Avoiding uncommercial borrowing conditions

The ATO has recently warned that SMSF income generated from limited recourse borrowing arrangements (LRBAs) deemed to be uncommercial may be subject to high tax rates.

If a LRBA is found to be uncommercial then all income derived from the related asset can be taxed at up to 45% including rental income, dividends, interest and capital gains.

At this point no detailed guidelines have been released, and LRBAs are being assessed on a case by case basis to determine whether or not the high tax rate will be applied to related income. As such it is advisable to ensure that all loans taken out by your SMSF meet commercial terms. It is also recommended that all documentation is retained in case you are required to provide evidence of commercial loan conditions.

What makes a LRBA uncommercial?

A LRBA may be considered uncommercial if the terms result in a greater return than would be expected from a standard industry loan. Factors that may be considered by the ATO when assessing the terms of a loan include the loan to value ratio, interest rates that are below market value, and unusually long repayment periods.

The ATO has also indicated that LRBAs used to purchase assets with limited material security, for example shares, will be more likely to attract the higher tax rate, as it is unusual for commercial lenders to approve loans for these types of investments.

New penalty scheme for SMSF trustees

From July 1 2014 the ATO will have increased powers to issue a range of penalties to SMSF trustees found to be in breach of superannuation laws.

The new regulations will give the ATO increased flexibility in dealing with non-compliant SMSF trustees. This will improve the ability to deal with cases fairly and appropriately.

Previous Penalties

Up until now the SMSF penalty options available to the ATO have been relatively harsh, including barring a person from being an SMSF trustee and subjecting the fund’s assets to a penalty tax.

As these penalties are disproportionate to many minor infringements by SMSF trustees, they have been used sparingly. As such there was no capacity for the ATO to deal with less serious non-compliance issues. Under the new system, the ATO will be able to apply a range of penalties to SMSF trustees including rectification orders, educational directions and administrative financial penalties. Trustees found to be in violation of superannuation law may subject to any combination of these penalties.

Rectification Orders

If a trustee is given a rectification order, they will be required to undertake specific action to rectify the non-compliance issue. Evidence of the rectification action will need to be provided to the ATO.

The ATO has indicated that it will take into consideration potential financial detriments to the fund that may be expected as a result of the rectification action.

Educational Directions

Trustees who are given educational directions will be required to undertake and complete an education program within a specified timeframe. Again, evidence of completion will need to be provided to the ATO.

While no fees can be charged for trustees who undertake a course as a result of an educational direction, any other related costs (such as travel) must not be paid or reimbursed by the relevant SMSF.

Administrative Penalties

The new administrative financial penalties are the most significant changes to current legislation. Financial penalties ranging from $850 to $10,200 can be issued for each individual non-compliance issue, and must be paid by the trustee personally.

Funds cannot be withdrawn from the SMSF to pay the penalties, nor can the trustee be reimbursed by the SMSF.

Using dividend franking credits

By investing in fully franked Australian shares, SMSF trustees can significantly reduce the amount of tax payable by their fund.

This is because these shares are issued with a franking credit, also known as an imputation credit, which can be used to offset the tax payable by the SMSF.

What are franking credits?

When companies pay out dividends to their shareholders, the income has already been subject to company tax. In order to avoid double taxation, where both the company and the shareholder have paid tax on the dividend, Australian dividends often come with a franking credit. This essentially means that the company tax that has already been paid is awarded to the shareholder as a franking credit, and the shareholder is then required to pay tax on the dividend at their marginal rate.

The benefits of imputation credits are also available to SMSFs who invest in fully franked Australian shares.

Franking credits and superannuation

From July 1 2015 the company tax rate will be 28.5% (cut from 30%), whereas the maximum amount of tax paid by an SMSF is just 15%. This makes acquiring fully franked shares with high yielding dividends an attractive tax break for SMSFs. If a significant portion of the fund’s investment portfolio is made up of fully franked shares, then their net tax bill can be considerably reduced.

If an SMSF receives a fully franked dividend in accumulation phase then the franking credit can offset the tax payable on the dividend. Franking credits can also be used to reduce or eliminate tax owed on any other income from the SMSF including capital gains tax, rental income and concessional contributions tax. If the SMSF has no other taxable income, the ATO provides the SMSF with a cash refund on the company tax paid.

