Monday, 02 July 2018 08:35

Tax Cuts - what it means for you

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The 1st July 2018 brings in the first round of income tax cuts that have been ferociously debated in parliament.

 

The table below outlines the level of tax that is currently paid for a range of incomes and projects the value of future tax cuts.

Income Current Tax Paid Tax cut from 2018/2019 Tax cut from 2022/2023 Tax cut from 2024/2025

Tax Paid in 2025

 $20,000  Nil  $0  $0 $0 $0
$40,000 $4,547  $290  $455  $455 $4,092
 $60,000 $11,047  $530  $540  $540 $10,507
$80,000 $17,547 $530 $540 $540 $17,007
$100,000 $24,632 $515 $1,125 $1,125 $23,507
$150,000 $43,132 $135 $2,025 $3,375 $39,757
$200,000 $63,632 $135 $2,025 $7,225 $56,407

 

The person earning $40,000 will pay 6% less tax in 2018/2019 and then in 2022/2023 will pay 10% less tax than they currently do.  

A person earning $150,000 will pay 0.3% less tax in 2018/2019 and then in 2022/2023 will pay 4.6% less tax than they currently do.  So while the gross dollar value of tax saving is higher for the $150,000 income earner, they are actually receiving a lower percentage tax cut.  The contribution to the tax base of someone earning $150,000 is also 10 times the value of the $40,000 income earner.  We dispute the view that is held in some sections of the media that suggests those earning lower amounts of income are being discriminated.

It is like suggesting that a person with a $500,000 mortgage receives a higher benefit from a 1% interest rate cut than a person with a $100,000 mortgage.  They are both treated equally in terms of the cut, but the higher mortgage saves more due to simple mathematics.  In reverse the person with the higher mortgage pays more when rates rise.

So it is with income tax, those who earn more, contribute more to the tax base for the purposes of health, education etc.  So when tax rates are reduced it is also logical that the dollar value for those earning higher incomes is also higher.

 

We recently met with Geoff Wilson, CEO Wilson Asset Management to discuss his view of the ALP proposal to scrap imputation credit refunds.

Geoff believes that this is policy on the run, which has not been thought through and disadvantages self funded retirees in 'the middle' and most certainly doesn't impact the 'big end of town' as Bill Shorten makes out.

Wilson Asset Management have established an online petition that investors can sign voicing their disapproval of this policy position.  We would encourage you to sign this petition online.  Here is the link to the petition.

 Sign the ONLINE PETITION AGAINST SCRAPPING IMPUTATION CREDIT REFUNDS

Below is the podcast we created with Geoff, complete with a transcript for those who would rather read than listen.

 

Speakers:  Mark Draper (GEM Capital) and Geoff Wilson (CEO Wilson Asset Management)

Mark:  Here with Geoff Wilson from Wilson Asset Management. Geoff, thanks for joining us.

Geoff:  Hi, thanks. It’s great to be here in Adelaide. One of my favorite cities.

Mark:  We’re meeting, talking about the ALP’s proposal on dividend imputation and particularly what the impact of it is. But let’s start with—

Geoff:  And not one of my favorite topics. [Laughs]

Mark:  Neither with us, it’s safe to say. Probably the best place to start is just to talk through what the ALP are proposing and before that, just to give a quick bit of background on what actually dividend imputation means and what it is.

Geoff:  Yeah. I mean, to me, dividend imputation, it was very intelligent doing that. What it’s trying—well, it what it was brought in for, was to stop the double taxation effect. 

So, if tax was paid by a company, then the individual wouldn’t have to pay tax and it was seen as being unfair. Effectively that would be—historically it’s been double taxation and that’s why imputation came in. And yeah, you end up—if tax has already been paid by the company, say at 30% and you’re only paying 10% tax, then you’ll get that other benefit, the other 20% back from the government.

And effectively what the ALP has said, is that we are not going to let that occur. And to me, it was just a classic—

[Chirping sound.]

Mark:  We’re shooting this in an office, by the way.

Geoff:  Yeah, that’s right.

Mark:  It’s just Geoff’s phone. [Laughs]

Geoff:  No, no, there was a frog in the corner. [Laughs]

[Laughter]

I mean, the ALP, the policy that they came up with just recently is—to me it is just so incredibly unfair.

Mark:  Yep, yep. And we’ll talk about who it’s unfair to in a second. Wasn’t it ALP that originally bought in dividend imputation back in…whenever it was?

Geoff:  Correct. Yeah, correct, it was. And the incredible thing is, the changes they propose recently, even though the refunds you get, if you’ve paid in theory, you know, there’s been too much tax paid, you know, the Liberal Party bought in, but it was actually the ALP’s plan to bring it in, but Liberals happened to be in office at that time.

Mark:  That was in the year 2000.

Geoff:  Yeah. Yeah. I mean, to me, it’s a little fascicle that part. You know, they’re trying to blame it on the Liberals. And things have changed significantly since then. To me, it is so unfair and cruel what they’re doing with this policy because this—yeah, I’ll go to superfund, yeah, I’m over the $1.6 million cap. This will affect me, but I’m in pension mode.

Mark:  This is you personally?

Geoff:  Yeah, personally, yeah. And my advisor says, “Well, Geoff, you just go back to 100% accumulation.” In theory, they talk about getting the big end of town—like hey, I don’t know which end of town I live at—

Mark:  Yeah. But they’re not going to impact you with this

Geoff:  They’re not going to impact me. And so to me, it’s just—and what makes me so angry, like we’ve got with our listed investment companies, we’ve got 55,000 shareholders. 60% of them are self-managed super investors and that live on what they give back or what they get through their income and this is going to have a significant impact on them.

