How to get some tax back.

I am somewhat surprised that the concept and tax practice relating to dividend imputation remains widely misunderstood over twenty years after it was first introduced. When imputation credits were first introduced this was an immediate tax break bonus for every single taxpayer in Australia who owned shares. This applied whether the shares were in a public company listed on the Stock Exchange or shares in a private company.

The common complaint among shareholders, especially of private companies, used to be that they were subject to “double taxation”. That reaction was understandable if there was a very close working arrangement between the owner of the company and the business that the company ran and the same person had to sign personal cheques and company cheques, both payable to the Taxation Office.

Subsequently a further significant change was introduced. Prior to that time imputation credits could be lost if there were no other taxes payable by the shareholder. This was most noticeable among pensioners. Starting with the 2002 tax year any excess franking credits (same as imputation credits) could produce a tax refund, even if no tax had been paid.

In simple terms the Tax Office will refund the company tax that has been paid by the company if the shareholder of that company does not have to pay any tax. It is not even necessary to complete a tax return to get this refund. There is a separate form with which you can make a claim.

There are probably thousands of Telstra and Commonwealth Bank shareholders in the country who could buy themselves a substantial Christmas present with this money.

How to avoid spending for the wrong reasons.

It is a normal part of my working life to be asked how to reduce tax. There are many different ways of doing this legitimately but the one recurrent theme that non professionals return to is the theme of spending some money so that a deduction can be claimed.

I wish I had a dollar for every time I have been asked the question “If I go out and buy a new utility will that save me some tax?”

If it is used for business purposes the answer is obviously “yes”.

However it really is the height of idiocy to go and spend some money just for the sake of getting a tax deduction. If you really need a new utility for your business and it makes good business sense to replace the old one then the fact that you get a bigger tax deduction for the new one than you got for the old one is simply icing on the cake.

If you spend a dollar and this gets a 31.5cent discount from the Tax office it has still cost 68.5 cents for every dollar that you have handed over. Even if your marginal tax rate is the maximum of 46.5% spending a dollar will still leave you 53.5 cents out of pocket.

Of course it is a factor that should be considered in looking at the cash flow consequences of any commercial decision but if the tax saving is the only factor being considered when a major expense is contemplated then a wrong business decision will probably be made.

Tax breaks should never drive any business or investment decisions.

What a corporate person is.

The Tax Office are serious about all those parts of the law that they are paid to uphold but it seems they have become really serious about insisting on superannuation guarantee payments being met on behalf of employees.

A couple of years ago the rules relating to employer contribution to superannuation have changed. In the past the law required employers to contribute 9% of staff wages to a superannuation fund (the Superannuation Guarantee Contribution Levy) . The law required that this payment had to be made at least annually and if it was not made by July 28th for the previous year it was no longer tax deductible and certain penalties and interest applied.

Probably because of the large number of defaulting employers the rules have changed and employers are now obliged to make these payments at least quarterly. Because of the sophisticated cross checks that the ATO are able to carry out we are noticing in our office an increasing number of defaulting employers are being caught.

Those being targeted include companies where the only employee is the sole director and sole shareholder. It is understandable that when such a company has a less than good year one of the first expenses that is dropped off is the compulsory 9% that has to be paid to a super fund. However it is the law.

This emphasises the fact that for taxation purposes a company is a “person” and that person is NOT the owner of the company, who also happens to be the only director and the only shareholder and the only employee.

The most damaging part of the penalty that is imposed is the fact that when the payment is finally made, to the Tax Office, not to the superannuation fund, it is no longer a tax deduction to the company but the contribution is still taxed within the superannuation fund.

A look at change.

Because society is always evolving the Tax Act and its administration is always evolving as well. Because I started studying tax 50 years ago I have obviously seen vast changes. They have not all been for the worst and they have not all been about rates of tax. The change of Company tax from 36% to 34% to 30% may be very desirable for investors but there is no fundamental change of principle involved.

The big changes inevitably revolve not around rates but around different methods of taxing different types of business structures like companies and trusts. Companies have been with us as separate legal entities for about 170 years. Trusts have been with us for about 500 years.