In pension phase, when the SMSF tax rate is reduced to 0%, franking credits become even more beneficial as the entire value of the franking credit is returned to the SMSF.

Franking credits can be particularly advantageous for high income earners seeking to limit the amount of tax paid on concessional super contributions. For individuals earning over $300,000, the tax on concessional super contributions is set to increase from 15% to 30%. Instead of balking at investing additional funds into super, individuals seeking circumvent this tax hike may look at increasing their SMSF’s investment in fully franked Australian shares.

 

Tax Tips to consider before 30 June 2013

With less than two weeks until the end of the financial year and after a federal budget designed to take away a bigger share of income than in previous years, there is no better time to put some effort into year-end planning.

To help you with this we have summarised some things that need to be done before year-end and some other useful ideas that may assist with reducing the tax payable when tax returns are lodged.

Trust distribution minutes

Similar to last year if you operate a trust, it is crucial that prior to 30 June 2013, the trust has resolved how it will distribute the income of the trust. Your adviser is aware of the importance of this issue and is currently in the process of preparing the required minutes. If the required resolution is not completed on time it can result in some unfavourable implications.

Don’t forget also that this year 30 June falls on Sunday. Therefore the target date for completing these resolutions needs to be Friday, 28 June. If you don’t hear from you adviser by 25 June please take steps to contact them.

Trust distributions to companies

Following on from the above distributing net income to a company can be an effective strategy to reduce tax.

While this will have the effect of capping the tax at 30%, consideration will need to be given to what is done with these funds once they are in the company.

In such a case our firm has designed some investment structures that you may find appealing. Please consult your adviser if you wish to find out more.

Loss carry-back rules

A new measure that is currently before the Senate and likely to be passsed soon, provides tax relief to companies by allowing them to carry-back tax losses so they receive a refund against tax previously paid.

These rules are new this year and will allow a one-year loss carry-back in the current financial year. These rules allow tax losses incurred to be carried back and offset against tax paid in the 2012 financial year.

For 2013/14 and later years, tax losses can be carried back and offset against tax paid up to two years earlier.

Loss carry-back will:

  • be available to companies and entities taxed like companies who elect to carry-back losses
  • be capped at $1 million of losses per year
  • apply to revenue losses only
  • be limited to the company’s franking account balance.

Are you thinking about buying a car?

If you operate a small business then there have been some changes from last year that mean that if you have purchased a new car since 1 July 2012, you can claim an instant tax write-off of the first $5,000.

The balance over $5,000 is depreciated as per usual.

Therefore if the business is in the process of buying a new car it is likely to be worthwhile ensuring the purchase happens before 30 June. This could combine with the year end run out sales to produce real benefit.

Purchase of depreciating business assets

In a similar vein to the previous point, the changes implemented from 1 July 2012 also mean that an eligible small business can claim an immediate deduction for depreciating assets costing less than $6,500.

If your business is therefore in need of any new equipment, such as computers or printers, then it might make sense to make those purchases before 30 June.

Superannuation contributions for the year ending 30 June 2013

Just like prior years don’t forget to lock some money away. While superannuation has taken a few punches from the government and the media during the year it is still the most tax effective environment for saving for the future.

It’s therefore critical that contributions are paid before 30 June. It is also critical that care is taken to not exceed the contribution limits.

The maximum concessional contributions for the year ending 30 June 2013 are $25,000. This limit applies on a per person basis and includes concessional contributions from all sources.

The concessional cap will increase to $35,000 for individuals over the age of 60 from 1 July 2013.

At this point it is also useful to note another widely publicised change to the super rules. This change will increase the contributions tax from 15% to 30% for individuals who have income of more than $300,000. It is proposed that this change will apply from 1 July 2012. These changes however are not yet law as their application depends on the passage of the law through parliament.

Government co-contribution

If you have a spouse, parent or child on a low income then consideration should also be given to paying a non-concessional contribution for them.

Non-concessional contributions up to $1,000 will be matched by a government co-contribution of $500 for people earning less than $31,920. Transitional rules apply for incomes up to $46,920.

To be eligible the person must be employed or self-employed.

Non-concessional contributions

While on the topic of superannuation it is also necessary to note non-concessional contributions. These contributions are broadly contributions you make to super from after tax dollars. This is typically used to get additional money into the low taxed super environment

The non-concessional contribution limits are $150,000 per member per year, or $450,000 per three-year period.

