Year of reckoning for wrap accounts

The Federal Government’s tax reform agenda will have a major impact on the retail investment sector this year and could crimp one of Australia’s fastest growing retail investment services, notes Philip La Greca.

Wrap accounts have been touted as a reporting service for all investments, including the consolidated tax position on each. It was then expected to allow investors to more quickly assess their position and respond to market conditions.

Yet the Federal Government's proposed tax reform package has the potential to undermine several of these advantages.

Since wrap accounts are clearly a service, the fees will be subject to the 10 per cent GST, thus increasing the cost of its operation to the client with little or no offsetting credits for inputs.

The tax package also includes a proposal to tax managed investments at source. With all distributions from trusts taxed as franked dividends, that will eliminate the complexity of tax treatment that the wrap service seeks to remove from the client. Lowering the average tax rate to 30 per cent and widening the number of people in this bracket will also reduce the need to perform complicated investment processes for tax purposes.

The target market for wrap accounts has yet to be specified. It could be argued that the market is similar to those for DIY superannuation (at least $200,000 in assets), which means about 180,000 funds.

But the target market for wraps may not be that large. Based on the superannuation surcharge, the Government's idea of high-income earners, the logical target market for such a service, is only 450,000 people. Interestingly, that $75,000 threshold is where the top marginal rate will apply under the proposed tax scale.

Wrap accounts, as well as any other 'collators of information', must prove to the market that their outsourced book-keeping service offers value for money and has economies of scale.

Tax reform will also force the industry to examine how they manage their back office.

This is because the GST credit system does not allow fund managers to pass on GST elements for in-house services. It may therefore be cheaper for a financial services player to outsource some of their functions such as back-office and administration to a provider who can offset GST inputs against charges.

The managed funds industry is also opposed to their trusts being taxed as companies because they fear funds will be disadvantaged against similar options. An example is cash management trusts versus bank deposits. Tax planning opportunities will also be reduced, as trusts will be taxed at a uniform rate rather than based on the underlying assets.

The superannuation industry does not object to taxing funds. But with no change to the existing levels of taxation, the attractiveness of super will be less compared to the proposed lower marginal rates. This combined with the taxation of super at entry, on earnings and on exit has prompted the industry to call for a rethink of the tax process.

Advisers must understand how these proposals will affect the products they sell and their impact on their clients' cash flows. And because they are running a business, advisers must consider the impact of tax reform on their own businesses.

Philip La Greca is manager of adviser technical services, AM Corporation.