Mark:  Let’s look at who does this impact because it doesn’t impact the people who’ve got millions of dollars, which is ironically is the very target that Shorten was allegedly trying to get at with this policy. So who does this negatively impact?

Geoff:  Well, in theory, it impacts everyone in the middle. Well, first of all, they came out with a policy and then they realized—to me, it’s policy on the run. They come out with something illogical, they haven’t even thought it through.

Mark:  Yep. They didn’t even know who it impacted on day one, did they?

Geoff:  No. No. That’s right. And then they had to come out and change it and say, “Look, okay, it won’t impact on people on pensions and part-pensions.” But what about all those other people? So, in theory, he was trying to say, “Oh, it’s the big end of town,” but it’s not impacting on that end of town, the wealthy. It’s actually impacting on the people that are in—have their own self-managed super funds, live on that income or those refunds, and all of a sudden, yeah, their income could be chopped by 15%. I mean, that is appalling.

Mark:  Yeah.

Geoff:  And particularly after—it’s not as if they haven’t had enough pain. The goalposts keep moving in that area. We had the Liberals bring in their cap, that moved the goalpost 1 degree.

Mark:  Yeah, and they had already reduced the asset test level back in 2016, I think as well. I think it’s 2016 or 2017, fairly recently. So, the poor people who’ve had $800,000, who saved all their life and worked really hard to accumulate that level, lost $15,000 worth of age pension and now they stand to lose probably another 10. So, we did the math on it and worked out somebody with $800,000 stands to lose about 40% of their income in the last two years.

Geoff:  Gee!

Mark:  That’s where the middle ground, is what you were talking about, given that 800 is roughly where the pension cut-out limit is for a married couple and a bit more than 500 for a single person.

Geoff:  And you think of that if you’re retired, I mean, that is brutal. 

Mark:  Yeah, absolutely.

Geoff:  That is brutal.

Mark:  It’s not hitting the big end of town, clearly. It is hitting the middle. They’re giving exemptions, which are going to be very, very difficult to actually administer. Let’s not even get down that path because the exemption, I think, at the moment, is relating to people who were on a part pension.

Who are the people other than the big end of town with superannuation, self-managed funds, or people with reasonable balances, who else gets out of this? Who else is not impacted by this?

Geoff:  Well, I mean, the big industry funds. Which it impacts on the self-managed super, players—

Mark:   Yeah, but not for big super funds.

Geoff:  Yeah, but not for big industry funds. So, to me, that’s again, an unfair thing. And we talked about the financial impact, but there are other impacts. Which, I mean, we see it with our shareholders. On a six-monthly basis, we present to them and a lot of people—having a self-managed super fund in retirement becomes—investing becomes part of their life. They follow the market very closely, they have good advisors, etc. And to me, what we haven’t measured is if they’re trying to do this to the self-managed super funds, is the actual negative mental health impact that it has. Say I’ve probably got my 800,000, oh, well, I’m not going to have a self-managed super fund anymore. I won’t have the enjoyment of managing my own money or being involved in managing my own money—which Labor is trying to push them to—I’ll just put it in an industry fund and be done with it. And then I go and sit on the beach and twiddle my thumbs.

To me, there are all these unintended consequences and to me, mental health of an aging population is very important. And mental health has got to be one of the biggest problems globally.

Mark:  What do you see as some of the other unintended consequences? Because one of the problems of policy on the run, which this clearly is, is that you’re not thinking through about the domino impacts. I mean, I just am reminded of the resources tax when that was brought in on the run and the dominoes were never considered in that. What are some of the other unintended consequences here, Geoff?

Geoff:  Well, then as an investor—I mean, you want people investing in companies. You want actually to invest in small or medium-size growing companies and they are the life blood—

Mark:  Life blood of the economy.

Geoff:  Of the economy. So you want people investing in sort of productive assets. You don’t want them investing in unproductive assets. And sort of what this does do, is drive money away from those productive assets. Am I better off investing in property or in a property trust where there’s—

Mark:  There’s no franking.

Geoff:  No franking. And so money is going into other areas. Am I better off investing it overseas? 

Mark:  So, it’s really removed.

Geoff:  The tax rate in the U.S., you know, Trump’s dropped it to 21%. Am I better off investing in a company where it only pays 21% tax rather than one where it pays 30% tax? 

Mark:  Yeah.

Geoff:  To me, it’s all these unintended consequences.

Mark:  Yeah. No, that’s a good point and it’s really removing some of the oxygen from the economy. It’s got potential to remove oxygen from the economy, essentially.

Geoff:  Yeah. And move money where it shouldn’t be moved to in theory. [Laughs]

Mark:  Yeah, yeah.

Geoff:  Now, does anyone—I know properties find it a little bit tough at the moment, but do you want—we all have to live in a home. We want to buy property as cheaply as we can. Do you want anything pushing it up? No. [Laughs]

Mark:  Yeah. Well, that’s quite comical that on one hand, Bill Shorten is saying, “Oh, we’re here for housing affordability,” and then on the other hand, he’s saying, “I don’t mind people pouring more money into property,” which can push the price up. It’s totally illogical.

Geoff:  Yeah, yeah.

Mark:  So, Geoff, just to finish up on, what would be your advice to investors at the moment? You deal with the whole swag of retiree investors, which is pretty much the audience we’re talking to here today. What would your advice be today on how people should frame this and how they should think about it and what they should do right now.

Geoff:  Yeah. Well, I mean, to me, you—well, first of all, we’ve seen that Labor, with policies on the run, they have flexibility to change.

