REDUCING YOUR TAX BILL
There are a range of strategies you can use to avoid paying higher taxes and improve your investments.
Q. How to improve investment returns.
A. A common way to improve investment returns is to move from low-risk assets, such as cash and bonds, to riskier assets, such as shares. This approach increases the variability of returns, because the higher-risk assets are more volatile. Strategies such as portfolio diversification are designed to smooth out this volatility. But diversification is only part of the story.
Q. Is there a range of strategies that can be used to lower tax rates on investment portfolios?
A. Investors can effectively elect the tax rate they pay on their investments.
The simplest way to illustrate the possibilities for enhancing investment returns by reducing taxes is to consider the difference between investing inside or outside the superannuation fund. Superannuation funds are taxed at the concessional rate of 15 per cent. Compare this to the marginal tax rate of 48.5 per cent for individuals and the 30 percent corporate tax rate. There are also deductions available for contributions to super, and we are all familiar with the additional tax impost of the superannuation surcharge.
Q. How does the dividend imputation system work inside Super Funds?
A. Imputation is, and always has been, a legitimate tool for super funds to reduce their effective tax rate.
All shareholders who receive franked dividends receive some tax benefit from them. Individuals, trusts and partnerships effectively reduce the tax payable on those dividends by suing the franking credits to offset that tax. Companies use the franking credits to pay franked dividends on their own shares.
But the additional power of franked dividends for super funds arises because of the difference between the tax rate for companies (30 per cent) and super funds (15 percent). Fully franked dividends paid by Australian companies provide a tax credit at the rate of 30 per cent, which means that for a lower rate taxpayer, there is spare tax shelter available.
The spare tax shelter from franked dividends can be used to reduce other taxes payable by the super fund, such as tax on other unfranked income, and contributions taxes. Now that surplus franking credits are cash-refundable, any unused franking can also be converted to generate additional returns.
Q. Are there any other tax shelters available to investors?
A. Yes, there are two other powerful tax shelters legitimately available.
Firstly, since the introduction of discount capital gains tax in 1999, Australian investors have only been taxed on half of their capital gains or on two-thirds of their capital gains if the investment is conducted through a super fund.
The other key tax benefits legitimately available to investors are tax deductions for interest expenses on borrowed money. Individuals and companies can use tax deductions in their own names, while trusts and partnerships effectively pass the tax deductions through to their members. Superannuation funds can also use tax deductions to reduce tax but are subject to strict limitations on the use of borrowings. Structured products like instalments are the only effective way for super funds to legitimately borrow to buy individual shares.
There are some rules that limit the use of these tax deductions, the primary issue being when and how much of the deduction can be claimed. Super funds are only able to spread tax deductions for interest expenses over the year to which the loan relates. Individual and corporate investors can use the deductions when the interest expense is outlaid. In practice this means that efficient tax planning will involve super funds making interest payments at the start of each tax year, while other investors can use deductions all through the tax year.
In summary, because of the significant concessional tax breaks available by investing via a superannuation structure, less tax is paid, additional funds are maintained and therefore a larger pool is available to you for retirement. How good is that!!
For further information contact Tony Martin - Director Advantage One
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