Personal Financial Strategies
In this issue:
SMSFs and your family business
The importance of estate planning
SMSF – think team
Tread carefully with trustee changes
Super or Property?
A crack down on tax discrepencies
Asset protection, a family affair
Voluntary disclosures for SMSFs
Implications of pre-GST property
SMSFs and your family business
Investing in property through a selfmanaged super fund (SMSF) could be risky. Business owners are advised to seek professional advice and to consider all potential challenges before entering into any landlord-and-tenant arrangements.
Consider, for example, that a tenant of a highly valuable, fund-owned property fails to pay their rent on time and this property is the sole or dominant asset of the fund. Much of its financial wellbeing could depend on these regular payments. Although necessary action would be taken to recover the overdue rent and the financially-troubled tenant may be removed from the premises, difficulties could escalate, especially if the wayward tenant is a family business.
It is a common practice for a family SMSF to own the business premises of the family business in order to gain a range of retirement, tax, business, and asset-protection advantages. The family business pays a commercial rent to the family SMSF and the fund claims tax deductions for interest on the loan to buy a typically geared property. This property is generally out of the reach of creditors if individual fund members are declared bankrupt and if the SMSF sells the property once fund assets are backing the payment of a pension, no capital gains tax is payable on the sale.
Many family SMSFs and family businesses, however, are at risk of becoming embroiled in inter-family disputes. There may be issues of conflicting loyalties and pressures if a business strikes financial problems and fails to pay its rent.
On one hand, the family business may require those premises to keep operating in the hope that profits will return. Yet on the other, the fund’s trustees – who are the same people as the business owners in these circumstances – are legally obliged to maintain the fund with the sole purpose of providing member retirement benefits.
In an respect, SMSFs renting commercial properties generally have to borrow to buy and require regular rent to meet their loan repayment obligations. For businesses experiencing financial difficulties, payments to creditors are usually slowed down and it is often their owner’s self-managed super fund that is the last to see any money. If a members’ business is not paying its rent to the family SMSF, the retirement savings of the members are being jeopardised.
Here are some key points to consider before entering into such arrangements:
Expect the unexpected
Plenty of problems could arise, such as the forced sale of the premises in the event of a marriage break-up, death or disability.
Understand the fund’s obligations
A fund is required to diligently pursue unpaid rent, even from its member’s own business. It may be appropriate for trustees to obtain personal guarantees from tenants.
Know the commercial and legal risks
If a breach to the Superannuation Industry (Supervision) Act occurs., fines may be given to its own members, the trustees could be disqualified or the fund could be declared non-complying. The market value of non-complying funds is taxed at the top marginal rate, less any non-concessional or un-deducted contributions. This can wipe out almost half a fund’s assets.
Losing ownership of geared property
If the business cannot pay rent to the SMSF, the fund could fail to make installments on its investment loan. This could lead to reposition of property by the banks.
Carefully consider affordability
Take into account the levels of debt already being carried by the SMSF, the business and the business owners in a personal capacity. Consider the impact of future interest rate rises and the effect that the next halving of the standard cap on concessional contributions for super fund members over 50 could have on the fund’s cash flow.
Ensure adequate diversification
This will mean that the fund members’ savings are not overly dependent on the profitability of a single costly asset, namely the business premises.
The importance of estate planning
The importance of estate planning
Estate planning is more than just having a will. It is about ensuring that a person’s estate is passed on to their beneficiaries in the most tax-effective and financially efficient way possible when they are gone. Getting advice on setting up an estate plan can help you to achieve peace of mind in knowing that your wealth will be passed accordingly.
An estate plan maximises your assets and takes into account other non-financial matters such as the care of dependent children, medical treatment and accommodation if you are incapacitated. It also considers your charitable, community and cultural requirements.
If you die without a will, your assets are distributed by following a standard statutory formula and it is likely that distribution will not play out the way you would have liked.
For those who do have a will, it may only cover what to do with your personally owned assets and other considerations like superannuation, trusts and business assets may have been left out.
In developing an effective action plan for dealing with your estate, the following considerations should be made:
An estate plan is something that should be considered, no matter how young or old you are.
SMSF - think team
Self-managed superannuation funds are a popular choice amongst small business owners and professionals. Self management has strong appeal for many but these funds are particularly vulnerable to mistakes, mismanagement, dishonesty, and sometimes even serial compliance breaches, often by spouses and adult children.
