Tax Rambling

In the Budget we got the following announcement…

From 1 July 2018, companies with turnover of $20 million or more, the rate of the R&D tax offset will depend on the R&D expenditure as a proportion of total expenditure for the year.

The current rate for these entities is 38.5%. As the company tax rate for these guys is generally 30% the actual tax saving is 8.5% of R&D expenditure… but now:

• If less than 2% of an entity’s expenses are R&D expenses, the rate will be 34% (or a 4% benefit);
• If between 2% and 5% of an entity’s expenses are R&D expenses, the rate will be 36.5%;
• If between 5% and 10% of an entity’s expenses are R&D expenses, the rate will be 39%; and
• If more than 10% of an entity’s expenses are R&D expenses, the rate will be 42.5%

This all assumes the company has a tax rate of 30%. If the tax rate is 27.5% all these rates are reduced by 2.5%.

As you can see, if your R&D spend is less than 5% of the company’s total spend this is a substantial reduction in the offset. If the R&D spend is less than 2% of the company’s total spend, the benefit of claiming the R&D Tax Incentive falls to just 4% of the amount the company claims.

But the costing show how few companies spend more than 2% of their expenditure on R&D. The most recent Tax Expenditure Statement that came out two months ago say that the cost of providing the R&D Tax Incentive is a loss of $720 million in tax each year.

The budget costing say this change will increase taxes by between $305million and $395 million a year.

This means these changes reduce the amount handed out through this incentive by half… ouch

The facts…

A taxpayer has a discretionary trust and the trust owns a share in a company that runs an accounting practice. The taxpayer is paid a salary of $250,000 for his work in the accounting practice. The profits of the company are paid to the discretionary trust and are generally around $60,000 but this is distributed to the taxpayer’s spouse and two adult kids at University.

The taxpayer also owns a series of rental properties that are negatively geared with losses of $60,000. The taxpayer sold one of the properties and made a gain of $100,000.

The taxpayer has an SMSF. As the taxpayer has substantial property holdings outside super they hold only listed shares in the SMSF. The fund has $1 million in listed share, returning $50,000 of fully franked dividends. The taxpayer makes a $25,000 deductible super contribution each year.

The taxpayer pays $5,000 for personal tax advice and lodging their return.

The effect if at the next election we get el Presidente Shorten…

The $60,000 profit paid to the discretionary trust was distributed $20,000 to the spouse and the children. Each would pay (almost) no tax now, but under the new tax arrangement proposed by the Opposition the Discretionary Trust Distribution Minimum Tax would apply 30% ($18,000).

$18,000 more Tax

The tax on the $250,000 salary will be increased by the Opposition from 47% to 49%, which is an increase of 2%. But in addition, under the Opposition’s announcements, the taxpayer is denied $2,000 of deductions for tax advice, $25,000 of deductions of super contributions and $60,000 from the losses on the rental properties.

Before these changes, the taxable income was $163,000 ($250,000 – $60,000 – $25,000 – $2,000) but now the taxable income is $250,000. The tax was about $47,000 but it rises to over $87,000.

$40,000 more tax

The sale of the shares for the capital gain of $100,000 was reduced to $50,000 and was (mostly) taxed at 47% so the tax was a bit less than $23,000. But now as the Opposition is reducing the CGT discount from 50% to 25%, the gain is only reduced to $75,000 with tax of $36,750

$14,000 more tax

Finally, under the Opposition’s announcements, the SMSF will lose its refundable tax credits of $15,000 each year.

$15,000 more tax

Total – $87,000 more tax each year

Sent this into a newspaper that will be screaming about unfair tax cuts tomorrow. Let’s see if they publish it. UPDATE… They did (it’s near the bottom of the page – https://www.canberratimes.com.au/national/act/roos-are-a-capital-asset-20180509-p4zecz.html)

Five men decided to split the $100 beer tab based what they earn (one in each 20% grouping based on income) and on the Aussie tax system.

That meant the first paid $0, the second paid $2, the third and fourth paid $14 each, and the fourth paid $70.

The bar owner gave them a $20 refund and based it on what they had paid already.

Therefore, the first got no refund, the second got 40 cents, the third and fourth got $2.4 and the fifth got just under $15.

The media ran headline saying how the refund was inappropriately skewed to the rich and how the refund should be split $4 each. Which is the fairest way to split a refund of this beer tab… or a tax reduction?

So what tax laws are sitting in the Parliament for our hard working MPs to consider in the last sitting week before the May Budget?

