Tax changes are suddenly the key item on the agenda as the government openly tests new ideas. The headlines are full of speculation on negative gearing, but inside wealth management circles they are already rushing to find a fix for an unprecedented new tax on unrealised gains.
The plan to tax ‘paper profits’ or so-called ‘unrealised gains’ in super has the potential to be a bigger deal than any amendment to negative gearing because it is — literally — a new way of taxing, as opposed to variations on tried and tested practice.
As a top financial adviser put it this week: “The tax system is wide open to the government, they got the personal tax amendments through parliament this week without a problem. Now we have this extraordinary tax planned for super which looks ever more likely — no wonder investors are wondering what’s next”.
The paper profits plan is set to begin on July 1 next year. It will hit super accounts with more than $3m — unrealised gains tax will apply to anyone with more over this threshold amount in their super account.
The tax (set at 15 per cent) will be applied on actual and notional earnings, but the payments will be real and immediate.
Each tax year the super account holder will have to pay the tax bill in cash from their personal funds or from their super fund.
If there is a loss there is no refund, rather the investor carries the loss forward against future profits.
Already top advisers say the plan is enough to drive many wealthier investors out of super — the $3m limit might be called a threshold, but it is seen by many as a cap, a point at which it no longer makes much sense to stay in the system.
They also suggest it will hit a much wider group than just the very wealthy. Farmers, small business owners and those who have had large lump sum payouts are also inside the net.
The ultimate concern is the paper profits tax technique could be applied more widely by the government if it gets successfully applied inside super.
Looking longer-term, investors are also wondering about the potential tax shelter alternatives to both super and traditional strategies, such as negative gearing and the Capital Gains Tax discount for assets held more than a year.
We don’t know yet what the government might do.
It could be something like a change to negative gearing which, for example, might only allow negative gearing on new houses rather than existing stock.
A possible change to CGT discounts could be to shave the discount from 50 per cent to 25 per cent — these ideas come straight from the Bill Shorten playbook of 2018.
One thing is for sure, tax changes which will happen will be changes which are politically feasible.
The government successfully halved the personal tax gains for earners above $180,000 by getting support in parliament. The unreleased gains tax is yet to play out in parliament — though it is due to begin on July 1 2025. So far, there is no obvious backlash from either the Greens or crossbenchers.
Instead, we already know the Greens have put their focus on negative gearing with the minor party demanding negative gearing reforms in return for support of the government’s ‘help to buy’ property scheme in the Senate.
Whatever happens next, negative gearing and CGT discounts are in the frame. Treasurer Jim Chalmers has already conceded he has spoken to Treasury secretary Steven Kennedy about current arrangements.
This does not mean anything else is safe, such as family trusts or franking credits, but it does mean they are less likely to become political targets.
Either way, regulatory risk is now a crucial item for investors at all levels.
After the surprises of last month, we cannot say for sure any tax structure is guaranteed. If the government denies there will be any future change, we cannot take this denial seriously after because the same government recently backflipped on its Stage Three tax cuts promise.
New alternatives are getting the numbers
As the wider debate fumes, there are two tax structures now getting much more attention than before.
For middle income investors, investment bonds (also known as education bonds) are increasingly on the table, for wealthier investors, family trusts are now increasingly considered.
You might be thinking ‘it’s still early days for the government’s tax changes, we have plenty of time’. But, the wealthiest investors in the land have not been waiting around. New Treasury statistics released a few days ago show one in ten taxpayers now report ‘trust income’. What’s more, 200,000 people joined this list in the last reported year by the ATO.
Family trusts are, of course, ‘being examined’ just now by the Treasury. But, hey, family trusts are always being examined by Treasury officials, and there is little evidence yet anything substantial is planned here.
Put simply, family trusts have the advantage where members can receive distributed income at tax rates much lower than income tax rates.
However, the issue is, unless you have a business or a farm, then they are seriously expensive to operate.
You will spend at least $2500 a year in expenses to run a trust — if you were lucky enough to have, say, $1m in a trust then these costs are a 0.25 per cent management expense ratio.
This is why top advisers have suggested — with the exception of small business and farms — family trusts need to have around $1m in them to make sense, outside of traditional business ownership arrangements.
Family trusts are there when investors have tapped out all other tax shelters, such as superannuation. They should also be there if — and when — the government clamps down on negative gearing and CGT.
The other key tax option for middle income families is the investment bond — sometimes promoted as education bonds.
In common with family trusts, these operate on the promise you will receive income at closer to company rates than marginal tax rates. They are not as expensive as family trusts, but to catch it you must leave the investment inside the bond for a decade to get the maximum tax benefits.
Until very recently advisers have been sceptical about the high fees sometimes associated with these bonds, but more recently the sector has become more competitive and often more tax-attractive through the use of franking credits.
As you can see the menu of tax options outside negative gearing and CGT discounts is slim. What’s more, they are often expensive and designed for a purpose which may not be for you.
If you are reshaping an investment portfolio to fit into a new, unknown-to-you tax system the problem (as we now know) is tax systems can change under your feet.
Discussing these issues with a range of advisers this week, one point continually popped up: whenever tax effectiveness is an issue with investors, the first place to begin should be the income tax tables.
Every Australian at any age has a tax-free income — up to $18,200 a year. For some investors, the best advantage might be sitting right under your nose.
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