Max Tax - Andrew Page

There are but two certainties in this life: death and taxes.

Neither are particularly attractive prospects, but the fact is they are both inevitable. In regard to tax, we must at least acknowledge it as a necessary evil. It provides the money Governments need to pay for essential services such as schools, hospitals, roads and a host of other things that are absolutely essential for a healthy and functional society.

Of course the Government doesn't always spend the money wisely, and the specifics of the tax system are far from perfect, but we must nonetheless acknowledge that as Australians we enjoy a reasonably fair system. The amount of tax we pay is directly proportional to our earnings; the more we earn, the more we are taxed (or alternatively, if we don't earn much, we aren't taxed much). Nevertheless, the majority of us loathe tax and will often feel as though we are being treated unfairly.

Figure 1. Relationship between income and tax. Calculated according to 2008-2009 tax scales.

Ask yourself this question: would you prefer to pay $10,000 or $1,000,000 in tax this financial year? Naturally, the lower amount seems more attractive at first glance, but I would definitely prefer to have the higher tax liability. After all, if your tax bill was $10,000 it means that you would have earned around $53,000 in taxable income last year. On the other hand, if you are paying a million dollars in tax you must have generated around $2.3 million in income. So in essence, the more tax we pay the more privileged we are.

We can however seek to generate income in a more tax effective manner, and in this regard it's hard to find a more tax effective income than dividends. Thanks to the imputation system, franked dividends come attached with tax credits that account for the tax already levied. With the corporate tax rate at 30%, that means that you essentially only pay the difference between that and your own personal income tax rate. What's more, you receive the full tax rebate even if your shares are held under a Self Managed Super Fund (SMSF), which means that in most cases you will actually pay no tax on your dividends, and indeed can even receive a tax refund.

Margin loans also offer a great tax advantage in the sense that interest payable is tax deductible. That is, interest is paid with pre-tax income. Investors can also elect to pre-pay interest, and if this is done prior to the end of the financial year, it can be claimed as a deduction for the 2008-2009 period. Furthermore, although shares are used to secure the loan, investors are still entitled to the full value of all franking credits received.

There is also the potential for you to take advantage of a negative gearing strategy (which tends to be popular amongst property investors). If the value of your dividends is less than the interest charged, you will pay no tax on your dividends at all, and as a bonus you are still able to use your franking credits to offset other sources of income.

Consider the example of an investor who has a $100,000 portfolio, with a $50,000 margin loan (that is, they are 50% geared). Assuming the portfolio produces a total dividend yield of 3.5%, and interest is charged at 7%, then the $3500 earned in dividends is completely offset by the interest deduction (in effect the dividends are completely tax free. Alternatively, you could view this as having an interest free loan). If the dividends are fully franked, the investor will also be able to claim around $1500 worth of imputation credits which, for those earning between $80,000 - $180,000, equates to a tax rebate of $900.

Had the investor decided instead to just invest the $50,000 of their own capital, they would have received $1750 in dividends and $750 in imputation credits. For those on the marginal rate of 40% (anyone earning between $80,000 - $180,000), that means a tax charge of $250, and an after tax dividend of $1,500. Although the net income position is greater than it was under the geared scenario, we must remember that the investor in the first example had exposure to $100,000 worth of shares, and hence is set to generate a capital gain that is twice as big. When a gain is eventually crystallized it too will be subject to tax, however if the shares are held for longer than 12 months tax is levied on only HALF the gain. Regardless of your marginal tax rate, that's a substantial discount.

The bottom line is that investors should do everything they can to minimize their tax, and the share market is the most tax effective asset class available. However, despite the tax advantages, success in the market will nevertheless eventually attract some tax in most situations, but this is something we can't really complain about. Ultimately it comes down to a choice between losing money and paying no tax, or making money and paying some tax. I certainly don't like paying tax, but I know what I would prefer.

Andrew Page -  Media & eLearning Manager - Hubb Financial Group

Download HUBB's free scanning & charting software at www.hubbinvestor.com

All recommendations are provided without consideration of any specific reader's investment objectives, financial situation or particular needs. Those acting upon such recommendations do so entirely at their own risk.

Rather than receiving a lump sum tax refund once a year, it is possible to organise smaller payments with each pay cheque. - Julia Hartman

AS the end of the financial year draws to a close, the thoughts of investors with negatively geared rental properties will no doubt turn to varying their PAYG instalments for 2009/10.

Scary isn't it; double digits again. Nearly a decade since the turn of the century and the introduction of GST!

A PAYG Income Tax Withholding Variation Application (ITWV) can be used by employees to gain the benefit of their annual tax refund cheque during the year, averaged over each pay period. This may even be necessary to maintain the cash flow to be able to afford a rental property.

Some investors don't apply for the variation because they feel the refund cheque is a form of compulsory saving. It may be but it's far better to have the money now and reduce the interest on non-deductible debt than let the Australian Tax Office (ATO) hold it.

Considering the time value of money - if you're disciplined enough - you should get your hands on this money as soon as possible.

There's nothing better than keeping your money in the first place rather than waiting for an ATO refund.

HOW TO DO IT

The ITWV form requires similar information to a tax return.

