates the rich to relocate their wealth to friendlier shores.  Take the example of France, which is far more advanced with draconian taxation rules for the rich.  The country is being crippled in part by investment wealth fleeing the country.  There is presently a generation of French patriots who are leaving France because of these rules.  Gerard Depardieu’s much publicised migration to Russia is an illustration.

Sadly, this is just the type of measure that could gain the support of the Greens and Independents. The Liberals will oppose it. So despite the fact we may have a Liberal government on September 15 2013, there is a fair chance that by budget night such a change might be law. This would then require Tony Abbott to repeal the law ab initio which it appears he is prepared to do. It increases the line of division between the Liberals and Labor.  It sets up the election campaign on terms that will increase Labor’s prospects in its marginal electorates in a campaign of class warfare which in my view ultimately damages Australia’s national interest.

If the Government wants revenue, the best way to do it is to either expand the tax base of the GST or raise the rate.  It is the blatantly obvious thing to do.  The Government must expand its review of the taxation system to include GST.  By the way – wasn’t the mining tax supposed to fill this revenue gap? … Oops.

Stephen Cribb is a Director of Prosperity Advisers
photo credit: betta design via photopin cc

How business can level the playing field after Budget blues

After the Federal Treasurer’s rhetoric on his Government being the government for small and medium business, the Federal Budget delivered on 8 May 2012 is remarkable in that if contains no new meaningful support to businesses that are not loss making.  If poor business conditions mean you are a loss maker this year (2012), please defer your loss until 2013 because the loss carry back rule to refund overpaid tax does not activate a refund until 2013. You must pay tax in 2012 to play.  Only a bureaucrat could come up with such a commercially inastute approach for suffering businesses.

Many business owners who have put in the kilowatt hours and made their way through difficult trading conditions to remain profitable have seen their positions deteriorate under recent budgets.  A working family in business may have seen their relative ability to contribute to their annual after tax wealth deteriorate by more than an annual $17,000 in post tax money. Losing that much cash hurts.  For someone selling out of their business or retiring in 2012/13 this position could snowball to more than $70,000 if you take into account a clever play to change tax rates to remove the benefit of a higher general tax free threshold from the “wealthy”, the exclusion of the middle to upper middle class in compensation for the effects of the carbon tax, lowering of tax deductible superannuation thresholds for those over 50 and the increase in superannuation contributions tax (see below).  One single measure causes most of the damage – the loss of a tax rebate on golden handshakes worth up to a whopping $52,500 if you do not retire before July 2012. Because so many of these measures hit people nearing retirement, some business owners will justifiably feel that the Government is changing the rules of the poker game just as they prepare to take some money off the table.

It is an article of faith in business that win-win deals produce better and more enduring results.  It is therefore deeply disturbing for the psyche of SME’s that an increasing focus on means testing full access to fundamental elements of our taxation system, such as the superannuation system or compensation for a scheme such as the Carbon Tax which has a universal effect, is producing winners and losers.  Losers often stop playing.

In 2012/13 when your tax deductible superannuation contribution is taxed at an extra 15% if your personal “adjusted taxable income” is greater than $300,000, you may feel a desire to throw in the towel and give away the superannuation system entirely.  Particularly if you and your spouse have been in business together but an act of history means one of you has all the family income counted mainly to one name only.  Take the case where one spouse owns all the shares in a trading company. It is time to pass out some profits to pay the bills. In such a case, let us take the example where there is a family cash income of say $200,000 funded as a dividend (effectively $100,000 for each spouse).   An add-back of your super and franking credits will easily take you over the $300,000 limit.  So could one-off leave pay-outs and gearing cash losses.  This creates what many would call the artificial result of placing you in the over $300,000 category. To have full access to super concessions denied to you feels unjust – why not just withdraw?

Don’t take the bait.  Leaving the superannuation system will ultimately do you far more harm than good.  Some of the people in Treasury would probably love to see you give away all those compounding tax concessions in a lifetime – they could be worth hundreds of thousands.  Instead, look at better ways to level the playing field and change the rules of the game to better protect yourself from any further unfavorable policy changes that this or any future Government might have on you.