As penalties can apply to excess non-concessional contributions, please discuss this with your adviser before making a large non-concessional contributions.

Superannuation pensioners

If your superannuation fund is in pension phase then an important thing to remember is to make the minimum pension payments from your SMSF before 30 June.

While the table below provides further details, we recommend that you discuss this with your adviser before making the payment to ensure the correct amount is paid and to also ensure an appropriate buffer.

Age Minimum
Under   65 3%
65 to   74 3.75%
75 to   79 4.5%
80 to   84 5.25%
85 to   89 6.75%
90 to   94 8.25%
95 to whenever! 10.5%

 

Are you over age 60?

If you are over age 60 and have not started a superannuation pension then you need to call your adviser ASAP, because you are missing out. The taxation benefits of starting a pension mean that there is no tax in the hands of the fund and no tax on the pension income in your hands.

Medical expenses claim

For the current financial year the net medical expenses rebate, which currently allows you to claim a 20% tax offset on out-of-pocket medical expenses above $2,120 (this includes medical costs for all family members), is means tested.

The test applies to people with adjusted taxable incomes in excess of $84,000 and in excess of $168,000 for couples. For people in this income category, the offset will only be available for out of pocket expenses above $5,000 allowing a claim of 10% only.

However the more important point this year is that the net medical expenses tax offset is being phased out from 1 July 2013. This basically means that you need to claim it this year to be able to claim it next year. Therefore if you are close to the line it may be worthwhile bringing forward the payment of some medical expenses to protect access to this concession next year.

Tax rates for 2012/13 and 2013/14

As previously advised new tax rates apply from 1 July 2012. These new rates broadly mean that individuals earning less than $80,000 will pay less tax than in previous years. If your trust distributes to multiple family members then this will be to your advantage.

The tax rates for 2012/13 and 2013/14 are shown below:

Taxable income Tax on this income
0 to $18,200 Nil
$18,201 to $37,000 19 cents for every dollar over $18,200
$37,001 to $80,000 $3,572 plus 32.5 cents for every dollar over $37,000
$80,001 to $180,000 $17,547 plus 37 cents  for every dollar over   $80,000
$180,001 and more $54,547 plus 45 cents for every dollar over $180,000

 

Other items

While there are various other year-end tax planning items that can be considered, it is impossible to provide a comprehensive list in an article such as this, please therefore discuss this with your adviser if there are other items you wish to consider.

This could include prepaying expenses, other issues that affect the timing of deductions, other issues that affect the timing of income receipts, or managing the sale of different assets to either delay a tax payment or offset other capital gains.

Please note that our comments above are general in nature, and should not be relied upon without seeking further advice from your adviser.

Grant Ellis is an Associate Director with Prosperity Advisers Group.

The Federal Budget 2013-2014: Comedy or Tragedy?


As potentially the final act plays out in Treasurer Wayne Swan’s Federal Budget performances, it is perhaps fitting to ask the question – was this long drama a comedy or a tragedy? 

Tonight’s budget was a safety first affair, largely being a renouncement of previous big announcements designed to reassure the patrons before they prepare to leave the theatre.  There is nothing in this budget to give a strong indication that the box office will not close on 14 September when the Federal Election is held.

The Budget confirms the announced significant deteriorations in the fiscal outlook.  Deteriorating commodity prices, diminished company tax revenues, disturbingly low carbon tax and mining tax revenues.  The inability of the Treasurer to reliably estimate short term forward revenue over past months definitely presents as a comedy.

But in my view, this is a tragic budget.  This Government, in its possible final act, has decided to attack large corporates and foreign investors in ways that achieve modest revenue gains, but which clearly present the message to the world that Australia is indifferent and ungrateful to inbound foreign capital  investors, or to corporate innovation and research and development by large corporates.

R&D concessions are scrapped for businesses with turnover of more than $20 billion.  Thin capitalisation thresholds are potentially reduced from a debt equity ratio of 3:1 to 1.5:1.  Outbound corporate investors will lose a tax deduction for interest on borrowings against some foreign investments that produce tax exempt dividends (still ultimately fully taxed to shareholders).  We will apply a non-final 10% of face value withholding tax when foreigners sell commercial real estate, mining assets (or residential real estate with a value of more than $2.5 million). Ultimately, we will require all entities with a turnover of more than $20 million to pay tax instalments monthly, creating a permanent cash drain even on smaller businesses.