It is not until the ATO moves in to act against a fund or a fund member, a marital relationship fails or member dies or retires that impropriety is detected. In the worst instances, unknowing members can see fund assets go missing. The ATO may declare a fund as non-complying for breaches of superannuation law, a move that can seriously impact fund assets in tax penalties and concessional tax.
In many cases, the negative actions of SMSF’s come about from ignorance and lazy management. Funds that work like a team to the benefit of all team members are less likely to lose retirement savings. Here are some suggestions to help fund members take a ‘team’ approach:
Spread the load
Whilst a characteristic of SMSFs is that one member controls all of the investment and administrative decisions, this can be a risky strategy.
The majority of SMSF’s comprise of husband-and-wife members with one typically dominating fund management. Under superannuation law, all SMSF members must be trustees or directors of a fund’s corporate trustee; however passive members generally do little to protect their interests.
Trustees should take a team approach to the running of the fund as it is there to provide retirement security for all members.
Monitor activities and assets
Understand why a key asset may no longer be listed as a fund asset - it may have been transferred into another member’s name without your knowledge.
Family lawyers and forensic accountants sometimes find that assets have been transferred into a spouse’s name in an effort to prevent it being included in the pool of assets in a marital property settlement.
Know what assets your fund owns and closely follow how those assets are performing. Also, ensure that any contributions deposited in your fund’s bank account are still in the account or have been invested for the fund with your agreement.
Agree on a game plan
Make sure that the strategy is being followed to the letter. You should be alarmed, for instance, if your fund is making investments that are inconsistent with your objectives. Further, you should insist that the investment strategy is regularly updated to reflect your changing circumstances and wishes.
There is not much point in having a plan if you are not going to stick with it. Investments outside a fund’s strategy may expose members to additional risks and without an investment strategy; a fund may find it hard to demonstrate to the ATO that investments are being made for the sole purpose of providing retirement benefits.
Get help
A financial adviser can tell you whether your self-managed fund is performing competitively as well as whether its investment strategy is consistent with the members’ risk profiles.
Getting advice and sharing the costs among members will help keep things in perspective and allow members to determine whether the fund is on track to deliver the expected retirement income.
Stick to fundamentals
Some members use their self-managed funds to invest in high-risk investments, many of which they would not pursue with their personal money. If a member wishes to pursue investments in memorabilia, it may be done on a personal level and not with member funds.
Borrow cautiously
While SMSF can borrow within the tight legal restrictions, funds can easily get it wrong. Some funds risk losing much of their value if a costly geared investment fails.
Tread carefully with trustee changes
The life-cycle of a typical trust estate includes the establishment and its vesting or termination dates. During the course of its life, the trust deed may be varied or amended for a number of reasons. However, anyone seeking to amend a trust deed needs to be aware of the potential consequences which can result, even with a seemingly insignificant change.
The effect of any change should be considered in the overall framework of the trust relationship to ensure that the character of the trust remains true to its original form.
Any contract, if varied or amended by the parties can result in something different to what was initially intended. The same principle applies if the essential character of a trust changes. It is a contract by the settlor. If the trustee changes it, it could result in something different to what the settlor originally intended.
The ATO’s view is that if changes are such that a new trust relationship arises, there must also be a new trust estate for income tax purposes. If the trustee remains the same, it would dispose of the trust property in its capacity as trustee of one trust estate and reacquire it as trustee of another. The disposal would trigger consequences under tax legislation, specifically under capital gains.
Due to the lack of continuity of the same estate, any other attributes held would cease to exist. Previously incurred losses, for example, would be lost and unable to be claimed despite whether these losses were on a capital or revenue account.
Changes potentially leading to a new trust can arise by several means, including variations under a power in the deed and a variation by agreement among the beneficiaries. Other changes may include:
Super or property?
Superannuation has long been a regulatory nightmare. For many people, choosing between superannuation and property investment for the more effective wealth creation vehicle can be a confusing experience.
Over the last five years, changes have been made to simplify superannuation rules, offering some very generous bonus conditions for workers. One of these changes included the opportunity to make extra and un-deducted contributions of up to $450,000 to your superfund over a period of 3 years for those under the age of 65.
This offered an excellent opportunity for people to invest money into their future retirement. But what is the best option when comparing this with property investment?
A super strategy:
What are the key issues when considering superannuation as a wealth creation strategy?
Tax-free redemptions
Superannuation redemptions are tax free for those over 60 years old. Additionally, these redemptions do not have to be treated as assessable income, ensuring income from other sources are taxed at a lower marginal rate.
Low or no tax on fund earnings
Investment earnings are taxed at a maximum rate of 15 percent. On the other hand, earnings outside super may be subject to tax as high as 46 percent. This is significant when you consider the after tax position of either option.
