As we approach the end of the 09-10 financial year, advisers should check in with their clients to ensure their investments and superannuation are structured appropriately for tax purposes and they have covered all the necessary administrative bases.
While there are few legislative changes that will necessitate changes in strategy this year, the recent market conditions have given rise to opportunities for some clients.
As with all tax matters, financial planners should be working closely with their clients' accountants or tax advisers to ensure compliance with regulations.
Strategies for investment portfolios
Managing capital gains
Strategies around managing capital gains and utilising capital losses will be important this financial year.
Because of the very sharp rise in equity markets over a short period of time, some funds, particularly those with a high level of turnover, may produce a high level of short-term fully taxed gains, according to Hugh McNally, director, Private Portfolio Managers (PPM).
However, Deborah Wixted, head of technical services for Colonial First State, believes advisers using managed funds should not necessarily expect large amounts of distributed capital gains.
"It will take some time to work the losses from the last couple of years through the system before funds are in a position to actually start distributing gains," Wixted said.
"Advisers should look to see whether there are other assets or investments that clients could use to realise some capital gains to utilise those losses, perhaps as part of a portfolio rebalancing or an overall review of the client's investment strategy."
The 08-09 financial year provided a good opportunity to sell assets to crystallise losses and consider using reduced values, and therefore lower capital gains tax liabilities, to perhaps move investment assets into a spouse's name or to a self-managed super fund. This may provide a better long-term tax outcome, Wixted said.
"That strategy might still have some validity now, but it would need to be far more targeted because there have been increases in market values of shares over the last 12 months. There may be some assets that are still holding a loss from when the client acquired them, and there may be others that have recovered sufficiently to realise capital gains if they were sold," Wixted said.
According to Kris Vogelsong, head of corporate development, PPM, direct share ownership can provide considerable flexibility in this regard, as investors can easily assess the loss or gain on individual positions (prior to year-end) and act accordingly to minimise the CGT liability. With managed funds this can be more difficult to manage, as the tax position is not known until after the end of the tax year.
McNally said the use of franking credits, particularly in superannuation funds, also comes to the fore, so advisers need to look at the composition of income the various managers are generating - whether it is largely short-term gains or largely fully franked dividends.
Deductible expenses
Advisers should also look at any deductible expenses relating to the client's investment income, and work with the client's taxation adviser or accountant to ensure they are realising the full value of these deductions.
Wixted said advisers should be particularly careful about accounting for various types of expenditure in the right way, as some expenses are not immediately tax deductible for an investor, but will reduce their cost base for capital gains tax purposes.
Capital costs which are incurred in purchasing or acquiring an investment (and which are therefore not immediately tax deductible) include:
· Upfront fees for financial advice (paid by the investor);
· Brokerage;
· Conveyancing, valuation and search fees on a property acquisition; and,
· Stamp duty.
· Deductible costs, that is, those which are incurred in the ongoing derivation of assessable income, include:
· Some ongoing fees for financial advice;
· Certain account-keeping or management fees;
· Interest on an investment loan; and,
· Costs incurred in managing investments, such as travel to an investment property and specialised investment journals.
Superannuation strategies
Avoiding excess contributions
While contributing to super can provide tax benefits, changes to the definition of income and the introduction of excess contributions tax can lessen or eliminate these benefits.
According to Graeme Colley, national technical services manager for ING Australia, when making a tax deductible contribution to super is done so primarily for tax purposes, the strategy must be executed correctly to yield the benefit expected.
Only certain individuals can actually claim a full tax deduction for contributions to super, including those who are self-employed, those who are earning passive income, and employees earning less than 10 per cent of their total income from employment-related income and benefits.
"Advisers need to be cognisant that some
individuals are unable to create or add to a carry-forward tax loss by claiming a tax deduction for personal super contributions. This means that the amount of a personal tax deduction is limited to an individual's assessable income less deductions," Colley said.
Tax deductible personal contributions made to super are also assessed against an individual's concessional contributions cap.
One of the new traps of this strategy is that the definition of income has changed. From 1 July 2009, income includes assessable income, reportable fringe benefits, and reportable employer super contributions.
In the past, employees were able to salary sacrifice all or part of their income so that less than 10 per cent of their income was from employment. This strategy effectively enabled employed individuals to claim a tax deduction for personal contributions to super.
