Feb 20, 2019
Welcome to Finance & Fury, the ‘Say What Wednesday’ edition
where every week we answer questions from you guys.
Today’s question is from John;
“Thanks for the podcast and the content you provide. I thought a
useful podcast topic could be the legislative changes Labour are
proposing if they win the next election. Such as changes to
franking credits, negative gearing and taxation of family trusts. I
thought this could be an interesting topic considering these
changes will possibly affect a lot of your listeners, especially
small business owners who are operating as a trust etc - John”
Thanks John, that’s a good question, and great timing with the
election between 33 days from now (if called on the day listening –
min time rules) and May 2019
To start, here is a quick list of the policy changes, not
including the bigger ones everyone is talking about;
- CGT Discount: Going from 50% to 25% (on new investments after
1/7/17). This applies to business as well.
- Superannuation:
- SG increase to 12%
- On one hand it’s good for people when they actually retire down
the track…but not so good along the way
- Plus, open to legislation risk and provides tax
surplus/infrastructure funds for the Government
- Non-concessional cap to be reduced to $75,000
- No more borrowing inside Super anymore (SMSF)
- 30% contribution tax for those earning over $200k p.a. in total
income (including super contributions)
The Three Big Changes
Removal of Negative Gearing
- Family Trusts – changes to distribution laws
- Implement a thirty percent (30%) floor on the taxation that
applies to distributions made by discretionary trusts
- ‘Distributions cost $3.5bn to government in lost tax
revenue’
- How it works – You have investments (or Business) inside of a
family trust
- Assets earn income (profits) which is distributed to the adult
members who have the lowest MTR
- Under 18 years of age get TFT of $416 – then 66% and down to
45%
- Can’t retain earnings
- The Income splitting example that Labour gives:
- Sam is a surgeon and is married to Melissa who doesn’t work.
They have two adult children who attend university and who also
don’t work.
- Sam earns $500,000 a year from his work (pays tax PAYG)
- They have a discretionary trust with investments which
generates $54,000 in income from their investments.
- They attribute $18,000 to Melissa and $18,000 to each of their
two children, so no tax is paid on the $54,000 distribution as
Melissa and the two children are each under the tax-free
threshold.
- This represents a tax saving of $14,460 compared to if the
investment income been attributed to just Sam and Melissa
- Total tax Sam pays on his earned income - $208,097
- They only get to save $14,460 on investments
- If the new rules are bought in, then $224,297 will need to be
paid in tax (40.5% compared to 37.6% tax on all income under the
current arrangement) … They are paying a lot in tax!
- What people forget is this; “Sam” spent $200k-300k on becoming
a surgeon, and delayed his earnings until his late 30s to early
40s.
- Also, being able to distribute to kids is very short lived
- $54k to Melissa = $9460 tax ($5k tax saved)
- Example 2 – A similar scenario with different earnings, and one
I see more commonly;
- Sam earns $120k, Melissa earns $60k. They have 2 adult children
earning $15k each while at uni. They split the $54k distribution
between the kids. This results in $9,391 tax saved, compared to
parents splitting the distribution 50/50
- Total income = $264k, of which the family pays $56,468 tax to
redistribute under the current agreement (rather than $65,859)
- Under new system the total tax will be $62,034
- Some Issues
- Shorten admitted 200 thousand small businesses will be impacted
– these are the people he is supposedly representing
- Tradies, and others, who use these structures for asset
protection at no benefit to income in most cases
- Now they will pay a minimum 30% tax on their earned income
rather than MTR
- Testamentary, disability and charitable trusts, deceased
estates and other good will trusts will be impacted
The removal of Franking Credits
How Franking Credits work
- You own shares in a company, and as owner you are entitled to
Profits (Dividend payments)
- Gross Profits come from Revenues – Costs (interest,
expenses), Net profits = Gross Profits
minus Taxes
- Profits are paid out to shareholders (minus what is kept by
company)
- The dividend is received by individuals. The ATO assesses the
Dividend + the Franking Credit ($1.425 instead of $1)
- If over 30% MTR, you get nothing back, under 30% MRT get
something back
The objective of the dividend imputation system is to
eliminate double taxation of company profits - once at
the corporate level and again on distribution as dividend to
shareholders. More specifically, it is intended to create a "level
playing field" by taxing the same activity in the same way,
irrespective of the business structure being used, namely a company
or trust, sole trader or partnership. This is
equality.
- Removal of Franking Credits will really only affect those in
the tax bracket less than 30%, that is, low income individuals and
Self-Funded retirees (Super)
- Pensioner exemption
- People on Benefit Payments from the Government will be exempt
(back dated to May 2018)
- The plan is for equity but you’ll have people receive lower
incomes overall if they aren’t receiving the pensioner
exemption
- Labour Claims; “Distributional analysis has shown that for
people of retirement age more than 80 per cent of the benefit of
imputation refundability goes to the wealthiest 20 per cent of
households”
- But how many retirees do you think own shares? It’s actually
22% of people over the age of 65. So, 80% of the benefits go to
these people … because they’re not on the Aged Pension
- 70-77% of over 65 are on support payments (Aged Pension)
- It’s this “wealthy” 20% that are funding their own retirement.