Furthermore, where superannuation benefits are rolled over to an allocated pension, earnings are then tax free.
Salary sacrifice
Employees have the opportunity to make significant tax savings by salary sacrificing more into super to the annual limit on tax-deductible super contributions. Salary sacrifice contributions are taxed at 15 percent when it is received by the superannuation fund. Employer contributions, including salary sacrifice, of more than $25,000, or $50,000 for those over 50 years old, is taxed at 46.5 percent.
The disadvantage of salary sacrificing is the fact that money contributed to super can’t be withdrawn until you reach your preservation age and retire. This is not a great concern for someone in their 50s because this group has a major motivation to salary sacrifice as much as possible.
No contributions tax
Property investors that sell a property and place the after capital gains tax proceeds into a superannuation fund (called the “non-concessional contribution” or after tax contribution), can contribute $450,000 over three years.
A Property strategy:
Flexibility
Once your money is locked into your superannuation fund it cannot be accessed until you reach what is known as the ‘preservation age’. Preservation age can range from 55 to 60, depending on the year in which you were born.
Another downside of superannuation is that you cannot use the money as security to borrow funds for any other purpose. Funds are basically quarantined. Property on the other hand is more flexible in the sense that it can be sold to meet personal financial obligations. In many respects it is a lower risk vehicle for individuals who circumstances may change suddenly, such as having a family.
Property as leverage
Property investing is a method of wealth generation, distinct from superannuation. In principle, most wealth generation initiatives involve financial leverage or gearing (using borrowed funds) to acquire additional capital growth assets from the equity generated in your existing portfolio. Property, more often than not, serves as the basis of security to borrow additional funds to acquire assets, provided that obligations on investment loans are maintained.
Capital gains tax benefits
Many individuals are using a self managed super fund to purchase property, on the basis that this will provide a means to minimise capital gains tax if the property is sold. Whilst there is an argument for this approach, there is a downside. Property held in a superannuation fund cannot be used as security to leverage an expanding property portfolio. As a result, there are opportunity costs associated with not expanding a property portfolio in order to take advantage of CGT benefits. The forfeited commercial gain may more than offset any tax saved.
Tax deductible expenditure
Wealth generation takes advantage of leverage to accelerate the net worth of individuals by the effective selection of capital assets and taking advantage of taxation benefits that accompany the borrowings for the asset acquisition. Property investing has some generous taxation concessions that allow taxpayers to claim cash and non-cash losses on annual property expenses as tax deductions off their primary income sources.
Deciding on a strategy of superannuation or property to build wealth requires some consideration, taking into account age, personal circumstances and income. Please feel free to contact our office to discuss any of these issues and how they make impact your wealth creation strategy.
A crack down on tax discrepancies
Each year the ATO compares information from tax returns with information they receive from third parties. Where discrepancies have been identified, the ATO will generally take compliance action. This includes the issuing of discrepancy letters and amending returns.
This year, the ATO has indicated that there are two common areas that will again be under review where income is being omitted from tax returns.
Capital gains tax
The ATO, as part of its data matching program, will use information from a number of external sources. These sources will include land title offices, offices of state revenue, share registries and the Australian Stock Exchange to identify capital gains tax (CGT). Information will then be compared with income tax returns, as well as with those who are not lodging returns. The ATO’s use of technology and sharing of information with other parties has revealed that some tax payers are omitting capital gains from their sales of property and shares.
Foreign source income
The ATO’s data sources are not just limited locally, those that drive income from foreign sources need to also be dilligent when reporting their income. The ATO receive information from their double tax agreement treaty partners, the Australian Transaction Reports and the Analysis Centre (AUSTRAC). One of the key issues the ATO faces is that some tax payers believe they don’t need to include income which they have derived overseas in their Australian income tax returns. Individuals who derive income overseas may also find that they are eligible for a foreign tax offset for any foreign tax they have paid.
Asset protection - a family affair
Asset rich individuals and business owners need to take stock of their particular circumstances and take time regularly to review how their assets are held. Individuals should aim to hold their investments in ways that protect assets and are tax effective.
This strategy requires a three- pronged approach to:
What is a Trust?
A trust is created as a result of forming a relationship where a person (the trustee) has an obligation to hold property for the benefit of another person (the beneficiaries). A trust is not a separate legal entity. However it is, required to have its own set of accounting records and lodge tax returns with the Australian Taxation Office each year.
What is a Discretionary Trust?
