Six Ways To Plan For A Tax Break

Sydney Morning Herald

Tuesday June 30, 1992

ROBERT RICHARDS

LAST minute tax planning is not normally good tax planning. Rather, the key is advance preparation. This is especially true for high income earners, most of whom have a range of opportunities to legitimately cut their tax. Here are some financial year resolutions.

* Review Your Salary Package.

Until 1987 (when the fringe benefits tax was first introduced) it used to be easy to reduce your tax by substituting all manner of benefits for your salary.

Those days are over. In fact, at law the benefits were most probably never there. It's just that the Tax Office never got around to challenging some of the more outrageous packages. As a result, we now all have to live with the fringe benefits tax. But it is still possible to make some worthwhile tax savings. If you want to take advantage of these savings, you should make certain they form part of your ongoing salary arrangements. You cannot suddenly restructure your salary at the end of the financial year.

Most obviously you should think about superannuation (see below). You might ask your employer to implement an employee-share scheme. These should be introduced in times when the stockmarket is low and not (as is more normally the case) when it is booming.

There are tax benefits in your employer providing you with a company car rather than you paying for it yourself.

This is because of the way the fringe benefits tax on the company car is calculated. Your employer can calculate his fringe benefits tax liability on your company car, under either the "operating method" (which means that the fringe benefits tax liability is imposed on the actual costs of running your car) or under the "statutory method".

Under the statutory method, your employer simply pays tax on a percentage of the cost of your car which can be reduced by one-third where your employer has held it for more than four years. The percentage used depends upon how far you have driven during the year.

It is this method which makes motor vehicles still attractive for most employees. The statutory method assumes that the car is used at least in part for business and it makes very generous assumptions as to the amount of time the car is used in this way. If you want to take the maximum benefit of this inbuilt assumption, your employer can provide you with two cars, one of which might be used by your spouse or children and never used for business.

There are benefits to you too (although security risks to your employer) in making interest-free or low-interest loans available to you.

This is because fringe benefits tax on employee loans is levied on the difference between a "benchmark rate" (now 9.25 per cent) and the actual interest payable by the employee to the employer.

The advantage here is that the benchmark rate may be less than what it will cost the employee to obtain a similar loan. As a consequence, the employer can effectively subsidise the difference between the benchmark rate and the market rate free of tax.

It also may make sense for your employer to provide you with generous entertainment and travel allowances. Your employer may lose (if it is a company) a tax deduction only at the 39 per cent company tax rate whereas you will have saved tax at a 48.25 per cent rate (presuming you are a top tax rate paying taxpayer).

There are, however, limits as to how far one can go in structuring salary packages. Some consultants will encourage you to go so far as substituting household and other personal expenses for salary. But there are unacceptable tax risks in doing this. You should remember that the golden rule of tax planning is moderation.

* Split your income.

Income splitting is still the simplest form of tax planning.

All that it involves is sharing income among family members so as to reduce the overall tax bill. It takes advantages of the fact that Australia has a progressive income tax system. That is, high income earners pay tax at higher rates than low income earners. Income splitting also allows a family to double up on the $5,400 tax free allowance (the first $5,400 of taxable income can be received by Australian residents tax free).

It's very easy to split income. But it's no use just putting the income into someone else's hands after it is derived by you.

Rather, the other person must have the legal entitlement to the income at the time it is so derived.

The simplest way to split income is to just give income producing assets to your spouse (but if you do, consider the capital gains tax implications).

Future investments should be bought by your spouse direct (using money either lent or given to him or her by yourself). If you are worried about keeping control of the assets, or are looking for additional flexibility, you may consider establishing your own family trust.

Income splitting is likely to be even more important in the future than it has been in the past. This is because both the Labor and Liberal parties propose raising the income level from which the maximum tax rates will first start.

This means that there will be more scope - and more benefits can be received - from income splitting.

* Dividend imputation.

Your tax bill will be a lot less if you receive franked dividend income rather than other income.

For executives, imputation means that the tax payable on dividends is, in effect, equal to the difference between the company tax rate of 39 per cent and the top marginal tax rate (including Medicare) of 48.25 per cent.

While it's out of fashion to borrow, borrowing to buy shares which pay franked dividends still makes sense.

Say you borrow at 12 per cent to buy shares, which currently yield about 6 per cent fully franked dividend. Since you are a 48.25 per cent marginal tax rate taxpayer your after tax interest cost would be only 6.21 per cent. Further, since the franked dividend will be subject only to a 9.25 per cent tax (48.25 per cent less 39 per cent), it means that the gap between your after-tax dividend income and your interest cost is only 3.04 percentage points. You need only a minimal rise in the price of your shares to cover that gap.

If you don't need (or don't want) to borrow to buy shares, you should, rather than buying the shares yourself, make sure that the shares are purchased by your spouse (assuming that your spouse is paying tax at a lesser rate than you are).

If your spouse is paying tax at less than the company tax rate, the dividend will create an excess franking rebate.

Provided your spouse has other income, that excess rebate will reduce the tax on that income. In a family group, franked dividend income should be received by the member with the lowest marginal tax rate.

* Invest To Ensure Any Interest Costs Are Tax Deductible.

Commonsense would indicate that your borrowings should fund your investments (which would mean that the interest costs on those borrowings would be tax deductible) and that surplus cash should be used to pay off the family home.

But more often than not it will be the other way around. Your non-tax deductible borrowings will have been used to pay for the family home. Excess cash will be used to buy investments or be placed in an income-earning bank account.

You should resolve that in future any surplus cash you may have is first used to pay off your personal borrowings.

If you want to make an investment, you should ensure that your bank, at the same time as it accepts a repayment of your personal borrowings, agrees to effectively replace your personal loan with an investment loan, the interest on which will be tax deductible.

* Make Maximum Use of Super.

Despite all the uncertainty which continues to surround super, it is still a tax-effective investment. In particular, if your employer makes contributions to a superannuation fund on your behalf, you will not be taxed on these contributions. The fund, however, which receives the contributions on your behalf will be taxed on them at a 15 per cent rate.

This means, at worst, that for every $100 of before-tax income you want to save, $85 will earn investment income. In contrast, if you didn't take the money as superannuation and instead took it as salary and then invested it yourself, the tax liability would mean that only about half could actually be invested.

In general, superannuation is not something you can leave until year end. This is because once your salary is paid to you, it forms part of your taxable income. So if you want to maximise those super benefits, you have to make certain that your salary is regularly reduced throughout the entire year.

* Keep Records.

This may sound simple, but who likes keeping records? How many people really think like the Tax Office?

You need to remember that at the end of the day you may be called in to explain your tax return to the Tax Office.

You should remember that if you are an employee and you want to claim more than $300 of work related expenses in any one year, you will have to satisfy the substantiation rules. This means you have to obtain receipts, invoices or similar documents that set out details of the receipt.

Alternatively, rather than obtain receipts, you can keep an "expense diary"(which is simply a record, made shortly after the expense was incurred, of the information which would otherwise have been included on the receipt) for certain types of expenses.

You can do this if the expense is no more than $10, but you can only claim a maximum of $200 of such expenses (for example, you might have a consideration of ten $10 expenses and twenty $5 expenses).

The Tax Office may also peruse your bank records and ask for details of all those receipts banked by you. Broadly, you should keep records explaining such receipts for at least a five year period.

If you sell an asset which is subject to the capital gains tax provisions, you are required to keep any records proving the date of acquisition of the asset, its cost, its disposal date and its disposal proceeds.

© 1992 Sydney Morning Herald

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