Mark:  Yep.

Geoff:  I mean, the better scenario is we don’t have to worry about this, so in the next election, next year sometime, the Liberals get in, but who knows.

Mark:  Yep.

Geoff:  But definitely put as much pressure as you can on any local member, any Labor member. Write to them just how appalled you are at what they’re doing. To me, it’s just the—like how many retirees do we have in Australia or, to me, there’s got to be a big group of people that are putting—that are making Labor realize that if they do this, there are significant consequences.

Mark:  That’s very interesting you say that. We agree. In terms of adjusting investments right now, is that something you do or would you leave that for now, given that A) They’re not in yet; and secondly, this is only policy proposal with nothing supporting it. What would you do on that?’

Geoff:  I definitely wouldn’t. I would definitely stay close to it. I would get as much advice as you can. 

Mark:  And write to your—or go and see—your Labor local MP.

Geoff:  Yeah.

Mark:  But not adjust your investments at the moment?

Geoff:  I wouldn’t. I wouldn’t. Because, I mean, you’d hate to change your portfolio or change your investments and it doesn’t happen and then you really got to work out how you’re going to deal with it. Assuming it is going to happen, and then how you’ll deal with it. And to me, you have the plan and if Labor get in, yeah then you have to—

Mark:  Then you execute it at that point.

Geoff:  Yeah.

Mark:  Geoff, thanks very much for your time. Very interesting issue. We’re both on the same page with it, so appreciate your input.

Geoff:  Thanks for that. Thanks, Mark. Thanks.

[End of Audio]

 

 

 

 

Wednesday, 21 March 2018 21:54

Robbing Granny in the name of Paul

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Written by Dr Don Hamson (CEO Plato Asset Management)

 

When I was first asked to comment about the ALP’s proposed scrapping of franking credit refunds my response was I was “flabbergasted”. “Flabbergasted” that the party whose Treasurer Paul Keating created franking credits would cut those benefits accruing to retired workers, “flabbergasted” that the Leader of ALP Opposition who earns over $375,000 a year would begrudge retirees receiving around $5000 a year on average, “flabbergasted” that the ALP would be offering tax relief to low- and middle-income Australians whilst pulling benefits from the lowest earning individuals who don’t even earn enough to pay tax, and finally “flabbergasted” that it is claimed that “this change only affects a very small number of shareholders”.

Having had time to reflect on this change, read through the fine print and discuss it with a number of people within the industry – and I thank those clients for their thoughts – my views have changed somewhat, but not necessarily in a positive sense.

“ Firstly, this change only affects a very small number of shareholders who currently have no tax liability and use their imputation credits to receive a cash refund.”

“1.17 million individuals, and superannuation funds”

Bill Shorten speech to Chifley Research Centre as quoted by SMH “Labor to target rich retirees in budget fix” 13 March 2018.

Discriminatory policy

We think this is a very discriminatory policy. Whilst we are happy that charities and not-for-profits are exempted from the changes, we are not so happy that the likely worst affected are the very lowest income earners with small holdings of Australian shares.

It is also discriminatory between different types of superannuation funds. Members of mature superannuation funds are discriminated against versus members of less mature funds. The most mature of funds are Self-Managed Superannuation Funds (SMSFs) whose members are all retired, and they would receive no franking credit refunds. The least mature or growing funds are funds largely dominated by younger accumulation phase members with a relatively small proportion number of pension members. These growing funds will be paying significant net tax to the government since the vast bulk of their fund members are in accumulation phase, paying 15% tax on fund earnings together with contributions tax. It is our understanding that pension phase investors in these least mature funds would still be receiving the full value of franking credit refunds under this proposal. The growing fund won’t be getting a refund of tax from the government, but within the fund pension members effectively get a full refund via offsetting (reducing) some of the net tax payable at the overall fund level. A $1m pension phase member of a growing fund would receive full value for franking credits, but the same $1m pension phase investor would not if they were to establish an SMSF. This proposal is clearly discriminatory, and if implemented would favour growing funds such as many industry funds, over SMSFs.

But we don’t believe this discrimination is restricted to SMSFs. Any superannuation fund dominated by pension phase investors will likely stand to lose the value of some or all of franking credits. Mature and often closed defined benefit funds would fit into this category. Some of these funds may be fine in financial years with good investment earnings, but may lose some franking credits in years with low or negative investment earnings where tax payable on accumulation phase earnings and contributions are less than the value of franking credits. We know of a few funds that are government or industry based which may likely be immediately impacted should these changes be implemented.

Industry ticking time bomb

We believe this change may ultimately impact a much greater number of Australians at some stage in their life than the current 1.17 million individuals targeted by this change. Whilst the proposed changes will primarily currently impact mature pension phase SMSFs and low income investors, we believe as the superannuation industry matures as a whole, as more and more members of pooled superannuation funds migrate to pension status, the loss of franking will likely start to impact a growing number of government, retail and industry funds. And these changes would then impact the returns and fund balances of pension phase members of those funds be they rich or poor.

Approximate $5000 a year impact

We estimate that denying the refund of franking credits will reduce the returns for pension phase SMSF by approximately 0.5% pa, meaning a retired couple with a $1m superannuation balance would be $5000 worse off each year, or a retired couple or individual with a $500,000 superannuation balance would lose $2,500. Now this might not sound a lot, but $50-$100 per week makes quite a difference for a retiree. It might mean being able to eat out once a week, take an annual domestic holiday, afford the expensive running costs of air conditioning or cover the cost of a cataract operation.