"Advisers that recommended this strategy need to be aware that salary sacrifice contributions are now included as income, and from 1 July 2009, the strategy is now ineffective," Colley said.
With these changes in mind, as well as the halving of concessional contribution limits to $50,000 per annum for those aged 50 and above, and $25,000 for those under 50, it is important to check clients' superannuation contributions.
"If we thought we had problems last financial year, they may be bigger this year, because people will just continue with their superannuation strategies as they have for the last couple of years, not realising the importance of the halving of the caps," Wixted said.
"I've seen cases where the client has been a member of a corporate superannuation fund where the employer is paying SG, the employee has the ability to salary sacrifice and the employer is also paying for the insurance premiums and the fees in the corporate plan. The client hasn't realised that all of those things together count towards their concessional contributions caps."
To avoid exceeding contribution caps and therefore incurring excess contributions tax, Wixted recommends conducting an audit with clients to check exactly what contributions are being made to their superannuation before the end of the financial year.
A common issue arising from the most recent round of changes to superannuation is in relation to submitting notice to the fund regarding personal concessional contributions, according to Count Financial technical services manager, Tim Sanderson.
"There are more strict timeframes under the new rules, so we are reminding clients about that," Sanderson said.
If an individual wishes to claim a tax deduction for a personal contribution, they must notify the super fund, and this notification must be made by the earlier of two dates: the submission of a tax return for the year the contribution is made, or the end of the financial year following the financial year in which the contribution was made.
A change in personal circumstances during the year can also make it more difficult to determine the correct amount to declare.
"Even after a notice of intent to claim a deduction has been lodged with the fund, there is provision for the amount of the tax deduction to be varied downwards. This can be achieved by lodging a variation notice, however there are some restrictions that apply," Colley said.
A variation must be lodged before a tax return is submitted, and before the end of the financial year following the year that the contribution was made. Where an amount of tax deduction for a
personal super contribution has been disallowed by the ATO, a variation notice can be lodged after the person submits their tax return. In all circumstances, a variation notice can't be accepted by a super fund if the contribution has been withdrawn, rolled over, or if an income stream has commenced.
Splitting contributions
Because superannuation benefits are tax-free once investors reach the age of 60, there is no longer the same imperative to split contributions between spouses. However Wixted said there are still benefits for clients to split contributions, particularly in terms of providing more flexibility about how they implement their retirement plans.
Salary sacrifice
Just as the new definition of income may change superannuation contributions strategies generally, salary sacrifice arrangements will also need to be reviewed.
From 1 July 2009, salary sacrifice to super contributions count as income for the following measures:
· Centrelink income-tested payments under Age Pension age;
· Government co-contribution;
· Selected tax offsets;
· Baby bonus;
· Family Tax Benefit (FTB) Part A and B;
· Personal deductible contributions to super; and,
· Medicare levy surcharge liability.
"I would suggest some caution around superannuation salary sacrifice strategies, given that the amount of that super salary sacrifice will now be brought in and counted as income in a wide variety of income tests that the Government uses," Wixted said.
"This is the first financial year that this has been in operation, so perhaps advisers need to be looking at that closely and having discussions with some of their clients about the consequences for their end taxation position."
Co-contribution
These changes may also have implications for co-contribution eligibility. While some clients may have had a salary sacrifice in place to ensure they qualified, because that amount is now counted in the co-contribution income test, they may not be eligible for the full amount of co-contribution. Wixted said it is important to flag this issue as early as possible with clients, as well as to consider whether continuing a salary sacrifice or taking the income as cash and receiving the co-contribution is more beneficial.
"We've done some analysis that shows that even in the band of incomes where you're eligible for the co-contribution, some people may actually get a greater net benefit by salary sacrificing, for example," Wixted said.
Superannuation account-based pensions
During the financial crisis, minimum payments from super account-based pensions were reduced for the 08-09 and 09-10 financial years, as asset prices dropped. Because these minimums will be lifted again from 1 July, Sanderson said advisers should be working with clients on what they will do with what will now be surplus income.
Self-managed superannuation funds
At this time of year, self-managed superannuation fund trustees should be checking all the administrative requirements for the financial year have been met.
"For example, making pension payments, ensuring contributions have been accepted and that any deduction notices have been received," Sanderson said.