The announced superannuation reforms are simply ill considered, riddled with potential injustices and inconsistencies which demonstrate a lack of proper due diligence and a tendency to announce measures without fully assessing potential impacts. Expect a red tape boom as compliance costs soar across all these measures that, by their nature, must be complex.

Small to medium business gets just about nothing (again!).  Exceptions are the quarterly refund of R&D tax credits to small enterprises – a welcome cash flow reprieve – and the removal of the thin capitalisation rules where debt deductions are less than $2 million.

The big picture measures have already been announced – the Gonski Education Reforms, the modest “Industry and Innovation” package, DisabilityCare Australia (funded by an increase in the Medicare levy from 1.5% to 2% from 1 July 2014).  Reannouncements of big infrastructure projects mainly already in the budget (again).  There is nothing to capture the imagination of businesses (large, small or international) and set up the environment for the next economic boom.  This budget represents an opportunity missed and simply sets up this Government and its people to tread water until voters express themselves at our looming election.  But most tragic of all, many of these budget measures may never see the light of day in Parliament. 

 

INDIVIDUALS & FAMILIES

Increase in the Medicare levy

From 1 July 2014, the Medicare levy will increase from 1.5% to 2%. This increase in the levy will fund DisabilityCare Australia.

2012/13 Medicare levy low income thresholds

The Medicare levy low income threshold for the 2012/13 income tax year will increase to $20,542 for individuals and $32,279 for pensioners eligible for the Seniors and Pensioners Tax Offset.

The Medicare levy low income threshold for families for the 2012/13 income tax year will increase to $33,693, and the additional family threshold for each dependant child or student will increase to $3,094.

Net Medical expenses tax offset to be phased out

For those taxpayers who claim the NME tax offset in the 2012/13 income year they will continue to be eligible for the offset in the 2013/14 income tax year if they have out of pocket medical expenses above the relevant thresholds.

The relevant threshold for people with adjusted taxable incomes above $84,000 ($168,000 for couples) is $5,000 in out of pocket expenses and the rate of reimbursement is 10%. For those taxpayers who claim the NME tax offset in the 2013/14 income year they will continue to be eligible for the tax offset in the 2014/15 income year.

Income tax cuts deferred 

Income tax cuts that had already been legislated (by way of increasing the tax free threshold) and that were due to commence on 1 July 2015 will be deferred indefinitely.

Replacing the Baby Bonus with new family payment arrangements 

Family Tax Benefit Part A (FTB Part A) payments will be increased by $2,000, to be paid in the year following the birth of a first child, and $1,000 for a second and subsequent child. The additional FTB Part A will be paid as an initial payment of $500, with the remainder to be paid in seven fortnightly instalments.

As a result of these reforms the Baby Bonus will be abolished.

HECS-HELP discount and voluntary HELP repayment bonus discounts will end

From 1 January 2014, the following discounts relating to the Higher Education Loan Program will be removed:

  • The 10% discount available to students electing to pay their student contribution upfront, and
  • The 5% bonus on voluntary payments made to the Tax Office of $500 or more. 

Work related self education expenses

From 1 July 2014, a taxpayer will only be able to claim a maximum deduction of $2,000 for work related self education expenses.

Eligible work related self education expenses include costs incurred on a course of study or other educational activity such as a conference or workshop, and include tuition fees, registration fees, textbooks, professional and trade journals, travel and accommodation expenses and computer expenses, where these expenses are incurred in the production of the taxpayer’s current assessable income.

Introduction of CGT Withholding Tax Regime for Non-resident Taxpayers

From 1 July 2016, where a foreign resident disposes of taxable Australian property, the purchaser will be required to withhold and remit to the Tax Office 10% of the proceeds from the sale. This measure will apply to commercial property and residential property with a value over $2.5million.

 

CORPORATES AND BUSINESS

The dramatic fall in the health of the budget has meant that for the business community the budget delivers only bad news. This bad news comes in the form of bringing forward the timing of tax payments irrespective of the cash flow and administrative problems this may cause, or the tightening of other provisions such as the thin capitalisation provisions for international businesses.