In a discretionary trust, beneficiaries are not entitled to a fixed distribution or interest in the trust funds. The trustee has the discretion to decide which beneficiaries receive the capital and income of the trust and how much each beneficiary receives. The level of discretion is determined by terms of the Trust Deed, which governs the operation of the trust. A properly established trust will provide asset protection in the case of unexpected financial setback or litigation.
Assets held in a discretionary trust are generally not available to a trustee in bankruptcy. The exception is when assets have been transferred to a discretionary trust with the intention of defeating creditors.
Distribution of Income
The Trust Deed sets out various alternatives for the Trustee in relation to trust income earned in each financial year. These alternatives include:
From a tax perspective, discretionary trusts are an excellent way to split investment capital gains and income with beneficiaries, particularly when beneficiaries have differential marginal tax rates. The trustee has the discretion to distribute profits to the lowest-taxed beneficiaries. The decision to form a discretionary trust is one that must be made by taking into consideration one’s personal, financial, and legal circumstances and adopted as part of an overall asset management plan.
Discretionary trusts are an excellent vehicle to protect assets. If you are not sure what steps to take next, or whether or not a discretionary trust would assist you with asset protection, we would be delighted to speak with you about your options.
Voluntary disclosures for SMSFs
If you have a self-managed super fund (SMSF) and you make a mistake when completing your SMSF annual return, you may wish to make a voluntary disclosure.
When making a voluntary disclosure, you must:
disclosures; for all other voluntary disclosures, you must lodge a complete amended SMSF annual return.
Implications for pre-GST property
The margin scheme was introduced as part of the GST regime in order to determine the GST payable on certain supplies of land. Whilst it usually applies to sales of property by property developers, it may also apply to businesses that have acquired property prior to the introduction of GST.
Properties that are held by companies or other structures, that are now being sold to fund retirement, may be subject to the margin scheme.
Where the margin scheme applies, GST is calculated as 1/11 of the difference between the sale price of the property and the consideration for the property (or its value as at 1 July 2000 - the date that GST was introduced). If the supplier or developer of the property acquired it prior to 1 July 2000, they may use an ‘approved valuation’ of the land, as at 1 July 2000, to determine its value at that date (rather than using the price at which the supplier acquired the property before 1 July 2000).
For example, property acquired in 1995 for $100,000, with an approved valuation of $150,000 at 1 July 2000, and sold in 2011 for $225,000, will be subject to GST for 1/11 of the difference between $225,000 and $150,000.
A valuation is considered ‘approved’ if it meets the requirements set out by the Australian Tax Office (ATO). There have been a number of disputes concerning the margin scheme, commonly in relation to whether valuations obtained are ‘approved valuations’. The Federal Court recently considered what constituted an ‘approved valuation’ for the purposes of the margin scheme in the Brady King case.
In considering whether the valuation in the Brady King case was an ‘approved valuation’, the Federal Court received evidence from both the valuer, who had prepared the valuation, and an expert valuer, called as a witness by the ATO.
After considering the evidence, the court concluded that the valuation did not meet the requirements of an ‘approved valuation’ and as a result, the margin scheme did not apply. The court accepted that a valuation could not be ruled out as an ‘approved valuation’ solely due to a difference of opinion.
In the Brady King case, the failure to satisfy the requirements of an ‘approved valuation’ came about for several reasons. The property sold was not the same as the one acquired (an office building was converted into strata units). In addition, there was a failure to properly account for the profit margin and GST, the costs of interest on acquisition, transactions costs (such as stamp duty and legal costs) and holding costs (rates and land taxes).
As the Brady King case was subsequently overturned in a decision by a full Federal Court, which held that the margin scheme did apply, it reveals that the application of the margin scheme needs to be carefully considered when being used.
This publication is meant for guidance only and professional advice should be obtained before acting on any information herein. We do not accept any responsibility for loss occasioned to any person or entity as a result of any action taken or refrained from in consequence of the contents of this publication.
Liability limited by a scheme approved under Professional Standards legislation.
In this issue:
SMSFs and your family business The importance of estate planning SMSF – think team Tread carefully with trustee changes Super or Property? A crack down on tax discrepencies Asset protection, a family affair Voluntary disclosures for SMSFs Implications of pre-GST property SMSFs and your family business
Investing in property through a selfmanaged super fund (SMSF) could be risky. Business owners are advised to seek professional advice and to consider all potential challenges before entering into any landlord-and-tenant arrangements.