1. A bill that has been in the Parliament for 4 days less than a year that supplements the ‘same business test’ with a ‘similar business test’  and to provide taxpayers with the choice to self-assess the effective life of certain intangible depreciating assets they start to hold on or after 1 July 2016… Its not like anyone has completed a 2017 tax return already!!!
2. A Bill to transfer the regulator role for early release of superannuation benefits on compassionate grounds from the Chief Executive Medicare to the Commissioner.
3. A Bill that prohibits the production, distribution, possession and use of sales suppression tools and also requires entities that provide courier or cleaning services to report details of transactions that involve engaging other entities to undertake those courier or cleaning services for them.
4. A Bill that provides that a corporate tax entity will not qualify for the lower 27.5 per cent corporate tax rate if more than 80 per cent of its assessable income is income of a passive nature.
5. A Bill that progressively extends the lower 27.5 per cent corporate tax rate to all corporate tax entities by the 2023-24 financial year; and further reduce the corporate tax rate in stages so that by the 2026-27 financial year, the corporate tax rate for all entities will be 25 per cent.
6. A Bill that removes the entitlement to the capital gains tax main residence exemption for foreign residents.
7. A Bill that requires purchasers of new residential premises and subdivisions of potential residential land to make a payment of part of the purchase price to the ATO.

Add to this some changes to tax concessions for Venture Capital, the Banking Levy, new whistle blower protections, a new Junior Mineral Exploration incentive, tax consolidation fixes, and a lot of minor super changes (can’t use salary sacrificed super to meet SGC requirements and those under EBAs must get a choice of super form)…

As almost all of these were announced in last years budget (some in the budget from the year before), wouldn’t it be great if they finalised these in the last sitting week before we get the next budget with an entirely new set of announcements!!!!

The only entities that will still be able to get these cash refunds are income tax exempt charities and not-for-profit institutions with deductible gift recipient status.

But what effect will this have?

Importantly, this change will put SMSFs at a disadvantage to APRA regulated funds when it comes to share ownership. As APRA funds are treated as a single entity they normally have enough other income to offset their imputation credits against so they get the full value of any imputation credits. But an SMSF that is heavily invested in listed shares will find a substantial reduction in returns if they can no longer obtain the refund of the excess imputation credits.

To own shares in an SMSF, and to use all their imputation credits on these shares, the trustee will need to have income from sources other than franked dividend that is greater than the franked dividend income. If an SMSF gets a $70 fully franked dividend they will need an additional $100 of income from other sources (unfranked dividends, rent, interest…) to use all the $30 of imputation credits on the $70 dividend.

So having an SMSF with a majority of share ownership might not be advisable any more as they could roll the amount into a retail or industry fund that gets the benefit of all of the imputation credits. And there are funds that allow an effective investment in majority listed shares. But what is the benefit of doing this?

Take the example of an SMSF and a retail fund that get a $70 fully franked dividend. The dividend is grossed up to $100 and the tax payable on it is $15. but neither pays the tax due to the imputation credit. At this point both the SMSF and the retail fund have $70. The retail fund uses the remaining $15 imputation credit to reduce tax on other income, which is credited to the member, so giving the member of the retail fund $85. This means the return on listed shares can be as much as 21% higher through a retail fund than an SMSF (but this will be lower if there is other income in the SMSF).

The days of the financial advisor who is a great stock picker and puts everyone in an SMSF and has every SMSF with a majority of listed shares might be over after the next election. Even the best stock picker is going to struggle if they start at as much as 21% behind.

“A FAIRER TAX SYSTEM: DIVIDEND IMPUTATION REFORM”, Media Release, Shadow Treasurer Chris Bowen, Chrisbowen.net, 13 March 2018

The ALP don’t appear to be scared to take some radical tax changes to the next election.

Today they announced removing the ability to get excess imputation credits refunded… There will be some very unhappy SMSF and retirees (and charities) who get lots of cash each year from the ATO in the form of refunded imputation credits.

But that is nowhere near all they want to change… and isn’t it funny that all the changes raise taxes…

• Removing the ability to get excess imputation credits refunded;
• They want to remove negative gearing deductions that can be applied against PAYGW income on all assets except new residential property;
• They want to reduce the CGT discount to 25%;
• They want to introduce a minimum 30% tax on discretionary trust distributions;
• They want to limit the 27.5% company tax rate to Small Business Entities (turnover less than $10m);
• They want to limit deductions for tax advice to $3,000 for non business entities;
• Decrease the threshold at which the Division 293 tax applies to $250,000;
• PERHAPS add back the temporary budget levy to get the highest marginal tax rate to 49% (I doubt they will actually do this); and 
• Changes to large business taxation like removing the safe harbour rule from thin capitalisation so that businesses can only use the worldwide gearing ratio, change the MEC rules for consolidated groups, reduce the public reporting rules for private companies from $200 million to $100 million, and make the country by country transfer pricing documentation publicly available.

Still more than a year to the election, which it looks like the ALP will win with a comfortable majority, and this will be our new tax system from possibly 1 July 2019…

The Bill making this change is before the Parliament (Treasury Laws Amendment (Reducing Pressure on Housing Affordability No. 2) Bill 2018).

Not much has changes…

The grandfathering is still the same. If you owned the property before 10 May 2017 and sell it before 30 June 2019 you still get the MRE. It looks like there will be lots of properties on the market in early 2019.