“$50-$100 per week makes quite a difference for a retiree.”

Our estimate of the impact of scrapping imputation credits is based on our submission to the Tax Discussion Paper entitled “Foreigners set to gain at the expense of Australian retirees?” (April 2015). We based our estimate of the impact of imputation assuming an average SMSF exposure to Australian shares, and the franking credit yield of the S&P/ASX200 Index. Investors with higher allocations to Australian shares, or allocations to higher yielding Australian shares could earn even higher levels of franking credits and would thus stand to lose more.

Impacts the lowest earning individuals who don’t even earn enough to pay tax 

Treasury’s analysis of ATO data indicates that 610,000 Australians in the lowest tax bracket (earning less than $18,200) would be impacted by this proposal, with a further 360,000 individuals impacted in the $18,201 to $37,000 tax bracket. Given this, I should not have been surprised that someone like my mother, who recently passed away, would have been significantly negatively impacted by this change. My parents worked hard all their working life, judiciously investing savings into the share market, managing to save enough to largely self-fund their retirement. They retired prior to the implementation of compulsory superannuation, so their share investments were held outside superannuation. My mother lived off the earnings from those shares, but she rarely earned enough to actually pay income tax, but I can assure you that she dearly valued the franking credit refunds which boosted her modest retirement income. When she was well they enabled her to take the odd holiday, and when she wasn’t so well, they helped pay the medical expenses.

Closing the gate after half the horse has bolted?

In introducing the proposals, Bill Shorten used an example of an extreme franking credit refund of $2.5m to a single SMSF in the 2014-15 financial year. This example is now well out of date and passed it’s used by date. The current government has introduced a $1.6m per person cap on pension phase superannuation which we estimate halves the problem. Perhaps a better way to eliminate the few extremely large franking credit refunds would be to either limit the total amount people can invest into super (not just the amount in pension phase) or limit the maximum franking credit refund per person. Let’s not make just about everyone’s retirement tougher because a few individuals have managed to take full advantage of the system.

Other Impacts

There are other impacts likely to arise from this change should it ever come to pass. Whilst members of defined benefit superannuation funds may not be directly impacted, the organizations’ that underwrite those benefits may need to increase their funding if the expected pension phase investment return assumptions are reduced. Banks and insurance companies may need to reconsider their capital positions in light of the potential impact of these changes on income securities.

Pension fund trustees may need to alter asset allocations. Some might argue that reducing exposure to the very concentrated Australian share market might be a good thing, but it will very much depend on where the money goes to. As well as Australian shares, SMSFs have a strong preference for Australian property, and we are not so sure allocating more money to a fairly expensive domestic property market is necessarily a good thing. Increasing exposure to global shares makes more sense, particularly since SMSF seem under-allocated to global shares compared with industry and retail fund allocations.

We also believe that any changes will likely impact the financial advice that investors receive, particularly investors in mature SMSFs.

Value of financial advice

Tax changes provide financial advisors and tax professionals the opportunity to add value for their clients. Pension phase SMSFs might likely restructure in a number of ways. They could move their pension assets into growing industry or retail funds to continue to receive the effective value of franking. Or they could look to “grow” their own SMSF, by adding say their children who are in accumulation phase as members, but there are constraints to this within the current SMSF rules.

Sadly, the 610,000 lowest income earners who would be affected by this change are probably least able to seek advice and least able to restructure their assets.

Don’t act too soon

We also discourage people from acting too soon on this proposal. It is the policy of the opposition. Not only do they have to win the next election, they would need to win over sufficient cross bench senators to make this change to the law. And even were it likely to happen, companies may act to flush out franking credits prior to any change coming into effect – buybacks and special dividends may come with a flurry in that case.

Conclusion

Overall, we don’t see this as good policy. It’s discriminatory. Whilst positioned as a “taking from the rich to give to the poor” policy, it’s actually 610,000 of the lowest earning individuals who will likely feel the most relative pain. It also discriminates between different types of superannuation funds, impacting the returns and fund balances of pension phase members of SMSFs, but not the returns and fund balances of pension phase members of growing funds such as many industry super funds. We also think that as the superannuation industry matures, and many more members of funds retire, these changes will likely impact members of many of the more mature government, industry, and retail super funds, not just SMSF members. If passed, this policy may become a ticking time bomb for many, many Australians.

Franking credits provide a very valuable increment to the income of all defined contribution retirees be they rich or less well off, as well as to very low income investors outside the super system, and surely we all hope to retire comfortably one day.

 

Thursday, 15 March 2018 05:42

Shorten's tax grab from retirees

Written by

The ALP has proposed that if it wins Government at the next election it will scrap cash refunds that are currently paid to investors with surplus imputation credits they receive from shares that they own which pay franked dividends.

Bill Shorten claims that only the wealthy will pay the tax, clearly continuing his class warfare with ‘the big end of town’.

He also said “a small number of people will no longer receive a cash refund but they will not be paying any additional tax”.

With all due respect to a potential future Prime Minister, this is rubbish! 

The Australian reports today that Treasury analysis of official tax data shows the largest group of people to be hit by Labor’s $59bn tax grab will be those receiving annual incomes of less than $18,200, the majority who receive the Age Pension.

In fact the likely number of people hit by this proposal is estimated at well over 1 million, bringing into question the ALP’s definition of small.

The current effective tax free threshold for a retiree couple over age 65 is around $29,000 each, courtesy of the Seniors Australian Tax Offset and of course the $18,200 tax free threshold that applies to everyone.

Therefore any retiree who’s taxable income is less than that, is currently not paying tax and at risk of having their surplus imputation credits retained by the ATO.