In a business environment that is probably best described a fragile, let’s hope the budget doesn’t further hamper an already difficult environment.

Monthly PAYG Tax Instalments

Changes to the PAYG tax instalment system to be introduced by government will result in all large entities paying monthly tax instalments to the government. These changes will be an administrative nightmare and result in cashflow management issues for the entities affected.

The entities caught and timing of the changes have been summarised in the table below:

Entity Affected Date Monthly Instalments Begin
Companies with turnover greater than $1b. 1 January 2014
Companies with turnover greater than $100m. 1 January 2015
Companies with turnover greater than $20m and all other entities with greater than $1b turnover. 1 January 2016
All other entities with turnover greater than $20m. 1 January 2017

As shown in the table above these changes are far reaching in the number of taxpayers that will be impacted.

Foreign Non-Portfolio Equity Interests

Presently, the receipt of dividends from a non-portfolio investment of greater than 10% in a foreign company are treated as exempt from tax. These rules are going to be tweaked by the government to ensure they operate as intended.

This will include ensuring that the exemption flows through a trust or partnership correctly.

Interest Expenses Relating to Foreign Exempt Income

The government has announced that it will be amending the legislation to prevent an interest deduction being claimed with respect to the derivation of certain foreign exempt income.

Changes to Mining Concessions 

The generous tax concession available to the mining industry are being tightened to exclude acquired mining rights and information from those assets that can be claimed as an immediate deduction as part of the cost of assets first used for exploration. Affected assets will need to be depreciated over the shorter of their effective life or 15 years.

Only original costs of issue from government and genuine new exploration expenditure will qualify for outright deduction.

This does not apply to rights and information acquired from a government authority. These changes will apply from budget night.

Thin Capitalisation

As was expected by many advisers, the government has made the decision to tighten the thin capitalisation rules that apply to foreign companies that have operations in Australia and Australian companies that have operations overseas.

The government has increased the de minimis threshold from $250,000 to $2 million. This means that taxpayers with total interest expense below $2 million are not subject to the thin capitalisation rules. The rules broadly apply to disallow interest deductions where a taxpayer has more than $3 of debt to every $1 of equity. Interest deductions are reduced on proportionate basis.

The budget has proposed that this ratio be reduced to $1.50 of debt for every $1 of equity. This is a significant blow to both Australian companies that are looking to expand offshore and to international companies looking to invest in Australia.

For foreign multinational companies this is a significant change that makes Australia a less appealing place to carry on business. When the boards of these large foreign companies sit down to determine where to invest their capital, this is one extra reason to choose a country other than Australia.

The government has noted that these changes will apply to financial years beginning on or after 1 July 2014. These changes are significant and therefore it will be crucial to closely monitor the details of how these changes will be implemented and the drafting of the legislation surrounding these changes.

Other Changes Impacting Corporate Taxpayers

Other changes to note include the following:

  • Removal of dividend washing opportunities exploited by some taxpayers. This enables some sophisticated investors to claim franking credits twice by selling shares ex-dividend and re-purchasing other shares that carry a right to dividends.
  • R&D benefits have been scrapped for corporate groups that have greater than $20b turnover.
  • The changes previously announced by the government in the 2009/2010 budget with respect to the CFC and FIF provisions have been put on hold until the OECD has finished a review of international profit shifting. This announcement means that businesses with international operations face a longer period of uncertainty.
  • The Venture Capital regime will be amended to encourage ‘angel’ investors. This will be achieved through lowering the minimum invested capital requirement from $10m to $5m.
  • Various amendments are to be made to the tax consolidation provisions, to prevent taxpayers from obtaining unintended benefits, such as double deductions through shifting assets between groups and deducting liabilities twice.

 

CHARITIES AND NOT FOR PROFIT ENTITIES

Definition of Charity

A statutory definition will be applied to the term charity from 1 January 2014, rather than the reliance that is currently placed on common law principles. The statutory definition will however preserve these principles.

Not For Profit Tax Concession Changes

Planned changes to the tax concession that apply to commercial activities that are carried on by not for profit entities are to be delayed. These changes will commence from either 1 July 2014 or 1 July 2015 depending on when the activities commenced.