Consider, for example, that a tenant of a highly valuable, fund-owned property fails to pay their rent on time and this property is the sole or dominant asset of the fund. Much of its financial wellbeing could depend on these regular payments. Although necessary action would be taken to recover the overdue rent and the financially-troubled tenant may be removed from the premises, difficulties could escalate, especially if the wayward tenant is a family business.
It is a common practice for a family SMSF to own the business premises of the family business in order to gain a range of retirement, tax, business, and asset-protection advantages. The family business pays a commercial rent to the family SMSF and the fund claims tax deductions for interest on the loan to buy a typically geared property. This property is generally out of the reach of creditors if individual fund members are declared bankrupt and if the SMSF sells the property once fund assets are backing the payment of a pension, no capital gains tax is payable on the sale.
Many family SMSFs and family businesses, however, are at risk of becoming embroiled in inter-family disputes. There may be issues of conflicting loyalties and pressures if a business strikes financial problems and fails to pay its rent.
On one hand, the family business may require those premises to keep operating in the hope that profits will return. Yet on the other, the fund’s trustees – who are the same people as the business owners in these circumstances – are legally obliged to maintain the fund with the sole purpose of providing member retirement benefits.
In an respect, SMSFs renting commercial properties generally have to borrow to buy and require regular rent to meet their loan repayment obligations. For businesses experiencing financial difficulties, payments to creditors are usually slowed down and it is often their owner’s self-managed super fund that is the last to see any money. If a members’ business is not paying its rent to the family SMSF, the retirement savings of the members are being jeopardised.
Here are some key points to consider before entering into such arrangements:
Expect the unexpected
Plenty of problems could arise, such as the forced sale of the premises in the event of a marriage break-up, death or disability.
Understand the fund’s obligations
A fund is required to diligently pursue unpaid rent, even from its member’s own business. It may be appropriate for trustees to obtain personal guarantees from tenants.
Know the commercial and legal risks
If a breach to the Superannuation Industry (Supervision) Act occurs., fines may be given to its own members, the trustees could be disqualified or the fund could be declared non-complying. The market value of non-complying funds is taxed at the top marginal rate, less any non-concessional or un-deducted contributions. This can wipe out almost half a fund’s assets.
Losing ownership of geared property
If the business cannot pay rent to the SMSF, the fund could fail to make installments on its investment loan. This could lead to reposition of property by the banks.
Carefully consider affordability
Take into account the levels of debt already being carried by the SMSF, the business and the business owners in a personal capacity. Consider the impact of future interest rate rises and the effect that the next halving of the standard cap on concessional contributions for super fund members over 50 could have on the fund’s cash flow.
Ensure adequate diversification
This will mean that the fund members’ savings are not overly dependent on the profitability of a single costly asset, namely the business premises.
The importance of estate planning
The importance of estate planning
Estate planning is more than just having a will. It is about ensuring that a person’s estate is passed on to their beneficiaries in the most tax-effective and financially efficient way possible when they are gone. Getting advice on setting up an estate plan can help you to achieve peace of mind in knowing that your wealth will be passed accordingly.
An estate plan maximises your assets and takes into account other non-financial matters such as the care of dependent children, medical treatment and accommodation if you are incapacitated. It also considers your charitable, community and cultural requirements.
If you die without a will, your assets are distributed by following a standard statutory formula and it is likely that distribution will not play out the way you would have liked.
For those who do have a will, it may only cover what to do with your personally owned assets and other considerations like superannuation, trusts and business assets may have been left out.
In developing an effective action plan for dealing with your estate, the following considerations should be made:
- How will your business wealth be dealt with?
- How should your superannuation be dealt with after your death?
- Who is to receive your gifts and legacies and when should they be given?
- Who will be appointed executors of your will?
- Who will control your non-estate wealth holding entities including family trusts?
An estate plan is something that should be considered, no matter how young or old you are.
SMSF - think team
Self-managed superannuation funds are a popular choice amongst small business owners and professionals. Self management has strong appeal for many but these funds are particularly vulnerable to mistakes, mismanagement, dishonesty, and sometimes even serial compliance breaches, often by spouses and adult children.
It is not until the ATO moves in to act against a fund or a fund member, a marital relationship fails or member dies or retires that impropriety is detected. In the worst instances, unknowing members can see fund assets go missing. The ATO may declare a fund as non-complying for breaches of superannuation law, a move that can seriously impact fund assets in tax penalties and concessional tax.
In many cases, the negative actions of SMSF’s come about from ignorance and lazy management. Funds that work like a team to the benefit of all team members are less likely to lose retirement savings. Here are some suggestions to help fund members take a ‘team’ approach:
Spread the load
Whilst a characteristic of SMSFs is that one member controls all of the investment and administrative decisions, this can be a risky strategy.