The whole point of dividend franking – introduced by a Labor treasurer Paul Keating of course was to stop the double taxation of dividends. 

Dividends have to be paid by companies out of profits which have already paid company tax.  In the old pre-Keating world those dividends would then be taxed a second time as personal income.

Under the Keating change you would get a ‘credit’ for the company tax paid on the dividend, you would then still be taxed at your full marginal tax rate on the underlying income out of which the dividend was paid.

Critically, if your marginal tax rate was lower than the 30% company tax rate, you still paid “too much” tax.  That is why Peter Costello legislated the cash return of that overpayment in 2000.

If the ALP proposal becomes law, this would result in high income earners gaining the full benefit of dividend imputation but retirees and low income earners being discriminated against and unable to use the tax credits.  In other words retirees would become one of the few groups in the country to pay double taxation on their dividends.  The very people the ALP are alleging to protect are those most likely to lose from this proposal.

So how much do retirees (including those with Self Managed Super Funds in pension phase) stand to lose from this proposal?.  The table below sets out different levels of investment in fully franked dividend paying investments and the corresponding potential loss of income for retirees.(assuming retirees are below effective tax free threshold)

Investment Level

Dividend Rate (fully franked)

Franked Income

Imputation Credit

Cut to Retiree income under ALP proposal

$100,000

5%

$5,000

$2,142

$2,142

$200,000

5%

$10,000

$4,285

$4,285

$300,000

5%

$15,000

$6,428

$6,428

$400,000

5%

$20,000

$8,571

$8,571

$500,000

5%

$25,000

$10,714

$10,714

$600,000

5%

$30,000

$12,857

$12,857

GEM Capital is not opposed to tax reform, but we are opposed to leaders using the tax system as a political wedge for political gain that disadvantages the retiree sector.

We are deeply concerned that a potential future Government can propose in an incredibly short time frame, in a retrospective manner, such a drastic reduction for retirees’ income.  Retirees have limited capacity to increase their earnings through employment which makes them a very vulnerable segment of the community to sudden changes in Government policy.

GEM Capital will be contributing to media articles in the coming weeks on this issue and will also be talking with politicians of both sides of politics with a view of broadening their perspective on the issue and at the same time represent the interests of retirees.

Feel free to share this article with anyone you believe may be impacted by this proposal.

Thursday, 31 March 2016 09:18

State tax competition - issues for South Australia

Written by

Helen Hodgson, Curtin University

Australia’s federal government initiated two major reform processes after the last election: a tax reform process and reform of the Federation. Prime Minister Malcolm Turnbull’s plan to hand income taxing powers to the states sits at the intersection of the two.

Under the Constitution, the states already have the right to levy income taxes. They effectively conceded this power to the Commonwealth after the Uniform Tax Cases, in wartime 1942 and affirmed in 1957. Both held that the Commonwealth use of the grants power was valid.

The Turnbull proposal is based around the Federal Government cutting income tax rates, then allowing the states to raise income tax directly from residents of that state.

The first challenge is the administration of such a proposal. The Commonwealth took over the collection of state income taxes in 1923 when the states agreed to the national collection of income tax. This led to the introduction of the Income Tax Assessment Act 1936, which ensured income tax laws were applied uniformly across Australia.

Turnbull has said the Commonwealth would continue to collect the tax for the states to avoid compliance costs. The Coalition government has campaigned against red tape, implementing a range of initiatives to reduce overlapping reporting requirements. These include the single touch payroll system that allows employers to report income tax and superannuation obligations in real time. The tax receipts that were issued to accompany tax assessments in the 2015 year would presumably be modified to show the share that was levied by the state.

The biggest challenge that would emerge is if states chose to exercise the right to increase or decrease their income tax rates. Accountability is one of the reasons being put forward for the proposal, on the basis that if the tax is more transparently related to services delivered by the state, the state government will use those taxes more wisely.

However tax competition can also lead to a race to the bottom: if one state lowers its taxes, other states are likely to follow.

Uniformity dominates

If tax competition results in lower income taxes in one state than another, interstate migration could increase, putting more pressure on the states that have not reduced their income tax rates. We have seen the problems that national governments are encountering regarding the appropriate jurisdiction to levy taxes: it can be expected that similar issues would emerge between the states, requiring a range of residency tests to attribute the residency of itinerant or technology-based workers.

Increasing migration between states would put pressure on state governments to reduce their own tax rates. Recent history shows that when the Queensland government reduced state taxes and abolished death duties in the late 1970s all other states and the Federal Government followed. A general lowering of tax rates would defeat the stated intention of allowing states to raise additional funding for health and education.

It would not be surprising to see mobile workers relocating to low tax states, while people more reliant on good health and education services, who may be at a stage in their life when they do not pay tax, would remain in states with better services.

Recent tax policy initiatives in Australia have focused on tax harmonisation as an antidote to tax competition. For example, since 2007 the states have implemented a harmonisation agenda to ensure that the administration of payroll tax is consistent across the country: however it does not extend to rates and thresholds.

There is also a question over what is meant by accountability: is it code for cost shifting? The Prime Minister has already acknowledged that states such as South Australia and Tasmania, which have a weak economic base, would have to be protected. Does this mean that if other states experienced a downturn in economic conditions they could also apply for assistance?

In his announcement the Prime Minister referred to this as the most significant change since World War II. History shows that it has been tried before: in 1978 the Fraser government introduced legislation that allowed the states to levy income tax. It did differ in the detail, but allowed states to impose surcharges or allow rebates. This legislation remained in force for 21 years without being applied by any states, partly due to changes in the political and economic environment.

