One thing we are sure of is that we all pay tax, and we all want to know how to reduce taxes we pay.
I’m sure you’ve heard of Benjamin Franklin’s famous quote; “there is nothing more certain than Death & Taxes”. However, there is one quote you may not have heard:
“The hardest thing to understand in the world is the income tax” – Albert Einstein
What I think Einstein is referring to is a belief that paying tax on revenue discourages the production of creating wealth, and that tax should instead be based on things such as on consumption (GST), or as a deterrence or as a penalty.
Even though one of the smartest minds of our history cannot understand a tax on income, income tax has proven over time to be an effective means of raising funds to fuel our standard of living, worldwide. Every country around the world pays tax.
Comparison of taxes in Australia Vs OECD.
It may surprise you to know, according to the OECD.org 2019 study, Australia’s top personal tax rate at 47% ranks 17th of all 37 OECD countries.
Data Extracted 19 April 2021 OECD.org
Our ranking in the company rate tells a different picture where Australia is ranked joint second at 30%. However, this is not an article on comparisons. There is however no doubt, taxes have become increasingly more complex and permeate our personal, business, investment, retirement, and estate planning, and leads to the topic of how to minimise your Australian taxes.
Illegal ways to reduce taxes
Word of WARNING: There is a very powerful general anti-avoidance provision in Australian income tax law known as PART IVA. Broadly, this provision applies if the sole or dominant purpose of a participant acting in a scheme is to avoid or reduce tax. The commissioner of taxation can then cancel the relevant tax benefit.
So, opening an offshore account, lodging incorrect or fraudulent returns, and participating in elaborate tax avoidance schemes will NEVER be a sound strategy.
Clever tax minimisation to reduce taxes
Our top tax planning strategies come in three main focus areas, and these should be discussed with a qualified and experienced tax accountant:
- Structure, Structure, Structure
- Timing is key to reduce taxes
- Know what Tax benefits are available
Structure, Structure, Structure
Before you start your next business, investment or job opportunity, work out which structure is best for you to operate or invest through. Is it a Company or a Trust, or as an Individual or a Partnership, or maybe even through your Self-Managed Super Fund?
Consider the tax rate applied to taxable income amongst each entity. The individual and the partnership is from 0% to 47%, the company rate is between 26% and 30%. The Trust rate is from 0% to 47%, and the Self-Managed Superfund is 15%.
Each entity has a myriad of rules and regulations which allow for combinations of the entities to be used to maximise tax benefits. I love examples, so let’s use one:
Example 1: Using a Discretionary Trust to reduce taxes
Jane earns $230,000 salary per year and has 2 adult children of 19 and 18. Both are studying and will continue education for another 5 years. She also has a partner who earns a salary of $180,000 pa.
Jane and partner are wanting to invest in a property, estimated to provide a net profit of $30,000 per year and a capital gain of $500,000 in 5 years’ time. The children’s education and upkeep is expected to cost $300,000 over the next 5 years.
Their wise advisors recommend purchasing their investment property in a Discretionary Family Trust, with all family members as beneficiaries.
A Discretionary Trust allows the Trustee to distribute taxable income to beneficiaries at their discretion. The Trustee can utilise lower marginal tax rates of the beneficiaries, and therefore reduce the total tax liability.
Each year the trust distributes $15,000 to both children in the form of paying for part of their education and living costs, with no other income received by the children. At the beginning of the 5th year they sell the property and the capital gain of the property is $480,000, and $240,000 is distributed to each child. Jane and partner are earning more than 5 years ago.
The net tax the family pay on the trust distributions over the 5 years, assuming rates do not change, and they have private health insurance, and ignoring any tax offsets, compared to purchasing in the parents own names as a partnership, is:
|Trust Structure||Personal Structure|
This is a net saving in tax of $105,466 over the 5 years. However, there is another tax that we must finally consider, and that is Land Tax. As the property is held in a Family trust there is no tax-free threshold, so 1.6% of the land value is charged. If we assume the land value is $500,000 over the 5 years, then the additional Land Tax is $8,000 per year, so $40,000 in total.
There is still a tax saving of around $65,466 over the 5 years to the family, which is significant.
The savings would be even greater if the investment was purchased in a Self-Managed Super Fund (SMSF) and the property sold when the fund was in pension phase, as there would be no tax on the gain made in the super fund and no Land Tax. This is assuming the balance of each member in the fund is under $1.7 million…… So many rules to consider !!!
This example illustrates the significant advantages of getting the structure correct, and why Structure, Structure, Structure is the first step to effectively reduce taxes.
There are many ways to restructure your interests to achieve significant, future tax savings and reduce risk. However, this does come at a cost and is complex and unique to every situation and group. Your experienced tax accountant will be able to offer suggestions and estimate costs to suit your situation.
