The May budget opens up great opportunities to benefit from changes to superannuation and marginal rates.

End of year tax planning has been turned upside down by the latest tax cuts and the Government's proposals to revamp the superannuation system.

In essence, for most, the best tax advice is to contribute as much as possible to superannuation.

Every June 30 that now passes without making the largest possible deducted and undeducted contributions to super are lost tax planning opportunities.

Superannuation has suddenly become much more attractive because of the Government's proposal that, from July next year, all lump sum and pension Super payouts will become tax free for those over 60.

The race to get money into super is triggered by expectations of tax free payouts, along with the Government's intention to limit annual deductible contributions to $50,000 (with special transitional arrangements in the next six years for those over 50), and the limiting of annual undeducted contributions to $150,000 from budget night. (See post script note)

The tax cuts give much greater impetus to the standard strategies of maximising tax deductions before the end of the financial year and deferring as much income as possible to the new financial year.

Tax deductions are obviously more valuable when tax rates are higher, and deferral of income is more tax effective when taxes are falling.

Here are some new end of year tax strategies:

1. Immediately maximise deductible super contributions:

Advantage One says fund members should get as much money into super as possible, given the Government's budget proposal to limit deductible contributions to a non-indexed $50,000 a year. This should include making the maximum deductible contribution allowable in tax law by June 30.

As a transitional measure, the Government proposes that a $100,000 limit on deductible contributions apply for the next six years to those over 50.

Those who should consider making large deducted contributions before July next year include fund members who have already been considering transferring some of their non-super wealth into a super fund. For example, fund members are allowed under superannuation law to transfer privately owned listed shares and real business property into Self Managed Funds. (The self-employed and members outside the workforce can claim a full deduction for the first $5,000 of contributions plus 75% of the remainder for contributions within the age-based limits. These fund members will gain full deductibility for their contributions from July next year, within the legal limits).

The impetus to contribute as much as possible to super is particularly crucial for members under 50 who will not benefit from the budget's transitional arrangements.

2. Maximise opportunities for members with more than one employer:

Fund members with multiple employers should consider making extra big deductible super contributions before July next year. Under the existing rules, an individual is able to salary sacrifice up to the age-based limits for each employer. But the Government intends to restrict all individuals to the $50,000 deductible limit from July next year, even if a person has more than one employer.

3. Accelerate deductions:

The big tax cuts announced in the budget - including increasing the income threshold for the top marginal rate from $95,001 plus in 2005-06 to $150,001 plus from 2006-07 - provide a powerful incentive to claim as much in tax deductions in this financial year, when tax is higher.

Ways to maximise deductions include pre-paying interest on an investment loan for 12 months (restrictions on pre-paid interest apply to some tax shelters), doing deductible repairs and maintenance to investment properties before June 30 and pre-paying premiums for income protection insurance for 12 months.

4. Defer income and capital gains:

The deferring of income and capital gains means that less tax will be paid because of the latest tax cuts. Ways to push income or capital gains into the next financial year include deferring the sale of assets - if appropriate for investment as well as for tax reasons - and the issuing of invoices for business and professional services until after June 30.

(Please note that disposal for capital gains tax (CGT) purposes takes place on the date of the sales contract - not when payment is received).

5. Make deductible super contributions to offset CGT on investment profits:

Self-employed and those outside the workforce can legally eliminate CGT payable on the sale of residential property or shares by making sufficient deductible super contributions. This approach may appeal to, among others, the non-working spouses of high income executives who hold valuable investments, as part of a family income-splitting or asset-protection strategy.

This opportunity is more widely available since a change in the law two years ago allowing those outside the paid workforce aged under 65 to make super contributions. (PreviosSuper contributions because their employers pay superannuation Guarantee Contributions. (There are very limited exceptions to this rule).

6. Pay bonus into super as salary sacrificed contribution:

Executives can arrange to receive bonuses due before the end of the financial year as salary sacrifice Super contributions as an alternative to cash. This will mean that the bonus is not subject to marginal tax rates of up to 48.5% (the top rate for 2005-06) but to 15% contributions tax upon entering a Super Fund.

7. Adopt a borrow-to-contribute strategy:

Self-employed Fund members within a few years of retirement should consider borrowing to make large deductible super contributions if the money is not readily available before June 30.

Although interest on the loan is not deductible, members can expect their contributions to lead to perhaps 25 years of tax free superannuation income during retirement under the Government's proposed new superannuation system.

This refers to the Government's intention to abolish tax on lump sum and pension payments from July next year.

8. Conduct a five-year borrow to contribute strategy:

Self-employed people over 50 could consider a borrow-to-contribute strategy for, perhaps, a five year period until retirement. The maximum deductible contribution allowable is made each year - all from borrowed money. This strategy, based on various assumptions, such as the investment performance of the super fund, could produce a profit of tens of thousands of dollars.

Under this strategy, interest on an interest only loan is capitalised and repaid, along with the borrowed money, from the Fund member's super balance on retirement. The large annual deductions are spent on reducing the mounting debt for money borrowed to make the contributions. The profit from the strategy comes from the value of the tax deductions for the contributions and the returns from the Super Fund, as well as expectations for many years of a tax free income from superannuation.

