Tax Update Blog – 31 January 2019
It is increasingly looking as though the Labor Party will be elected in the upcoming Federal election, although Liberal seem to be releasing details of some policies that are good for the economy and particularly in relation to small business and individual tax, it may be too little too late.
We need to spend some time looking at the proposals being put forward by Labor and what it will mean for your business and your back pocket.
Labor’s proposed tax policies would increase taxes, predominantly taxes on retirees, housing, investments and family businesses, by an estimated $200billion, yes, that’s “Billion”. The most significant changes proposed by Labor are;
Raising the top Marginal Rate of Tax by 2%.
Denying refunds of Dividend Imputation Credits where the tax credit exceeds the tax payable.
Taxing Discretionary Family Trusts, and other Non-Fixed Trusts at a minimum tax rate of 30%.
Limiting deductions for the cost of managing tax affairs to no more than $3,000 per entity.
Limiting or eliminating Negative Gearing.
Halving the Capital Gains Tax discount.
Many of these issues are controversial and have seen a substantial amount of media coverage recently.
No More Dividend Imputation Credit Refunds!
The major impact that we see from the proposal to eliminate refunds from Dividend Imputation Credits will be to retirees and their Self-Managed Superannuation Funds.
The Imputation System was introduced to eliminate the double taxation of profits derived by a company when those profits were subsequently paid to shareholders as a dividend. It effectively taxes the shareholder on the income derived by the company at the shareholder’s marginal rate of tax.
A superannuation fund in retirement phase paying a pension to its members does not pay any tax on its income, thus the 30% tax credit attached to its dividend income would be lost under a Labor regime. As an example, an SMSF receiving $30,000 in dividends during the year would have received a refund of the tax credits attached of $12,857, providing the fund with a total of $42,857 to pay to its member as a pension. Under Labor’s proposal the refunded credits are not available and so the fund only has $30,000 for the pension payment, a fall of 30% of the retiree’s pension. The same result would happen for a retiree directly investing in shares.
The result of this proposal would seem to be a mass exodus of superannuation fund and retiree investors from the share market which would likely result in massive share price reductions, resulting in capital losses to those willing to ride out the storm.
No More Negative Gearing
The proposal to deny tax deductions for interest and other costs in relation to any geared investment would have a number of far reaching impacts. Negative Gearing is intended to entice investors into the property market so that there is a sufficient supply of rental properties available. It is intended to entice capital into the share market so that businesses are supported and are able to pay reasonable dividends to shareholders, in Australia predominantly mums and dads and retirees or their superannuation funds.
As an example, an investor rents out their property for $25,000 pa, with rates, insurances and other costs of say $4,000, repairs and maintenance of the property of $3,000, and depreciation of $3,000, giving a net profit of $15,000 before interest. Interest on their loan to acquire the property is $20,000, so they incur a loss of $5,000 for the year. Currently the investor gets a tax deduction for this which would generate a refund of $1,950 at their marginal rate of tax of 37% plus Medicare levy.
Under Labor’s proposal they would be denied the tax deduction and lose the refund of $1,950.
If, however the repairs to the property were substantial during the year, say $23,000 the investor has now lost $15,000 during the year and will get no tax benefit from having repaired the property, currently $5,850.
We consider that the proposed policy would take away the incentive of an investor to make repairs to their property as they will be denied tax relief for doing so. The loss in cash flow derived from the tax benefit would also lead to increases in rent charged to compensate for the lost cash inflow.
Halving the CGT Discount
Labor’s proposal to halve the current discount available on Capital Gains made by investors will also have substantial impact on a number of sectors.
Many investors invest in property trusts or similar investments which buy and sell assets held for longer periods of time and distribute a share of their capital gains to unitholders/investors. These investors are currently taxed on half of the gains received at their marginal rate of tax. Under the Labor proposal they will now be taxed on three quarters of these gains, thus their tax liability is increased by 50%!
As an example, an investor receives a capital gain of $10,000 via a listed investment unit trust. The investor is eligible for the current 50% discount and so is taxed on $5,000 at their marginal rate of tax of 37% plus Medicare levy, or $1,950. Under Labor’s proposal they are now taxed on three quarters of the gain, or $7,500 which will attract tax of $2,925, a 50% increase in their tax payable on this income. The same will occur with investors investing in the share market who will be hit with both the additional tax on the capital gain and the loss of imputation credit refunds, making shares an even worse investment choice.
An investor in property is also affected. If you bought a rental property in 1990 for $400,000 and sold it in 2019 for $800,000. Assume that the investor has other income from their wages of say $70,000pa.
The investor has earned a capital gain of $400,000 over the 29 years that they owned and maintained the property. Currently they would be taxed on half of the gain of $200,000 which would incur tax of $84,300 at their marginal rates of tax plus Medicare levy.
Under Labor’s proposal the investor is now taxed on three quarters of the gain, an amount of $300,000 which will attract tax of $131,300, an increase of $47,000 or 56% more than the current amount payable.
We consider that this policy will actively drive investors out of the property market due to the lack of tax deduction for the annual loss from holding the property and the substantial increase in tax when the property is eventually sold. Property owners may alternatively consider holding their investments over much longer terms to not incur the tax or leave the property to be passed to the next generation under their will to avoid paying the tax. This will substantially reduce the number of properties available for sale, providing first home buyers with even less choice and pushing prices of these few much higher.
Taxing the Family Trust
Trusts operate in such a way that their income is taxed in the hands of the beneficiary in receipt of the income it derives. Labor proposes to impose tax at source on the trust’s net income at the rate of 30%. This will effectively overtax beneficiaries of any trust that is taxed at a lower personal tax rate. Labor’s intention is to eliminate income splitting through trusts and tax families at higher rates of tax than may otherwise be payable.
As an example, an adult beneficiary of a trust with no other income who receives a distribution of $18,000 currently pays no tax, however under Labor’s proposal their distribution will be taxed at source at 30% ($5,400) and the net distribution of $12,600 made available to them, a substantial fall in their available cash flow.