These changes will broadly mean that income tax concessions will not always be available for unrelated commercial activities carried on by not for profit groups. The availability of income tax concessions will only be available where the unrelated commercial activity profits are not directed back to the organisations altruistic purpose.

FBT, GST and DGR benefits will also not be available in relation to the unrelated commercial activities.

These changes could be far reaching for the not for profit sector and should therefore be considered in detail for clients that operate in this sector. This issue is further hampered by uncertainty surrounding what these provisions will actually entail when legislated.

 

SUPERANNUATION

Increase in concessional contributions cap

A temporary cap of $35,000 (up from $25,000) will apply from 1 July 2013 for individuals aged 60 and over. The increased cap will apply for individuals aged 50 and over from 1 July 2014.

The government will index the general cap of $25,000 that applies to everyone else from the 2015 financial year onwards. The increase in the cap to $35,000 will apply as follows:

Start Date Age Requirement
From 1 July 2013 60 and over
From 1 July 2014 50 and over
From 1 July 2018 No age requirement 

Example

Tony’s birthday is 12 May 1954. He is 59 years old on 30 June 2013. For the 2013-14 financial year, Tony’s concessional contributions cap is $35,000, and his non-concessional contributions cap is $150,000 (where the general concessional contributions cap is $25,000).

Removal of $500,000 superannuation balance test 

As a result of the above-proposed increase in the concessional contributions cap, the previously announced concessional contribution limit of $50,000 for individuals with superannuation balances below $500,000 will be removed.

Taxation of earnings on superannuation assets supporting income streams 

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 (to be indexed in $10,000 increments), and the balance of earnings will be taxed at 15%.

Under the current law, all superannuation earnings on assets supporting superannuation pensions and annuities are tax-free.

The change to the taxation of superannuation funds in pension phase will undoubtedly punish good investment performance. For example, the Government announcement points out that “assuming a conservative estimated rate of return of 5%, earnings of $100,000 would be derived from individuals with around $2 million in superannuation”. However, if a superannuation fund earns 10%, then it will be subject to tax for assets that are at the $1 million level.

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.

The government is yet to release draft legislation with respect to this measure but the flow-on impact, if legislated, is likely to impact other areas. For example, if after 1 July 2014 you buy a capital asset in your superannuation fund, sit on it for 10 years, and then realise a $1 million gain to fund your pension as a one-off.

Without further clarification from the government, it might be that averaging will apply to the capital gain, that is, $100,000 gain each year that the asset was held, thereby limiting tax exposure. Alternatively, $900,000 of the capital gain could potentially be taxed at a higher tax rate.

Tax relief for excess contributions

Many innocent people have been subject to a punitive rate of tax if they accidentally exceed their concessional contributions threshold. Individuals are taxed at 46.5% even if their personal tax rate is lower, where they have exceeded the cap. 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.

Changes to government co-contributions

The government has introduced legislation to halve the co-contribution to $500 for eligible taxpayers.

The superannuation co-contribution matches eligible (after-tax) personal superannuation contributions made to a superannuation fund up to the maximum amount of $500. However, the government has recognised that this benefit is not as popular with the targeted group – lower income earners.

Increase in Superannuation Guarantee

The Superannuation Guarantee rate is gradually increasing from the current 9% to 12% by 1 July 2019 in 0.25% increments each financial year. From 1 July 2013, employer will be required to contribute 9.25% to superannuation.

The government has also increased the maximum age limit to 75 for when employers are required to make superannuation guarantee contributions for employees. Previously, employers were not required to make superannuation contributions on behalf of employees over the age of 70.

 

INNOVATION AND RESEARCH

While not specifically a budget measure, one of the key developments in 2013 was the announcement of the 1 billion dollar “Industry and Innovation Statement” in February 2013. Financials of this package were re-announced in the budget.  There are some beneficial elements which apply from 1 July 2013 in this package.

Research and Development

Following the announced changes, there are now three tiers of research and development support:

  • A 45% refundable tax offset for those businesses with an aggregated assessable income turnover of less than $20 million.
  • A non-refundable 40% tax offset which is available for businesses with turnover between $20 million and $20 billion.
  • Access to the ordinary dollar for dollar tax deduction rules, capital allowance rules and blackhole expenditure rules for large businesses that have a turnover of more than $20 billion.

Essentially, the message is that research and development incentives are not for the top end of town.