As it stands the reaction from the premiers on the current proposal has been lukewarm. It would seem that a GST style agreement would be advisable to ensure passage through all relevant parliaments.

While both the formal tax and federation reform processes appeared to have stalled, it seems the government is putting them firmly on the election agenda.

The Conversation

Helen Hodgson, Associate Professor, Curtin Law School. Curtin Business School, Curtin University

This article was originally published on The Conversation. Read the original article.

Thursday, 29 October 2015 15:56

Busting tax myths for better reform

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An extract from Deloittes report on Tax Reform.

 

Australia’s tax reform debate is in desperate need of a circuit breaker, and our report Mythbusting tax reform #2 aims to achieve exactly that. It slices through the myths that clog clear thinking on super, negative gearing and capital gains, and recommends reforms that return simplicity, fairness and sustainability to the way Australia taxes superannuation contributions and capital gains.

This is the second of Deloitte’s mythbusting tax reform reports. The first focussed on issues that are central to Australian prosperity – bracket creep, GST and company tax. This second report covers matters at the heart of Australian fairness – super, negative gearing and capital gains.

Myth 1: Superannuation concessions cost more than the age pension

Super concessions do cost a lot – but nothing like the pension does.

The Treasury estimate of the dollars ‘lost’ to super tax concessions uses a particularly tough benchmark: the biggest possible tax bill that could be levied if super was treated as wage income. It also doesn’t allow for offsetting benefits via future pension savings, or any offsetting behavioural changes. Better measures of super concession costs are still huge, but rather less than the pension.

Myth 2: We can’t change super rules now, because the system needs stability to win back trust

So super concessions don’t cost more than the pension. Yet the costs are still pretty big. And that’s what puts the lie to this second myth. If our super concessions cost lots but achieve relatively little, then Australians are spending a fortune on ‘stability and trust’ in super settings while actually achieving neither. Governments can only truly promise stability if the cost to taxpayers of our superannuation system is sustainable.

Chart: Proposed reform of the tax benefit (loss) of diverting a dollar from wages to super

Deloitte Figure1 301015As the chart above shows, there’s a Heartbreak Hill at the centre of Australia’s taxation system: low income earners actually pay more tax when a dollar of their earnings shows up in superannuation rather than wages, whereas middle and high income earners get big marginal benefits. So one example of a better super tax system would be an updated and simplified version of the contributions tax changes proposed in the Henry Review – where everyone gets the same tax advantage out of a dollar going into super, with a concession of 15 cents in the dollar for both princes and paupers.

Making the tax incentives for contributing into super the same for everyone also comes with a pretty big silver lining. As current incentives are weighted towards the better off, there is a tax saving from making super better – a reform dividend of around $6 billion in 2016-17 alone.

Even better, because this is a change to the taxation of contributions – when the money goes in – it avoids the need for any additional grandfathering. Nor does it add extra taxes to either earnings or benefits.

And because the incentives are simpler and fairer, the current caps on concessional (pre-tax) contributions can also be simpler and fairer. They could be abolished completely for everyone under 50, and the cap could be raised for everyone else (subject only to a safety net of a lifetime cap). That would put super on a simpler, fairer and more sustainable basis.

And, depending on how the super savings are used (to cut taxes that really hurt our economy, or to fund social spending, or to help close the Budget deficit), the resultant package could appropriately help Australians to work, invest and save. For example, this reform alone would pay for shifting the company tax rate down to 26% from the current 30%.

Myth 3: Negative gearing is an evil tax loophole that should be closed

The blackest hat in Australia’s tax reform debate is worn by negative gearing. Yet negative gearing isn’t evil, and it isn’t a loophole in the tax system. It simply allows taxpayers to claim a cost of earning their income. That’s a feature of most tax systems around the world, and a longstanding element of ours too.

Yes, negative gearing is over-used, but that’s due to (1) record low interest rates and easy access to credit, (2) heated property markets and (3) problems in taxing Australia’s capital gains. Sure, the rich use negative gearing a lot, but that’s because they own lots of assets, and gearing is a cost related to owning assets: no smoking gun there.

Myth 4: Negative gearing drives property prices up, but ditching it would send rents soaring

And those who argue the toss on negative gearing raise conflicting arguments on its impact on housing.

Let’s start with a key perspective: interest rates have a far larger impact on house prices than taxes. The main reason why housing prices are through the roof is because mortgage rates have never been lower. And, among tax factors, it is the favourable treatment of capital gains that is the key culprit – not negative gearing.

Equally, while negative gearing isn’t evil, nor would ditching it have a big impact on rents. By lowering the effective cost of buying, negative gearing long since raised the demand for buying homes that are then rented out. Yet the impact on housing prices of negative gearing isn’t large, meaning that the impact of it (or its removal) on rents similarly wouldn’t be large.

Myth 5: The discount on capital gains is an appropriate reward to savers

The basic idea of a discount on the taxation of capital gains is very much right. There should be more generous treatment of capital gains than of ordinary income, because that helps to encourage savings (and hence the prosperity of Australia and Australians), and because the greater time elapsed between earning income and earning a capital gain means it is important to allow for inflation in the meantime.

But we overdid it. We gave really big incentives for some taxpayers (such as high income earners) to earn capital gains, versus little incentive for others (such as companies). And the discounts adopted back in 1999 assumed that inflation would be higher than it has been – meaning they’ve been too generous.

So the capital gains discount is no longer meeting its policy objectives. That not only comes at a cost to taxpayers, but to the economy as well. One possible option would be to reduce the current 50% discount for individuals to 33.33%.