The rest are on government benefits.
- Current demographics - approximately 16% of Australia’s
population is over 65. This is going to increase to more than 25%
in less than 30 years.
- This new agreement degrades individuals’ ability to have a
self-funded retirement and generate their own income… which puts
them into the government support system instead.
- Self-funded retirees
- If the Franking Credit Rebate goes, the income from Australian
Shares can drop by 30% (gross)
- Remember, we’re talking not just about SMSF, individual super
accounts also benefit from franking credits
- Here’s an example; a husband and wife have saved hard, and have
investments of $800k in shares (inside or outside super is
irrelevant). This generates (based on a 5% dividend yield) $57,142
of income off Fully Franked shares and credits
- This drops to $40k if the changes get passed – loss of 30% of
income
- This also applies if individual don’t have this in super – a
lot of older Australians who are self-funded don’t have
superannuation
- Reduces people’s ability to be self-funded in retirement, which
is going to be an issue if the Government can’t keep up increased
payments required – the $5bn to $10bn forward estimates on extra
tax wont cover this increase in AP payments
- Long term – opens the door for removal of Franking Credits all
together. There are only 3 countries left with them (Australia,
Malta, NZ). Others removed them over the years.
- Soon it won’t be fair for someone earning $100k in dividends
only to pay only a few hundred in tax ($42k paid by company
already). If Franking Credits are removed an individual pays $27k
of tax on top of the $42k paid by company
- Change of company behaviour – what if investors no longer value
dividends? Or if companies prefer to reinvest income and pay less
tax?
- American model – Reinvestment of funds better than double
taxation of income = Capital gains > Dividends
- Biggest companies in USA have very small profits as they don’t
need to pay investors income
- Alphabet (Google) = 0% at $785bn market cap, Amazon = 0% at
$805bn MC – Second year $0 tax paid
- Facebook, Microsoft, Berkshire - Warren Buffett, believes it is
more beneficial to allocate the company's earnings in other ways
- Reinvestment = CAPEX cost to business – more you spend less you
pay in tax – especially if you fund it off debt – don’t need to
make money to pay dividends
- Typically, companies not paying tax = no dividends
- Capital gains are fine – but you will pay more tax when you
sell under 25% CGT discount
- Australian Market - unfranked 6.5% dividend yield on bank
stocks – gross us 8%
- 9% yield they can get on US equities – Our index is 4.4%
- EU and Asia – about 3% average – Partial franking
What these policies will really hurt (Franking Credits and
Trusts) – What’s not spoken about
- Small – medium businesses – 200k+ businesses trying to make it
on their own (and employ others)
- Small businesses are set up in trusts – tradies pay themselves
drawings out of the trust at MTRs
- Increase to 30% tax will means they now have to pay themselves
super
- Increases to 12% in SG payments = Drop in what you can
draw
- Disabled, Charity trusts – All payments will be 30% rather than
0% due to nature of structures
- Low income earners – Not on Income Support – no cash back
- Self-funded retirees
Who this helps
- Large construction/trades companies
- Less competition long term – lower wages – limited to start
something of your own effectively
- Industry Super Funds – Less competition in alternative choices
- More money flowing into super funds from SG increase
- No benefits from SMSF or
Love going through election budget promises – This budget is
‘fair go’ – going for equity (equalise outcomes)
Not taking you is portrayed as a ‘cost’ – ironic – Costs in
government language is not charging you tax beyond that they
already do
- Not taking all income earned is a Trillion-dollar cost to
them
- Everything is saying the budget is in deficit – true – so stop
spending –
- Every year more taxes – to cover spending – ill cover this
point in the future – but spending to GDP over 100 years is
confronting
All of this is just another carve out for more money based
around the argument of making things equitable (one rule for me and
one rule for thee)
I don’t think it will just stop with this. – further complexity
= more money needed to run ATO – Billions more in costs to collect
tax – almost like debt collectors who take a large clip of what
they get back
Thanks for the question John. If you have any other questions
head to www.financeandfurycom.au and head to the contact page
Links
https://www.charteredaccountantsanz.com/member-services/technical/tax/tax-in-focus/Australian-Labor-Party-Policies-for-2019-Federal-Election
https://www.alp.org.au/campaigns/
https://www.alp.org.au/media/1276/2018_alp_national_platform_-_consultation_draft.pdf
Share ownership stats
https://www.asx.com.au/documents/resources/australian-share-ownership-study-2014.pdf