SMSFs which are utilising the new borrowing exemption to effectively gear through super must also ensure the appropriate decisions have been made around interest payments for the end of the financial year.
Other general strategies
General year-end strategies such as delaying income, bring forward deductible expenses and prepaying interest if gearing to optimise income and tax payable will also be relevant this financial year. As there are further tweaks to the marginal income tax tables that will also come into play from 1 July, it may be worthwhile comparing the options.
"If the end result is that you'll possibly be paying a lower amount of tax next year than this year, the usual strategies about deferring income to next year if you can and bringing forward deductible expenses to this financial year would have greater value this year," Wixted said.
The great unknown
Although these are measures that should be considered in accordance with the taxation status quo, there are in fact several bigger question marks hanging over the tax space. The first is, of course, what the outcomes of the Henry review of the taxation system will be, and the second is whether there will be tax reforms announced as part of the 2010 Federal Budget.
While the report of the Henry review was submitted to the Federal Government before Christmas in 2009, Federal Treasurer Wayne Swan has indicated that the government's response will be released in 2010. At the time of writing, that has not yet occurred.
According to HLB Mann Judd tax director Jolyon Dare, there have been some indications of what Henry's recommendations might be, from the tax review panel and previous tax reform experiences.
"Potential reforms might include measures to reduce or eliminate investment imbalances, including the current tax-bias towards debt finance and capital appreciating assets, and away from savings," Dare said.
"Also rating a mention in Henry's potential to-do list are a range of reforms to issues that have traditionally been states' issues, including road use pricing, and the states' various 'nuisance' narrow-base transaction and payroll taxes with typically high compliance and administration costs."
According to Dare, many also had expected the Henry review to recommend the removal of the dividend imputation system. Australia and New Zealand are the only countries still applying this type of system, with others overseas abandoning this approach because of its bias against both inbound and outbound investors who do not benefit from domestic imputation credits.
"Henry says that in the short term the time has not yet come to abandon imputation, although it might need to be replaced in the medium term by another form of relief more attuned to the needs of international investment," Dare said.
He added that significant tax reform of any kind attracts a great deal of political attention, and what does get through the political process often is quite different from the original policy intent. Henry has also made the point that tax reform takes a long time to implement, and should not be perceived as "the equivalent of a short, sharp jab".
The critical issue for advisers, in this context, is that while reform may take time and political debate, they need to remain abreast of the Government response to the Henry review and others, and be ready to take action on behalf of clients if necessary.
"There may be a 12-month lag before anything is actually legislated, but we always see that in the lead-up to legislative changes there are opportunities for putting in place plans where clients can benefit from quick response," Wixted said.
Case study: Disallowing deductions
Ben (52) is a self-employed painter, who made a tax-deductible contribution to super of $45,000. Ben's taxable income for the financial year ending 30 June 2009 was $42,000.
Upon lodging his tax return, the ATO disallowed $3,000 of Ben's tax deduction. The amount was disallowed as the deduction exceeded his assessable income. Any excess amount is in contributions measured against his non-concessional cap.
If Ben doesn't take any action, the excess amount continues to be assessed as a concessional contribution within the super fund. A variation notice could be lodged to vary the amount of deduction down, even though he has lodged his tax return. As Ben has not withdrawn, rolled over, or commenced an income stream, his super fund is able to accept the variation notice.
"In the event that an amount of tax deduction is disallowed, and attributed to a person's non-concessional contribution cap, the situation worsens for someone who has utilised their non-concessional cap," Colley said.
Source: ING Australia
Case study: Excess contributions
Jill (67) is a retired French language tutor, who ceased working last year. Upon retirement, she sold her investment property and contributed the proceeds to super. Jill made two separate contributions to super, a $50,000 concessional contribution and a $150,000 non-concessional contribution. She used the proceeds of her contributions to commence an account-based income stream.
Jill's tax deductible contribution to super of $50,000 exceeded her assessable income of $38,000. The ATO will re-classify of her contributions from her concessional contribution cap to her non-concessional contribution cap, incurring additional tax of 46.5 per cent on her excess non-concessional contributions.
Ordinarily, Jill could lodge a variation notice to vary her tax deduction down. However, as she has commenced an income stream, her super fund is unable to accept a variation notice. This results in Jill paying $7,380 of tax on her $12,000 contribution.
Source: ING Australia