Deloitte’s report ‘Mythbusting tax reform #2’ was prepared by tax and superannuation specialists from Deloitte in conjunction with economists from Deloitte Access Economics. See full report for disclaimers.

Wednesday, 08 July 2015 14:54

Do Franking Credits Matter?

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Dividend imputation has been under scrutiny. The Tax Discussion Paper raises the notion that imputation does little to encourage investment in a small, open economy like Australia, where share prices and hence the cost of capital are set in international capital markets. Imputation is thus seen as a costly tax break for domestic shareholders with minimal associated benefits for the overall economy. The idea is that the removal of imputation could fund a reduction in the corporate tax rate, perhaps to as low as 20%, leading to a surge in foreign investment.

This line of argument has some merit: lowering the corporate tax rate should indeed attract additional foreign investment at the margin. However, this stance is somewhat narrow. To be fair, the Tax Discussion Paper is only airing a view for discussion, not making a policy recommendation. Nevertheless, it is worth asking what may be overlooked in adopting this line.

Mixed evidence on whether imputation is priced

The relationship between imputation and the return on investment required to satisfy the market (which might be called ‘cost of capital’) has been extensively examined in the finance literature. Unfortunately, there is no agreement.

One problem is that investors benefit from imputation to varying degrees. There are two theoretical approaches to solving this. The first involves identifying the ‘marginal investor’ – the last investor enticed to hold a stock, so that demand equals supply. The idea that share prices are determined in international capital markets implicitly assumes a marginal overseas investor who places no value on imputation credits. The second approach views share prices as reflecting some weighted average of investor demands. Here imputation credits would be partially priced, perhaps in accord with the 60-80% held by domestic investors.

Empirical analysis is no more enlightening. Four methods have been used to estimate the market value of imputation credits: analysing ex-dividend price drop-offs; comparing securities that differ in their dividend/imputation entitlements; examining if imputation credits are associated with lower market returns; and establishing whether stocks offering imputation credits trade on higher prices relative to fundamentals like earnings. Results are mixed. The majority of drop-off and comparative pricing studies find imputation to be partially priced, with a wide range of estimates. Meanwhile, footprints from imputation are hard to detect in returns and price levels. In any event, all empirical studies suffer from significant methodological issues.

Another issue is that the pricing of imputation might vary across stocks or time, perhaps due to differing marginal investors. Of particular relevance is the smaller, domestic company segment where investors are substantially local. In this case, it is reasonable to expect that imputation might be priced.

With the finance literature failing to arrive at a consensus, the assumption that imputation does not lower the cost of capital amounts to an extreme position along the spectrum. The possibility remains that imputation credits might be priced either partially, or in certain situations.

Imputation and behaviour

Of prime importance is how imputation influences behaviour, and whether these behaviours are beneficial or otherwise. This matters more than how imputation impacts ‘numbers’ like cost of capital estimates. Many decisions are not based on formal quantitative analysis; and imputation tends to be a second-order influence in any event. Analysis may be used to support decisions, but rarely drives them.

Recognition of the value of imputation credits has influence over behaviour in three notable areas, the first being the clearest and most important:

  • Payout policy – Imputation has encouraged higher company payouts: the divergence in the payout ratio for Australia versus the world post imputation is stark (see chart). Actions taken by companies to distribute imputation credits clearly indicate they recognise their value to certain shareholders, e.g. off-market buy-backs.
    .
  • Where taxes are paid – Imputation encourages paying Australian company tax at the margin (referred to as ‘integrity benefits’ in the Tax Discussion Paper). If the tax rate is roughly the same in Australia and overseas, why not pay locally and generate imputation credits?
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  • Portfolios – Australian investors may prefer domestic companies paying high, fully-franked yields, all other things being equal. This preference is more likely to manifest as a ‘tilt’, rather than a dominating factor. There are multiple reasons for home bias, or the historical favour for bank stocks, for instance.

GW Figure1 030715

Would removing imputation matter?

Whether and how removing imputation would make a difference depends on what else happens, especially any concurrent corporate tax rate reduction. For instance, this could dictate the tenor of share price reactions, as effects from loss of imputation are pitted against higher earnings. Rather than delve into a multitude of possibilities, I offer two substantial comments.

First, removing imputation would do away with a major driving force for higher payouts. Higher payouts have contributed to more disciplined use of capital, through reducing the ‘cash burning a hole in company’s pockets’, and creating more situations where justification is required to secure funding. This is a MAJOR benefit of the imputation system: a view also expressed by many fund managers. Hence dismantling imputation could be detrimental to both shareholders and the Australian economy through less efficient deployment of capital.

Second, imputation probably matters most for small, domestic companies, many of which are unlisted. In this sector, it is more likely that local investors who value imputation credits are the ones setting prices and providing the funding. Any adverse impacts from removing imputation may be concentrated in this (economically important) segment.

Imputation removes the double-taxation of corporate earnings, but only for resident shareholders. The concept of reintroducing double-taxation for domestic investors in order to fund a revenue-neutral switch that provides a net benefit to overseas investors doesn’t seem quite right. The notion that the outcome will be substantially greater foreign investment with limited losses elsewhere appears questionable, especially once the implications for domestically-focused companies and potential behavioural responses are taken into account.

