Tax strategies turn over a new leaf

While it is inevitable that everyone pays tax, how much is paid is another issue.

At this time of year, tax strategies are a hot issue for both clients and planners looking to minimise their tax bills.

Some of the strategies available to advisers and clients alike remain applicable from one year to the next, including salary sacrificing into superannuation, reviewing capital gains tax implications and maximising deductible expenses.

However, the tax developments and reform in any one financial year will have a significant impact on the final tax strategy for a client.

According to Westpac retail business development manager Kim Cowie, changes to the tax system over the past financial year have been less structural than in the past.

“There has been a little bit of fiddling and tightening around the edges,” she says.

ING Distribution and Solutions national technical and research manager Louise Biti agrees, saying the year’s taxation reform has reflected the ATO’s own shift in attitude.

“Changes have been all around schemes or arrangements to get tax benefits, whereas before changes were to the tax system,” she says.

Tax avoidance schemes

Biti says a lot of the issues that the Australian Taxation Office (ATO) has looked at this financial year have been centred around tax avoidance schemes, including agribusiness schemes and tax schemes such as the Budplan products, which collapsed last year without producing any significant returns for individual investors. Further, the ATO ruled that people were disallowed the tax concessions they thought they would receive as part of their Budplan investment.

The crackdown on the entitlement of tax concessions has been focused on ensuring those receiving tax concessions are people with genuine businesses and costs.

“A lot of these schemes have pushed tax concessions to the limit and people are not going into them as a business [venture],” Biti says.

She says this further highlights the need for planners to maintain a client’s focus on the possible returns as the primary purpose of the investment and not on the tax benefits.

Further, investing in products with tax rulings will provide some certainty on how the ATO will treat these products.

According to Macquarie technical manager David Shirlow, a lot of year-end tax planning relates to gearing and pre-payment of expenses.

“The Government has introduced rules to constrain the deduction of the pre-payment of expenses,” he says.

Shirlow says this has particularly been the case with agribusiness schemes that had “flourished with upfront tax deductions”.

International gearing

The ATO has also madechanges to gearing for international equities.

In the past, assuming that the interest deducted in the first place was negatively geared into an international share portfolio, the excess interest wasn’t allowed as a deduction in the current year, so it had to be carried forward.

However, the Capitalisation Act, which effectively quarantined the deduction of income, has now been removed, so for the average investor, there is no longer a constraint on the amount of interest that can be deducted.

“Advisers now don’t have to be quite so concerned if gearing into international or domestic securities,” Shirlow says.

Biti says the changes to international gearing are favourable because they isolate the interest costs from the investment, making the administration of these investments simpler. However, advisers still need to be careful that clients are aware of the dangers of these types of investments.

“If a client makes a loss, gearing can magnify this. There is an increased risk, but there can also be an increased payoff,” she says.

Capital protected loans

A recent Federal Court decision is set to have implications for capital protected loans.

Capital protected loans are another option to a simple margin loan. The loan provider lends 100 per cent capital and provides capital protection, so that if the shares’ value declines, the investor will not have to find the money to pack the loan back. Instead, the lender will buy back the shares at their reduced value to repay the loan.

Shirlow says Macquarie offers loans with either an 85 or 80 per cent deductability. However, in the recent Firth case, the Federal Court ruled that a capital protected loan was 100 per cent deductible. Shirlow says it is unclear whether the ATO will appeal to the High Court.

This creates uncertainty for planners about how the ATO will treat these investments in the future.

Shirlow’s advice to planners is to stick with the facts.

“My focus is on what is certain, that there are some products with product rulings of 80 to 85 per cent tax deductability,” he says.

Biti says there are are some important implications for advisers with regard to the future assessment of capital protected loans.

“Advisers need to look for the tax ruling and alert their clients that the ATO only sees interest as part of its deductability,” she says.

Prepayment rules and taxshelters

Prior to June 30 last year, clients could claim expenses in June and pre-pay the interest for the whole of the next year and claim this in the current financial year.

However, now clients are able to pay in advance for the 12-month period, not 13 months.

This means there is an immediate deduction where the payment is incurred for a period not exceeding 12 months and the period ends in the next income year, unless tax shelter arrangements apply.

According to Cowie, this has reduced the tax benefit available.

Superannuation

Eligibility to contribute and changes to the tax treatment of superannuation are two developments in the last year that will affect a client’s tax strategy.

Employers, self-employed or people without any superannuation support may be able to claim a tax deduction for their super contributions up to the age-based limits for contributions made from July 1, 2002.

This means the fully deductible amount for superannuation contributions by self-employed and other eligible persons will be increased from $3,000 to $5,000.

The 75 per cent deductability of the remaining contributions up to the age-based limits will remain.

Further, the reduction in the superannuation surcharge — currently at 15 per cent at all three stages of a superannuation investment — could also impact a client’s decision on whether to delay salary sacrifice.

“With surcharge reductions, people could consider deferring salary sacrifice for a few years and gearing in the meantime, if they attract the full surcharge,” Shirlow says.

Changes to the surcharge will begin on July 1 this year, reducing the maximum surcharge to 13.5 per cent this year, 12 per cent next year and 10.5 per cent by 2004.

However, following the Federal Budget, Opposition leader Simon Crean has said he will not support the reduction in the surcharge, leaving a question mark over these reductions.

Capital gains relief forshareholders of listedinvestment companies

From July 1, 2001, shareholders in Listed Investment Companies (LIC) received comparable tax treatment to investors in managed funds to distributions sourced from eligible capital gains.

According to Cowie, these shareholders can now benefit from the 50 per cent capital gains tax (CGT) discount on gross distribution from eligible CGT assets realised by a LIC that have been held by the LIC for more than 12 months.