For businesses that are not yet cash flow positive and that have a turnover of less than $20 million, an important improvement in the refundable tax offset system is the ability to opt in for a quarterly refund from 1 July 2013. The refund for each quarter will be physically paid 28 days after quarter end. In theory, this means that the first payment of a quarterly refund would be 28 October (i.e. after the next Federal election).

Taxpayers can either choose to adopt a “safe harbour” instalment credit based on last years R&D claim. Alternatively, a reasonable assessment can be made. There are two key requirements in order to get the quarterly credit. The first is that the taxpayer must have a reasonable expectation of qualifying for the credit in this years income tax return. The second is that the taxpayer must have complied with all its obligations for the last five years and it must be reasonable to expect it will continue to comply. The ATO has a discretion to waive certain types of non-compliance.

Australian Industry Participation Authority

A non-revenue measure which has been announced by the government is that businesses that plan to initiate projects with a cost of greater than $500 million will be required to create an Australian Industry Participation Plan in the early stages of project planning to outline opportunities for local industry to participate in the project. The Australian Industry Participation Authority will then coordinate with industry to improve supply of local production, creating local jobs.

Projects which have a value of more than $2 billion will be required to “embed” Australian Industry Participation Officers.

Innovation Precincts

The government also announced plans to create up to 10 “innovation precincts”. The first two precincts have been announced in the manufacturing and food industries with hubs based around Melbourne. Participation in the precinct also opens access to a $50 million Industry Collaboration Fund which is aimed at getting different businesses aligned around common technology and process solutions required to drive that particular industry segment forward.

Venture Australia

An additional $350 million has been made available for new “Infrastructure Investment Funds”. In summary, approved managed fund operators will have the opportunity to place strategic investments in applicant businesses from this fund subject to the investment rules specified by government.

Enterprise Connect and Enterprise Solutions

The enterprise connect program has been expanded to include additional industry categories of professional services, information and communication technologies, and transport and logistics. This gives qualifying businesses the opportunity to work with a business coach to develop an appropriate business plan and is to apply for grant funding from the government to implement recommendations that are specified in that business plan. This can release $20,000 or in some cases more for businesses to address improvements to systems and processes.

Additionally, the government intends to proceed with a program to assist growing businesses to develop their capabilities to meet the standards for supply required by government.

Finally, qualifying businesses will gain access to “Gold” Executive Training (Growth Opportunities Leadership Development). This is a new executive training program aimed at building the next generation of leaders in future industry employers.

Superannuation Pensions – Implications of not playing by the rules

Many Australians who are either approaching retirement or have permanently retired from the workforce are running ‘Account Based Pensions’ through their superannuation structures. It is important to understand the rules of running an Account Based Pension in order to avoid potential taxation penalties in the future.

Under the current legislation it is a requirement for individuals to make a minimum drawdown payment from their pension account each financial year. This minimum payment is calculated based on two factors, firstly a percentage factor which is dependent on the member’s age (as detailed in the table below) and secondly the persons account balance.

Age at start of account based pension (and 1 July each year)                      

2012/13
Minimum Drawdown

2013/14
Minimum Drawdown

Under 65

3%

4%

65-74

3.75%

5%

75-79

4.5%

6%

80-84

5.25%

7%

85-89

6.75%

9%

90-94

8.25%

11%

95+

10.5%

14%

The current tax rate that applies to investment income derived from superannuation assets is 15% and the tax rate for realised capital gains is 10% to 15% (depending on whether the asset has been held for more than 12 months).

Once a superannuation fund commences to pay an Account Based Pension, the fund maybe entitled to an exemption on the payment of tax for the investment income and realised capital gains derived from fund assets backing the Account Based Pension. This income is referred to as ‘exempt current pension income’.

For trustees running Self-Managed Superannuation Fund (SMSF), these rules are particularly important given that the ultimate responsibility for making the minimum pension payment each year lies with the trustees.

So what are the implications under the current superannuation regulations if the trustee of the superannuation fund fails to pay the minimum pension?

The pension will be deemed to have ceased for income tax purposes at the start of the financial year (or the start date of the pension if it’s a new pension). As a result, the superannuation fund will not be entitled to treat any investment income or realised capital gains as ‘exempt current pension income’ for that year. Also any payments made to the member during the financial year will be treated as superannuation lump sum payments for both taxation and superannuation purposes.