The majority of SMSF’s comprise of husband-and-wife members with one typically dominating fund management. Under superannuation law, all SMSF members must be trustees or directors of a fund’s corporate trustee; however passive members generally do little to protect their interests.
Trustees should take a team approach to the running of the fund as it is there to provide retirement security for all members.
Monitor activities and assets
Understand why a key asset may no longer be listed as a fund asset - it may have been transferred into another member’s name without your knowledge.
Family lawyers and forensic accountants sometimes find that assets have been transferred into a spouse’s name in an effort to prevent it being included in the pool of assets in a marital property settlement.
Know what assets your fund owns and closely follow how those assets are performing. Also, ensure that any contributions deposited in your fund’s bank account are still in the account or have been invested for the fund with your agreement.
Agree on a game plan
Make sure that the strategy is being followed to the letter. You should be alarmed, for instance, if your fund is making investments that are inconsistent with your objectives. Further, you should insist that the investment strategy is regularly updated to reflect your changing circumstances and wishes.
There is not much point in having a plan if you are not going to stick with it. Investments outside a fund’s strategy may expose members to additional risks and without an investment strategy; a fund may find it hard to demonstrate to the ATO that investments are being made for the sole purpose of providing retirement benefits.
Get help
A financial adviser can tell you whether your self-managed fund is performing competitively as well as whether its investment strategy is consistent with the members’ risk profiles.
Getting advice and sharing the costs among members will help keep things in perspective and allow members to determine whether the fund is on track to deliver the expected retirement income.
Stick to fundamentals
Some members use their self-managed funds to invest in high-risk investments, many of which they would not pursue with their personal money. If a member wishes to pursue investments in memorabilia, it may be done on a personal level and not with member funds.
Borrow cautiously
While SMSF can borrow within the tight legal restrictions, funds can easily get it wrong. Some funds risk losing much of their value if a costly geared investment fails.
Tread carefully with trustee changes
The life-cycle of a typical trust estate includes the establishment and its vesting or termination dates. During the course of its life, the trust deed may be varied or amended for a number of reasons. However, anyone seeking to amend a trust deed needs to be aware of the potential consequences which can result, even with a seemingly insignificant change.
The effect of any change should be considered in the overall framework of the trust relationship to ensure that the character of the trust remains true to its original form.
Any contract, if varied or amended by the parties can result in something different to what was initially intended. The same principle applies if the essential character of a trust changes. It is a contract by the settlor. If the trustee changes it, it could result in something different to what the settlor originally intended.
The ATO’s view is that if changes are such that a new trust relationship arises, there must also be a new trust estate for income tax purposes. If the trustee remains the same, it would dispose of the trust property in its capacity as trustee of one trust estate and reacquire it as trustee of another. The disposal would trigger consequences under tax legislation, specifically under capital gains.
Due to the lack of continuity of the same estate, any other attributes held would cease to exist. Previously incurred losses, for example, would be lost and unable to be claimed despite whether these losses were on a capital or revenue account.
Changes potentially leading to a new trust can arise by several means, including variations under a power in the deed and a variation by agreement among the beneficiaries. Other changes may include:
- those in beneficial interests in trust property;
- redefinitions of the beneficiary class;
- changes to the rights and obligations of the trustee;
- changes to the termination date of the trust;
- changes to the purpose of the trust; or
- if the trust splits into two or merges with another.
Super or property?
Superannuation has long been a regulatory nightmare. For many people, choosing between superannuation and property investment for the more effective wealth creation vehicle can be a confusing experience.
Over the last five years, changes have been made to simplify superannuation rules, offering some very generous bonus conditions for workers. One of these changes included the opportunity to make extra and un-deducted contributions of up to $450,000 to your superfund over a period of 3 years for those under the age of 65.
This offered an excellent opportunity for people to invest money into their future retirement. But what is the best option when comparing this with property investment?
A super strategy:
What are the key issues when considering superannuation as a wealth creation strategy?
Tax-free redemptions
Superannuation redemptions are tax free for those over 60 years old. Additionally, these redemptions do not have to be treated as assessable income, ensuring income from other sources are taxed at a lower marginal rate.
Low or no tax on fund earnings
Investment earnings are taxed at a maximum rate of 15 percent. On the other hand, earnings outside super may be subject to tax as high as 46 percent. This is significant when you consider the after tax position of either option.
Furthermore, where superannuation benefits are rolled over to an allocated pension, earnings are then tax free.
