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;

  1. CGT Discount: Going from 50% to 25% (on new investments after 1/7/17). This applies to business as well.
  2. Superannuation:
    1. SG increase to 12%
      1. On one hand it’s good for people when they actually retire down the track…but not so good along the way
      2. Plus, open to legislation risk and provides tax surplus/infrastructure funds for the Government
    2. Non-concessional cap to be reduced to $75,000
    3. No more borrowing inside Super anymore (SMSF)
    4. 30% contribution tax for those earning over $200k p.a. in total income (including super contributions)

The Three Big Changes

Removal of Negative Gearing

  1. 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
    1. Shorten admitted 200 thousand small businesses will be impacted – these are the people he is supposedly representing
      1. Tradies, and others, who use these structures for asset protection at no benefit to income in most cases
      2. Now they will pay a minimum 30% tax on their earned income rather than MTR
    2. 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.

 

  1. 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)
  2. 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
  3. 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”
  4. 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
    1. 70-77% of over 65 are on support payments (Aged Pension)
    2. It’s this “wealthy” 20% that are funding their own retirement. The rest are on government benefits.
    3. 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.
  5. 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.
  6. Self-funded retirees
    1. If the Franking Credit Rebate goes, the income from Australian Shares can drop by 30% (gross)
    2. Remember, we’re talking not just about SMSF, individual super accounts also benefit from franking credits
    3. 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
      1. This drops to $40k if the changes get passed – loss of 30% of income
    4. This also applies if individual don’t have this in super – a lot of older Australians who are self-funded don’t have superannuation
    5. 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
  7. 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.
    1. 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
  8. Change of company behaviour – what if investors no longer value dividends? Or if companies prefer to reinvest income and pay less tax?
    1. American model – Reinvestment of funds better than double taxation of income = Capital gains > Dividends
    2. Biggest companies in USA have very small profits as they don’t need to pay investors income
    3. Alphabet (Google) = 0% at $785bn market cap, Amazon = 0% at $805bn MC – Second year $0 tax paid
    4. Facebook, Microsoft, Berkshire – Warren Buffett, believes it is more beneficial to allocate the company’s earnings in other ways
      1. 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
      2. Typically, companies not paying tax = no dividends
    5. Capital gains are fine – but you will pay more tax when you sell under 25% CGT discount
  9. Australian Market – unfranked 6.5% dividend yield on bank stocks – gross us 8%
    1. 9% yield they can get on US equities – Our index is 4.4%
    2. EU and Asia – about 3% average – Partial franking

 

What these policies will really hurt (Franking Credits and Trusts) – What’s not spoken about

  1. Small – medium businesses – 200k+ businesses trying to make it on their own (and employ others)
  2. Small businesses are set up in trusts – tradies pay themselves drawings out of the trust at MTRs
    1. Increase to 30% tax will means they now have to pay themselves super
    2. Increases to 12% in SG payments = Drop in what you can draw
  3. Disabled, Charity trusts – All payments will be 30% rather than 0% due to nature of structures
  4. Low income earners – Not on Income Support – no cash back
  5. Self-funded retirees

Who this helps

  1. Large construction/trades companies
    1. Less competition long term – lower wages – limited to start something of your own effectively
  2. Industry Super Funds – Less competition in alternative choices
    1. More money flowing into super funds from SG increase
    2. 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

  1. Not taking all income earned is a Trillion-dollar cost to them
  2. Everything is saying the budget is in deficit – true – so stop spending –
  3. 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

 

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