Caution and discipline are required with this strategy.

9. Use super to extract money from private companies:

Cashed-up private companies could consider paying their shareholders who are outside the paid workforce high, fully franked dividends before June 30. Under this strategy, the shareholders would contribute the money to super as deductible contributions before June 30. (As discussed in the strategy above, those outside the workforce and the self-employed can claim deductions for their personal super contributions).

The end of year tax strategy is designed to overcome the problem of removing money from private companies in a tax effective way. (Many private companies are bursting with cash because they are used as beneficiaries of family trusts to shelter individual family members from personal tax rates).

This strategy means that someone outside the workforce who has no other income could receive a fully franked dividend of $246,850 in 2005-06 without paying personal tax. Under the strategy, the person uses $132,450 of the dividend to make a contribution to super within the age-based limit for deductible contributions. (The contribution is, of course, subject to the standard 15% contributions - a big break on the top marginal rate that otherwise would have been payable). The best thing about the strategy is that the individual ends up with cash of $114,000, which could be used as an undeducted contribution to super.

The strategy is in line with the desirability of contributing as much as possible to super, given the proposed limits on deductible contributions and the attraction of receiving tax free payouts from super after the ago of 60.

A person over 50 could make a total of $600,000 in deductible super contributions under the Government's transitional arrangements for this age group that are in force until 2011-12. After that date, the Government proposes to limit all fund members to deductible contributions of $50,000 a year.

10. Cut tax on private company dividends

Private companies should consider paying themselves dividends, unless they are practicing strategy 9.

The July 1 tax cuts mean that a shareholder with no other income could receive a fully franked dividend of a little more than $70,000 - without having to pay any personal tax.

11. Watch for deemed dividends/debit loans:

Private companies should check before the financial year ends whether precautions have been taken to prevent loans to shareholders being deemed as dividends under division 7A of the Taxation Act. This is to prevent private companies from distributing profits to shareholders disguised as loans.

Under division 7A, the commissioner of taxation can deem loans as dividends, resulting in the amounts being taxable at the recipient's marginal tax rate without the benefit of imputation credits - yet the company's franking account is debited.

To protect against the possibility of having a loan declared a deemed dividend, private companies should use properly documented loan agreements that provide for repayment within seven years and the payment of interest at the minimum legal benchmark rate.

12. Delay retirement

Anyone who has been considering retirement this financial year should consider postponing their retirement because of the proposal that super payouts become tax-free if received after July 1, 2007, by those over 60. Some people might decide to retire before that date but receive their super benefits after it.

13. Take big golden hand-shakes before July next year

High income earners expecting big redundancy payouts have a strong tax incentive to leave their jobs before July 1 next year. After that date, these executives will have to pay much more tax on their payouts and will be prevented from rolling the amounts into super in an effort to reduce this higher tax.

As part of its budget measures, the Government intends to:
* Tax at 16.5% for those over 55 the first $140,000 of a redundancy payout classifies as an employer eligible termination payment. (Redundancy payouts include tax-free amounts for each year of service).
* Tax the proportion of a redundancy payout above $140,000 at the top marginal tax rate.

14. Clean out share portfolio

A standard end of year strategy is to sell for capital loss non-performing shares with poor expectations in the same financial year that other assets are sold for capital gains. In this way, losses can be offset against the gains for CGT purposes. (Tax law stipulates that capital losses can be applied only to capital gains in the same financial year or carried forward to offset against future gains.)

An extra incentive for the clean-out strategy this financial year is that many investors are overweight in shares, following the strong gains in the market since March 2003, and might want to rebalance their investment portfolios.

15. Recalculate tax-effectiveness of salary-packaged cars.

Increasing the income threshold for the top marginal rate from $95,001 in 2005- 06 to $150,001 this financial year may marginally reduce the tax effectiveness of a salary packaged car, even though packaged vehicles can be concessionally valued for fringe benefits tax (FBT). This is because the FBT rate is based on the top marginal rate. Employees intending to sign new car releases this financial year, should take care not to overlook this issue.

A highly tax-effective strategy that is popular with employees with incomes under the top marginal rate is to personally contribute the taxable value of their car from after-tax income. This is known as the employee contribution method and neatly removes the vehicle from the FBT net, so FBT is no longer payable. In effect, an employee with a marginal rate of, say 31.5% will pay a tax rate of 31.5% on the car's taxable value.

Most employees who fall under the marginal rate because of the latest tax cuts will not seek to introduce the employee contribution method until their existing car lease expires.


Note

As of 6th September 2006, Peter Costello announced further changes as a result of Treasury's eight week consultation with businesses.

Significantly it has abandoned it's controversial proposal to impose an immediate $150,000 cap on post tax contributions. People can now put $1m into their super betweeen May 10 2006 and June 2007 ie $400,000 more than previously announced. People who sell small businesses, where assets have been held for 15 years, can put an extra $1m into super.

Careful consideration of your own unique circumstances is required before acting on any of the above strategies.

Tony Martin - Director
Strategic Financial Coach