Timing is key to reduce tax liabilities
The income tax year is broadly 1 July to 30th June. This is a cut-off date, so any income earned, or expenses incurred during this time are included in that year. This makes planning the timing of your income and expenses a critical part of reducing your taxes. The following areas have been summarised as effective tax planning, which are time critical:
Plan your income
Where possible, defer earning income until after June 30th to avoid paying tax in the current financial year. This may involve planning projects to be delayed, where it does not negatively impact the business. Remember, this only ‘kicks the can down the road’. However, sometimes this can be very effective if the current year income is high and the following year income is expected to be low.
Time the sale of assets to reduce taxes
The time an asset, such as a property investment or a business, is sold is critical in taking advantage of various tax concessions. Here are some to consider:
50% general exemption
Where a sale of an asset will result in a Capital Gain, ensure the time of the sale takes advantage of Capital Gains Tax (CGT) concessions.
There is a 50% CGT discount on assets held for more than 12 months. Also, be aware that a sale of property takes place in the year you sign the contract, not on settlement day.
Apply the 15-year exemption
Small business owners aged 55 or older who retire and have owned a business asset for at least 15 years, are exempt from paying CGT when they dispose of the asset.
Small business owners who own assets with significant Capital Gains outside of their super account should time the sale of the assets to reduce the amount of CGT.
There is a lifetime limit of $500,000 CGT exemption on the sale of an active business asset. For those who are under 55, the proceeds from the sale of the asset must be paid into a superannuation fund or retirement savings account.
Prepaying up to 12 months of deductible expenses can bring the deduction forward to the current financial year. This may include prepaying interest on an investment loan.
Know what tax benefits are available
There are a range of options that may be available to assist in reducing taxes. Let’s look at some of the most common ones:
Superannuation contribution options to reduce taxes:
Salary sacrificing super
Salary sacrificing into super involves forgoing some of your pre-tax salary/wages and putting it into super instead. This is a tax-effective strategy, because super contributions are taxed at the concessional rate of 15% in Australia. This rate is lower than the personal income tax rate.
One allowable tax deduction that can also be a significant long-term wealth creation strategy is maximising your voluntary superannuation contributions. You can currently claim up to $25,000 as a tax deduction each year. This is known as the concessional contributions cap.
Unused concessional cap carry forward
From 1 July 2018, you may be entitled to contribute the unused amounts of your concessional contributions cap for a maximum of 5 years.
For example, if you didn’t pay any superannuation contributions for FY2018, FY 2019 and FY 2020, then you may be entitled to make deductible super contributions to the value of $100,000 in FY 2021. This could save $47,000 in tax for the FY2021 year.
Salary packaging in a charity
If you are working for a charity that has the FBT exemption, you can save by having $15,900 of your living expenses paid tax-free, these include expenses such as:
- Rental payments
- Personal loan payment
- Mortgage payments
- Credit card payments/living expense cards
- General living expenses
- Utility bills or rates notices
Instant asset write-off and allowances
Eligible businesses can claim an immediate deduction for the business portion of the cost of an asset in the year the asset is first used or installed ready for use.
For assets first used or installed ready for use between 12 March 2020 until 30 June 2021, and purchased by 31 December 2020, the instant asset write-off threshold amount for each asset is $150,000 (up from $30,000).
See your tax accountant for more details, as there are many conditions applicable.
Claim for property depreciation
Most properties that generate income qualify for some level of depreciation. Property investors can claim Division 43 capital works deduction and Division 40 plant and equipment depreciation. The capital works deduction applies to items that are fixed to a property’s structure, and includes renovations. The plant and equipment deduction relates to what you can claim for eligible items within the property, such as curtains or blinds.
Use a quantity surveyor
Quantity surveyors can help prepare a depreciation schedule to help maximise an investor’s claim for depreciation. The cost of preparing this report is also tax-deductible.
Did you know there is an unintended ‘Death Tax’ in Australia?
Super benefits paid on the death of a member are tax-free for a deceased member’s dependants. However, many members are not survived by dependants, and are often survived by adult independent children who do not receive distributions tax-free. The taxable component of the lump-sum super death payment is usually subject to 15% tax
To minimise the chance of surviving adult children paying the ‘death-tax’, members should consider using a recontribution strategy, keeping a separate pension or even drawing down on their super before their death. This means having clear instructions in the will and for any Power of Attorney in the event of incapacity.
Use your Franking Credits wisely to reduce taxes
Use of Franking Credits in your tax planning can save you tax. This is achieved by utilising the tax paid by the company, which is passed on to the shareholder when a Franked Dividend is paid.
Franking credits can reduce the income tax paid on dividends, or potentially be received as a tax refund.
Effective tax planning is the key
This list is not exhaustive, and we highly recommend you talk to an experienced tax accountant, as every person’s tax position is unique and requires consideration of a multitude of factors to design an effective tax plan.
Let’s also keep in mind, as Thomas Dewar founder of Dewars Scotch on tax once said:
‘The only thing that hurts more than paying income tax is not having to pay income tax.’