 

 

Geoff Warren is Research Director at the Centre for International Finance and Regulation (CIFR). This article draws on a paper titled “Do Franking Credits Matter? Exploring the Financial Implications of Dividend Imputation”, written with Andrew Ainsworth and Graham Partington from the University of Sydney. The paper can be found at: http://www.cifr.edu.au/project/F004.aspx

Pausing indexation of the Medicare Levy Surcharge and Private Health Insurance Rebate thresholds

1 July 2015

 

 

The Government will pause indexation of the Medicare Levy Surcharge and Private Health Insurance Rebate income thresholds for three years from 1 July 2015.

The threshold and rebate levels applicable from 1 April 2014 are:

Singles Families

≤$88,000 ≤$176,000

$88,001-102,000 $176,001-204,000

$102,001-136,000 $204,001-272,000

≥$136,001 ≥$272,001

Rebate

 

Standard

Tier 1

Tier 2

Tier 3

< Age 65

29.04%

19.36%

9.68%

0%

Age 65-69

33.88%

24.20%

14.52%

0%

Age 70+

38.72%

29.04%

19.36%

0%

Medicare Levy Surcharge

All ages

0.0%

1.0%

1.25%

1.5%

Single parents and couples (including de facto couples) are subject to family tiers. For families with children, the thresholds are increased by $1,500 for each child after the first.

 

Increase the Medicare levy low-income thresholds for families

1 July 2013

 

 

The Government will increase the Medicare levy low-income phase-in threshold for families. The threshold for couples with no children will be increased to $34,367 (from $33,693 in 2012-13), the additional amount of threshold for each dependent child or student will also be increased to $3,156 (from $3,094 in 2012-13).

There will be no increase in the Medicare levy low-income thresholds for individuals ($20,542) and pensioners ($32,279 individual / $46,000 married or sole parent) which will remain at 2012-13 levels.

 

Dependent Spouse Tax Offset (DSTO) to be abolished

1 July 2014

 

 

The Government will abolish the dependent spouse tax offset for all taxpayers from 1 July 2014. Therefore, the limited access to the DSTO to those whose dependent spouse was born before 1 July 1952 will no longer be available.

Taxpayers that qualified for the Zone Tax Offset, the Overseas Civilians Tax Offset or Overseas Forces Tax Offset and that qualified for the DSTO may instead now qualify for the Dependent (Invalid and Carer) Tax Offset (DICTO) where eligible.

Taxpayers with a dependant who is genuinely unable to work due to a care obligation or a disability may be eligible for the DICTO.

 

Mature Age Worker Tax Offset (MAWTO) to be abolished

1 July 2014

 

 

From 1 July 2014, the Government will abolish the MAWTO. The phase out that was introduced from 1 July 2012, limiting it to taxpayers born before 1 July 1957, will no longer apply.

The Government believes that encouraging mature age workers to participate in the workforce can be done more effectively through incentive payments such as Restart.

 

Reminder: Increase in the Medicare Levy from 1 July 2014

 

As per the 2013 Budget, the Medicare Levy will increase from 1.5% to 2.0% from 1 July 2014 to provide funding for DisabilityCare Australia. This measure has already been legislated.

Low income earners will continue to receive relief from the Medicare Levy through the low income thresholds for singles, families, seniors and pensioners.

The current exemptions from the Medicare Levy will also remain in place, including for blind pensioners and sickness allowance recipients.

GEM Capital Comment

Taking into account the new Temporary Budget Repair Levy, the increase in the Medicare Levy will result in an effective tax rate for taxable income over $180,000 of 49% for the period between 1 July 2014 and 30 June 2017. 

Wednesday, 14 May 2014 08:13

Budget 2014 - Reduction in Company Tax rate

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Reduction in company tax rate

1 July 2015

 

 

The company tax rate will be reduced by 1.5% to 28.5% from 1 July 2015. For companies earning more than $5,000,000 in taxable income, this reduction will be offset by the 1.5% levy to fund the paid parental leave scheme which also commences from 1 July 2015.

GEM Capital Comment

With the reduction in the company tax rate, investors in companies earning less than $5 million may receive greater dividends but less franking credits, leaving them in the same net after tax position. However, for shareholders of companies with income of more than $5 million, the 1.5% reduction in tax will be offset by the 1.5% levy for the paid parental leave scheme. As a result, shareholders may receive the same level of dividends but less franking credits (assuming the levy is not franked), leaving them worse off. 

Friday, 02 May 2014 13:34

Increasing attraction of Salary Sacrifice

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The imminent increase to the Medicare Levy and the planned Deficit Tax will soon make salary sacrifice even more attractive.

 

By way of background, from 1 July 2014, the Medicare Levy will increase from 1.5% to 2%.  For those who are employees and there are therefore in a position to salary sacrifice, the increase in the Medicare Levy actually increases the tax effectiveness of salary sacrificing.  This is because the Medicare Levy does not apply sacrificed amounts whereas it does apply to your taxable income.  However to emjoy this tax saving, you will need to sacrifice benefits that are exempt from fringe benefits tax such as superannuation, tools of trade, work related laptops, briefcases etc.  Where you sacrifice benefits that attract FBT (such as home loan repayments, cars used privately, school fees etc) the higher FBT rate of 47% will apply and thuse negate the benefit of this strategy.

 

The tax effectiveness of salary sacrifice will be enhanced even further if the Government goes ahead with its planned Deficit Tax which has been foreshadowed in recent times.  If implemented as reported, from 1 July 2014 the Deficit Tax would add 1% to the current 37% personal income tax rate, and 2% to the top marginal rate of 45%.  By salary sacrificing FBT exempt benefits however (such as superannuation) you can avoid these tax increases, and of course enjoy the benefit for which you have sacrificed salary (eg superannuation, laptops etc)

 

Those wanting to enter into a salary sacrifice arrangement, should discuss it with their employer.

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