Salary sacrifice
Employees have the opportunity to make significant tax savings by salary sacrificing more into super to the annual limit on tax-deductible super contributions. Salary sacrifice contributions are taxed at 15 percent when it is received by the superannuation fund. Employer contributions, including salary sacrifice, of more than $25,000, or $50,000 for those over 50 years old, is taxed at 46.5 percent.
The disadvantage of salary sacrificing is the fact that money contributed to super can’t be withdrawn until you reach your preservation age and retire. This is not a great concern for someone in their 50s because this group has a major motivation to salary sacrifice as much as possible.
No contributions tax
Property investors that sell a property and place the after capital gains tax proceeds into a superannuation fund (called the “non-concessional contribution” or after tax contribution), can contribute $450,000 over three years.
A Property strategy:
Flexibility
Once your money is locked into your superannuation fund it cannot be accessed until you reach what is known as the ‘preservation age’. Preservation age can range from 55 to 60, depending on the year in which you were born.
Another downside of superannuation is that you cannot use the money as security to borrow funds for any other purpose. Funds are basically quarantined. Property on the other hand is more flexible in the sense that it can be sold to meet personal financial obligations. In many respects it is a lower risk vehicle for individuals who circumstances may change suddenly, such as having a family.
Property as leverage
Property investing is a method of wealth generation, distinct from superannuation. In principle, most wealth generation initiatives involve financial leverage or gearing (using borrowed funds) to acquire additional capital growth assets from the equity generated in your existing portfolio. Property, more often than not, serves as the basis of security to borrow additional funds to acquire assets, provided that obligations on investment loans are maintained.
Capital gains tax benefits
Many individuals are using a self managed super fund to purchase property, on the basis that this will provide a means to minimise capital gains tax if the property is sold. Whilst there is an argument for this approach, there is a downside. Property held in a superannuation fund cannot be used as security to leverage an expanding property portfolio. As a result, there are opportunity costs associated with not expanding a property portfolio in order to take advantage of CGT benefits. The forfeited commercial gain may more than offset any tax saved.
Tax deductible expenditure
Wealth generation takes advantage of leverage to accelerate the net worth of individuals by the effective selection of capital assets and taking advantage of taxation benefits that accompany the borrowings for the asset acquisition. Property investing has some generous taxation concessions that allow taxpayers to claim cash and non-cash losses on annual property expenses as tax deductions off their primary income sources.
Deciding on a strategy of superannuation or property to build wealth requires some consideration, taking into account age, personal circumstances and income. Please feel free to contact our office to discuss any of these issues and how they make impact your wealth creation strategy.
A crack down on tax discrepancies
Each year the ATO compares information from tax returns with information they receive from third parties. Where discrepancies have been identified, the ATO will generally take compliance action. This includes the issuing of discrepancy letters and amending returns.
This year, the ATO has indicated that there are two common areas that will again be under review where income is being omitted from tax returns.
Capital gains tax
The ATO, as part of its data matching program, will use information from a number of external sources. These sources will include land title offices, offices of state revenue, share registries and the Australian Stock Exchange to identify capital gains tax (CGT). Information will then be compared with income tax returns, as well as with those who are not lodging returns. The ATO’s use of technology and sharing of information with other parties has revealed that some tax payers are omitting capital gains from their sales of property and shares.
Foreign source income
The ATO’s data sources are not just limited locally, those that drive income from foreign sources need to also be dilligent when reporting their income. The ATO receive information from their double tax agreement treaty partners, the Australian Transaction Reports and the Analysis Centre (AUSTRAC). One of the key issues the ATO faces is that some tax payers believe they don’t need to include income which they have derived overseas in their Australian income tax returns. Individuals who derive income overseas may also find that they are eligible for a foreign tax offset for any foreign tax they have paid.
Asset protection - a family affair
Asset rich individuals and business owners need to take stock of their particular circumstances and take time regularly to review how their assets are held. Individuals should aim to hold their investments in ways that protect assets and are tax effective.
This strategy requires a three- pronged approach to:
- Minimise tax exposure
- Isolate business and personal assets
- Hold assets in a separate entity
What is a Trust?
A trust is created as a result of forming a relationship where a person (the trustee) has an obligation to hold property for the benefit of another person (the beneficiaries). A trust is not a separate legal entity. However it is, required to have its own set of accounting records and lodge tax returns with the Australian Taxation Office each year.
What is a Discretionary Trust?