You're effectively estimating your tax return for the 2009/10 year. If you think 2008 was similar, you may want to copy the information from that year's tax return.

Think each entry through for your current circumstances. Of particular concern should be your estimated interest expense. If you have a variable loan your interest expense in 2009/10 should be a lot less than 2008. With a principal and interest loan you need to take into account that two years down the track the interest portion of the repayments will be less.

Capital gains aren't given a specific section on the variation form but you still need to include an estimate of any capital gains you may receive in 2009/10. Use the 'other income' box on the form.

If you wait until after June 30, 2009 to lodge your variation you'll have to tell the ATO how much you've earned in the 2009/10 financial year to date and how much tax you've paid.

Avoiding all that information is a good reason to lodge your form before June 30.

You can find the form and relevant information by going to www.ato.gov.au and entering 'Income Tax Withholding Variation form' in the search field at the top of the website.

The 2009/10 PAYG ITWV application should be available online by the beginning of this month.

The ATO uses the information provided in your variation application to calculate a flat percentage rate of tax. If your employer applies this flat rate to your wages each pay period it will result in the correct tax for the year on all of your income and expenses.

The ATO writes to your employer advising them to deduct tax at this new flat rate.

Your employer shouldn't mind, as a computerised payroll system can easily adapt. If they're calculating the tax on your pay manually then it will actually make their job easier.

It's even worth lodging a variation application towards the end of a financial year but you have to do so before May 15. The later in the year, the lower your flat rate of tax will be because you've already paid some tax. This means you'll get the benefit of your refund in just the few remaining pay packets for this financial year.

If you apply late enough this can sometimes result in a zero tax rate.

Be warned, if you underestimate your income to the extent that you end up receiving a tax bill once you lodge your tax return then the ATO can deny you the right to lodge a variation in future years.

Take the time to accurately estimate the figures considering the differences that will apply to next financial year, in particular interest expense.

Don't forget all your possible sources of income; for example capital gains, interest, and dividends (even if they're reinvested).

If something happens during the year that you haven't included in your variation application you can lodge another one.

If your circumstances change and that could result in you receiving a tax bill of $500 or more when you finally lodge your tax return then you're required to lodge a new variation application.

© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission.

This information is of a general nature only and does not constitute professional advice. You must seek professional advice in relation to your particular circumstances before acting. Please read our warning and disclaimer.

Preparing your SMSF for the new financial year - Laura Menschik

In considering the Federal Budget's changes to superannuation, there are still some planning opportunities that should be used for the new financial year. By considering all options you will be in a better position going forward.

Managing changes to contributions from 01/07/09

As mentioned in last month's article, from 1 July 2009 the concessional (pre-tax) contributions caps have been halved as follows:

• For those aged under 50 from $50,000 pa to $25,000 pa (indexed)
• For those aged over 50 from $100,000 pa to $50,000 pa (indexed) and available only until 2012

You will need to manage this change from July 2009 and may need to amend any employment salary sacrifice agreements or transition to retirement strategies and monitor the contributions into your SMSF accordingly.

It should be noted that there is a penalty tax for contributions in excess of the caps.

• The ATO will identify any concessional contributions made above these limits and the excess contributions will be taxed at a penalty rate of 31.5%, in addition to the normal contributions tax rate of 15%.
  • This is then equivalent to the top marginal tax rate of 46.5%.
  • This penalty can be paid by the individual out of his/her own pocket or from their super account.
• Also, any excess concessional contributions will be counted towards the individual's non-concessional contributions cap.

Also, the Government co-contribution will be reduced to $1.00 (from $1.50) for up to $1,000 for the next three financial years. This will rise to $1.25 in the 2012-2013 financial year.

Strategic opportunity to transfer shares

Because of the decline in asset values over the past 18 months there is a strategic opportunity for people to make contributions to super by using their existing shares. This is referred to as in specie transfers.

Shareholders should consider this type of transfer in order to keep shares in a potentially more tax efficient environment while keeping the ability for these shares to regain or continue to grow for future retirement planning.

This can also assist those who may not have the cash to make additional super contributions by allowing their SMSF to receive these in specie contributions instead.

You must note that the in specie transfer may trigger a capital gains tax event, but this may be able to be offset if the contributions are tax deductible. If the transfers trigger capital losses, this loss can be used to offset future capital gains.

Summary

You may need to review your arrangements or consider boosting your contributions for the new financial year. Also, consider the non-concessional bring-forward rule (up to 2 years + current year).

For those approaching retirement, you may need to revisit your contributions strategy and consider making smaller contributions over a longer time frame to ensure you can meet your retirement goals.

Also remember that legislation and taxation rates are subject to change.

As with all matters of importance, consult your professional advisers to optimise your situation.

Laura Menschik
Director and Authorised Representative
WLM Financial Services Pty Ltd.
CERTIFIED FINANCIAL PLANNER TM - SMSF SPECIALIST ADVISER TM
WLM provides wealth and lifestyle management services in a professional and personalised manner, by qualified advisers, on a fee-for-service basis. WLM is independently owned by its Directors. Visit WLM Financial Services online wlm.com.au

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