For this reason I get very cranky when journalists and politicians suggest that the Tax Office should “attack ” trusts because they are only used for tax avoidance. Like hundreds (? thousands) of grandfathers throughout the country I have set up a Trust for my grandchildren. This provides them with certainty and provides me with the assurance that my gifting to them will keep going even if I die before the Trust is determined. Tax had and has nothing to do with it.

In the last year I have set up at least half a dozen Trust structures for business where tax treatment was only a minor consideration

In my opinion the most significant factor in personal taxation since the 50s has been the introduction of imputation credits and very recently the capacity to have these credits refunded. When imputation was first introduced it immediately made investing in shares significantly more attractive and effectively made dividends virtually tax free for the majority of Australian taxpayers.

Over the past couple of years the refundability of imputation credits has made a huge difference to pensioner shareholders. The pensioners who receive a $140 dividend from Telstra , and there are a lot who do, are entitled to a further $60 cash refund from the Tax Office.

This is the major factor that makes investing in shares so much better than bank deposits or property.

Self education.

In the early 70s tax deductibility was introduced for expenditure on “self education”. No matter what was being studied, as long as it was a formal course, the cost was tax deductible.

We have come a long way since then and stringent tests are now applied which basically link self education with current work.

It is a strange anomaly that two University students sitting next to each other in the same lecture theatre can be in opposite camps – one where all his fees and other expenses are deductible, including parking the car that took him to University, and the other where nothing is a deduction. It is even possible that they could be working for the same employer.

The terms “self education” and “continuous professional development” have received a lot of professional attention ever since an architect named Finn successfully challenged the Tax Department over his claims for a study tour of Europe to look at buildings like the Eiffel Tower, the Colosseum, the Tower of London and Stonehenge!

The link that is absolutely obligatory between study expenses and tax deductibility is today’s present job. If your line of study does not relate to what you are being paid to do NOW then it basically does not qualify as a tax deductible expense.

Last year I greatly disappointed an overseas student doing a Masters degree in computer science because I would not claim his University costs as a necessary expense incurred in his job packing shelves at Coles.

A few words on punting.

The Melbourne Cup brings out “the punter” in hundreds of thousands of Australians who only have one bet a year. It is nice to know that those few people who actually finish the day richer do not have to pay tax on the spoils of their good luck.

Such is not the case for those Australians who prefer to have a punt on what the share market is going to do. “Winnings” from trading shares are taxed and they are fully taxed if held for less than 12 months.

The sharemarket can be a bit like a race track (so can the property market) but I think there is a very wide misunderstanding that everyone who operates in the market on the same day is driven by the same motives.

I have been a shareholder in BHP since 1969. I have never sold any BHP shares and do nor expect to do so in my lifetime. I object violently to being described as a punter if I chose to top up my BHP holding by buying some more of their shares – not because I thought they would go up next week but simply to add to my holding. The person who sells to me today may very well have bought last Tuesday (with borrowed money) and is happy to take a modest profit.

Some people do gamble on the share market. The paper can call them punters!

The fact that income tax is not paid on winnings from the racetrack but is paid on winnings from the sharemarket sounds good.

However bookmakers do pay turnover tax and so does the TAB.

Contemplating a tax free world.

During the 70s I had an appointment with a young man who came to see me about the problem he had about paying too much tax. At least 50% of my clients today still present the same apparent problem.

The difference with this bloke was the fact that he did not have a job, he was not studying, he had no formal qualifications and at the time he was not paying any tax at all.

I think it is crazy for anyone to expect to live in a modern city or country and not pay any tax.

In his book “The Fall of the Fourth Republic” William Schirer put the view forward that the near collapse of modern day France between the years 1919 and 1959 had as its primary cause the widespread attitude that tax levied by the Government was an inherently bad thing and therefore tax evasion was the patriotic cure.

When I process tax returns for clients with very high incomes, at least above $100,000 I notice that they fall into two distinct categories. The negatives concentrate on how much money they have sent to Canberra, the positives look at how much they have left to spend.