Under what circumstances will the Australian Taxation Office (ATO) exercise discretion to allow an SMSF to continue to claim the tax exemption on pension income even if the minimum pension payment is not met?

  1. If the SMSF has failed to pay the minimum pension amount due to a trustee error or honest mistake that has resulted in a small underpayment (i.e. is less than one twelfth of the annual minimum payment); and
  2. The entitlement to exempt pension income would have continued but for the trustees failing to make the minimum payment; and
  3. The SMSF endeavours to make a catch up payment as soon as possible (within 28 days of the trustee becoming aware of the underpayment) in the following financial year which would has resulted in the minimum payment being satisfied in the previous financial year; and
  4. The SMSF treats the catch up payment as if it was made in the prior financial year.

Does a superannuation income stream cease in the event of a member’s death if the account based pension does not automatically revert to a dependent beneficiary?

In August 2011 the ATO released a draft tax ruling (TR 2011/D3). The purpose of this ruling was to address ‘when a superannuation pension commences and ceases’. This ruling indicated that superannuation pensions cease as soon as a member dies unless the member had in place a reversionary pension nomination (which means that the pension automatically reverts to a dependent beneficiary upon death). Therefore, in the event that the member did not have a reversionary beneficiary in place, then the member’s assets would revert back to superannuation phase and subsequently loose the tax exempt pension income status. Therefore, should these assets be disposed of, then capital gains tax maybe applicable upon sale at the rate of 10% to 15%. This draft ruling resulted in confusion amongst superannuation advisers.

As a result of this confusion the Government released amendments to the regulations on 29 January 2013 which aimed to clarify that if a superannuation fund member was receiving a pension and then died, the superannuation fund will continue to be entitled to the earnings tax exemption in the period from the members date of death until their benefit is paid out by the fund. This amendment will  be a welcome relief for beneficiaries of death benefits as no capital gains tax will be payable from the superannuation fund when the pension assets are sold or transferred to fund the payment of death benefits.

 

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. 

Super tax to be doubled for high income earners

If the Government raises the super contribution tax to 30% for high income earners in the budget next week, will you be affected?The Government announced to the major media over the weekend that Wayne Swan is going to double the 15% tax on concessional superannuation contributions to 30% for those with adjusted income over $300,000 per annum in his budget speech on 8th May 2012.  

 

For these purposes, adjusted income is expected to include taxable income, concessional superannuation contributions, adjusted fringe benefits, total net investment loss, some foreign income, tax-free pensions and benefits, less child support.

As a result of the adjusted income definition, a taxpayer with salary income of say $250,000 but with significant negative gearing into property or shares might still be caught by these measures.

The start date for this change is expected to be 1 July 2012 (although it is conceivable that this could be brought forward to budget night – 8 May 2012 – if budget surplus pressures are strong enough).

The 30% tax rate will apply to all concessional superannuation contributions with one exception.  The exception is where the adjusted income threshold of $300,000 is breached by an amount less than your concessional superannuation contributions amount.  In that case, the 30% tax rate will only apply to the concessional superannuation contributions that exceeds the adjusted income threshold.

Whilst it is said this change will affect just 128,000 people nationwide, it is clearly something that, if it impacts you, you may want to consider preparing for now.

Under certain circumstances, those who may not ordinarily have an adjusted income of $300,000 or more may have to be alert to this change.  For example, this could impact investors selling assets such as property or shares which might throw their adjusted income above the threshold (in the year they enter contracts to sell).

The measure will increase the tax on a standard $25,000 contribution by $3,750 per person in a move that is estimated to bring in more than $1 billion in revenue over the period forecast in the budget.
What can you do?  What should you do? 

If you are unsure whether you might be impacted by these measures, contact your Prosperity Adviser for advice, or speak to one of our leading wealth advisers, John Manuel or Gavin Fernando, who work across our Newcastle, Sydney and Brisbane offices.

If you would be affected by these measures, you should consider:

  • Maximising your concessional superannuation contributions for the 2012 year whilst the tax rate is still 15% (if possible, it would be ideal if this could be done prior to the budget announcement on 8 May 2012 in case the expected start date is brought forward); and
  • Other ways to build wealth in superannuation, including property ownership in a self managed superannuation fund.