In a discretionary trust, beneficiaries are not entitled to a fixed distribution or interest in the trust funds. The trustee has the discretion to decide which beneficiaries receive the capital and income of the trust and how much each beneficiary receives. The level of discretion is determined by terms of the Trust Deed, which governs the operation of the trust. A properly established trust will provide asset protection in the case of unexpected financial setback or litigation.
Assets held in a discretionary trust are generally not available to a trustee in bankruptcy. The exception is when assets have been transferred to a discretionary trust with the intention of defeating creditors.
Distribution of Income
The Trust Deed sets out various alternatives for the Trustee in relation to trust income earned in each financial year. These alternatives include:
- The trustee may distribute the net trust income amongst the beneficiaries. All the trust income can be distributed to one beneficiary to the exclusion of others, the income can be distributed equally, or it can be distributed disproportionately.
- The trustee may decide not to distribute any proportion of the net income of the trust but to accumulate that income as an addition to the Trust Fund.
- The trustee may decide to distribute part of the net trust income and to accumulate the balance of that income.
From a tax perspective, discretionary trusts are an excellent way to split investment capital gains and income with beneficiaries, particularly when beneficiaries have differential marginal tax rates. The trustee has the discretion to distribute profits to the lowest-taxed beneficiaries. The decision to form a discretionary trust is one that must be made by taking into consideration one’s personal, financial, and legal circumstances and adopted as part of an overall asset management plan.
Discretionary trusts are an excellent vehicle to protect assets. If you are not sure what steps to take next, or whether or not a discretionary trust would assist you with asset protection, we would be delighted to speak with you about your options.
Voluntary disclosures for SMSFs
If you have a self-managed super fund (SMSF) and you make a mistake when completing your SMSF annual return, you may wish to make a voluntary disclosure.
When making a voluntary disclosure, you must:
- include all the information needed by the ATO; and
- provide the disclosure to the ATO in a specified manner.
disclosures; for all other voluntary disclosures, you must lodge a complete amended SMSF annual return.
If you are unsure of how to complete your annual return or have any questions regarding voluntary disclosures or your SMSF, please feel free to call our office.
Implications for pre-GST property
The margin scheme was introduced as part of the GST regime in order to determine the GST payable on certain supplies of land. Whilst it usually applies to sales of property by property developers, it may also apply to businesses that have acquired property prior to the introduction of GST.
Properties that are held by companies or other structures, that are now being sold to fund retirement, may be subject to the margin scheme.
Where the margin scheme applies, GST is calculated as 1/11 of the difference between the sale price of the property and the consideration for the property (or its value as at 1 July 2000 - the date that GST was introduced). If the supplier or developer of the property acquired it prior to 1 July 2000, they may use an ‘approved valuation’ of the land, as at 1 July 2000, to determine its value at that date (rather than using the price at which the supplier acquired the property before 1 July 2000).
For example, property acquired in 1995 for $100,000, with an approved valuation of $150,000 at 1 July 2000, and sold in 2011 for $225,000, will be subject to GST for 1/11 of the difference between $225,000 and $150,000.
A valuation is considered ‘approved’ if it meets the requirements set out by the Australian Tax Office (ATO). There have been a number of disputes concerning the margin scheme, commonly in relation to whether valuations obtained are ‘approved valuations’. The Federal Court recently considered what constituted an ‘approved valuation’ for the purposes of the margin scheme in the Brady King case.
In considering whether the valuation in the Brady King case was an ‘approved valuation’, the Federal Court received evidence from both the valuer, who had prepared the valuation, and an expert valuer, called as a witness by the ATO.
After considering the evidence, the court concluded that the valuation did not meet the requirements of an ‘approved valuation’ and as a result, the margin scheme did not apply. The court accepted that a valuation could not be ruled out as an ‘approved valuation’ solely due to a difference of opinion.
In the Brady King case, the failure to satisfy the requirements of an ‘approved valuation’ came about for several reasons. The property sold was not the same as the one acquired (an office building was converted into strata units). In addition, there was a failure to properly account for the profit margin and GST, the costs of interest on acquisition, transactions costs (such as stamp duty and legal costs) and holding costs (rates and land taxes).
As the Brady King case was subsequently overturned in a decision by a full Federal Court, which held that the margin scheme did apply, it reveals that the application of the margin scheme needs to be carefully considered when being used.
This publication is meant for guidance only and professional advice should be obtained before acting on any information herein. We do not accept any responsibility for loss occasioned to any person or entity as a result of any action taken or refrained from in consequence of the contents of this publication.
Liability limited by a scheme approved under Professional Standards legislation.
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