If we wish to be activists then our concentration should be directed towards governments – local State and Federal – to pester our representatives about how they are spending our money.

Where not to gossip.

Since capital gains tax was introduced by Mr Keating in 1985 there is one section of the Tax Act that is largely forgotten and mostly ignored. One should be careful about ignoring the Tax Act.

If you buy a property with the INTENTION of jazzing it up, renting as a negatively geared property and subsequently selling to receive capital gains it is very clear that you have entered into a profit making scheme. At the end of the day the profit made on the eventual sale of the property is not taxed as a capital gain (such tax has always been concessional) but is fully taxed as the profit made from a profit making scheme.

It is even possible that a negatively geared property with an interest only loan MUST be part of a profit making scheme because no sensible business man would ever tie himself to losing money indefinitely.

If you are thinking that it is about time to pluck several tens of thousands of dollars from the property money tree that is allegedly growing in backyards throughout every suburb in Brisbane , simply by buying renting and then selling at a huge profit after the rent has paid for the building, you should seek to avoid the profit making scheme trap.

Tax is payable fully on any profit making scheme, there is no 50% discount on the “capital gains” that have been made.

How will the tax office know what your intention was? Pieces of paper that mention sale and/or future capital gains sent to a bank, an accountant, or a letter to grandma asking for her financial help. I have received an e-mail in my office clearly spelling out a development intention which would have been unshakeable evidence that the original property was purchased with the intention of making a profit at the end. If that matter had proceeded and the Tax Office had seen that e-mail the potential tax bill would have increased by the order of $80,000.

During the war there was a saying plastered on billboards throughout the city “Loose lips sink ships”

Be warned!

Contemplating healthy choices.

We see and hear a lot in the media about the so called mess that Australia’s health system is in. This of course leads to the immediate call for the Government to “do something”.

(I’m not sure that it is in such a mess comparatively speaking. I was recently told by a doctor that one of his English colleagues expressed the view that if he became sick he would come to Australia for treatment.)

Whenever the Government is asked to pay for something the effect of this payment is felt in the national accounts and very soon that is reflected in the tax system. We already have this with the medicare levy which catches the vast majority of Australian taxpayers for 1.5% of their taxable income and as well the 1% surcharge for people who earn over $50,000 and who are not insured. This is a case of history repeating itself because the original medicare levy of the Whitlam era was only applied against taxpayers who were not members of private Health funds.

As someone whose average annual expenditure at the doctor for myself during 40 years of adulthood was about $10 I can understand why many people elect not to insure themselves. Like me they believe they are bullet proof. (I hope they don’t find out like me that they are not!)

If taxpayers elect NOT to be in a health fund they should at least ensure that they set up an emergency fund to meet all their medical expenses. Additions to this fund should match the charges made by MBF and of course their medical expenses should come from the fund. At the end of 20 or 30 years the balance in the fund, if any, will determine whether their judgment was right.

One of my friends had a $30,000 operation a year ago. That would make a big hole in anyone’s budget.

A blast from the past.

It is almost as obvious as saying that night follows day and Spring follows Winter that the administration of the Tax Act is full of oddities.

One of these oddities relates to the payment of travelling expenses, especially within the building industry, where expenses are automatically paid to workers whether they travel or not. This is a long term hangover from a hard fought industrial issue which is now impossible to get rid of.

The general rule for tax deductibility is that the money has to be actually spent before you get a tax deduction. That is the general rule to which is added the further issue of self assessment coupled with substantiation. If a Tax inspector comes calling you are expected to be able to substantiate your expenses.

To stop Australia being cluttered with millions of Woolworths dockets the ATO allow claims of up to $300 without documentary evidence. This does NOT mean without substantiation, although a great many taxpayers believe so.

The travelling allowance referred to above provides yet another opportunity to make a claim without documentary evidence

However a deduction is allowed for part of this payment, without any receipts required, if a claim is made at the rate that was allowed in certain awards 25 years ago.

Substantiation means that proof is required. If the claim is made at the same rate that applied in the 1986 Award no proof is required.

That’s odd but I still think that the greatest oddity in the Act is the non deductibility of the expense of getting to and from work.