Maximize what opportunities remain on the table and in particular at the State Government level with a modest improvement in the NSW state taxes landscape and strengthen your business against the general risks of difficult trading conditions.  Put a passive holding company over your trading company to create improved asset protection.  Examine shifting your wealth into structures that are separated from your personal names so that the income does not get counted towards your “$300,000” limit.  If you and your spouse are in business together and the allocation of equity is actually unfair and articificial based on contribution, look at restructuring this to create an enduring platform that can benefit both you and next generations of the family.  The Government has demonstrated its agenda to distribute wealth away from the middle to upper middle class.  You do not just have to sit there and take it.

If the Government is not going to help you grow your business, it’s time to take matters into your own hands.  There are many constructive and efficient actions that you can take to outmaneuver a “lose” position. Take control.

Stephen Cribb is a Partner, and the leader of the Growthstar program at Prosperity Advisers. 

Kickbacks – Are they a problem in your Department?

Disciplinary action from the investigations into corruption in our State and Local Governments littered the press recently, with many Councils and State Government Departments now under increasing internal and external scrutiny over contracts awarded and gifts received.

So we thought it was timely to look at what constitutes a kickback, fraud or inappropriate acceptance of gifts, and offer you some tips into how you can reduce the incidence of fraud in your organisation.

Occupational fraud is defined as ‘The use of ones occupation for personal enrichment through the deliberate misuse or misapplication of the employing organisation’s resources or assets’.

It covers a wide range of potential misconduct by employees, managers and executives, but the three most common are:

Asset misappropriation:

The misuse or theft of assets belonging to an organisation. In the real world this can be as simple as the inappropriate expensing of funds, theft of items from the office, or skimming of money being paid to the organisation.

By and large asset misappropriation is the most common type of occupational fraud.

Corruption and bribery:

The use of legitimate power for illegitimate private gain. In real world application, corruption is seen often as bribery, the inappropriate request for, or receipt of gifts as kickbacks for contracts awarded or decisions made, or coercive acts like extortion, where threats of violence are used to make somebody endure or do something they otherwise would not do.

Fraudulent statements:

The deliberate creation of false statements and documents that substantially affect a business’ or persons’ decision to enter into a contract or pursue a particular course of action. In business and Government this is seen in the calculated dishonesty of those submitting for a tender or contract, misstating their financial strength; or by concealing something that should have been disclosed in the application for credit, finance or similar.

So how can you minimise the risk of occupational fraud in your organisation?

Fraud, corruption and bribery are an enormous concern for both Government and business in our modern society. Dishonesty in the awarding of contracts and the delivery of services and monies have the capacity to disarm whole divisions of Government, and retard the legitimate business development efforts of honest product and services providers.

Paul Horne, the Director of our Government Audit Division suggests these eight steps:

Prepare and publicise a written code of conduct that makes sure management knows it is their job to understand risk areas for fraud, and play an important role in reporting inappropriate behaviour.

Educate employees about what constitutes fraudulent behavior and how they can prevent and detect it in their division.

Train and motivate management to lead with incredible integrity and honesty, setting a solid example for the organisation.

Set up an anonymous fraud hotline where staff, suppliers and customers can report inappropriate activity.

Reduce the opportunity for fraud to be committed without detection by holding regular audits, and putting in place diligent internal control systems that require signoff and oversight from peers and managers.

Divide up the financial tasks that can be performed by any one individual to avoid one person being completely responsible for all financial elements.

Carefully selecting and screening employees that work in areas of concern or risk, like procurement, finance and project management.

If it all gets messy, and fraud has been found, don’t be afraid to visibly prosecute those who perpetrate it. A public prosecution increases the understanding of the risks associated with inappropriate behaviour and hopefully discourages anyone who might have been thinking it was a smart idea.

Government Fraud Prevention Program

Our Government Fraud Prevention Program takes an in-depth look into the systems, processes and the operations of your department, and prepares a plan to tackle all points of weakness. Our comprehensive audit ensures that you completely understand your fraud risks and develops a tactical implementation plan to roll out risk mitigation strategies that are specific to your requirements. It is our role to make your procurement, management and governance completely transparent.