Monthly Archives: June 2015

Keeping up to date records, the key to claiming Motor Vehicle Expenses.

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We trust you’re enjoying our tax planning series and that our editorials have provided you with some ideas that you can implement to assist you with improving your financial outcomes.  Remember, we love doing tax planning for our clients so please take advantage of our special offers during this series.Today’s topic is on Motor Vehicle Record Keeping.  We outline the 2014/2015 tax benefits and the changes to the 2015/2016 Motor Vehicle Record Keeping Requirements.

If you have missed any of the previous editorials you can view them at
http://www.mcmahonosborne.com.au/www/content/default.aspx?cid=1010

Today’s strategy is targeted at Motor Vehicle Record Keeping.  If you are claiming a deduction for using your own car (including a car you lease or hire), it is treated as a car expense.

For the 2014/2015 Income Tax Year there are 4 ways in which you can claim legitimate Motor Vehicle expenses in your tax return, these are:

1. Cents per km
2. 12% of the cost of the vehicle
3. One-third of actual expenses
4. Log Book method

From 1 July 2015 (for the 2015/2016 Income Tax Year and moving forward), there will only be 2 ways in which you can claim legitimate Motor Vehicle expenses, these are:

1. Cents per km
2. Log Book method

The following outlines the records required in order to substantiate a deduction for your motor vehicle. We have listed all 4 claim methods for assistance with requirements for your 2014-2015 Income Tax Return.

Method When to use it
Records Required
Cents per km If your business travel is 5,000km per vehicle or less per year
  • Ownership
  • Details of how you calculated your claim
Log Book Method Anytime- generally used when 5,000km per year is exceeded but can be used by anyone
  • Ownership
  • A logbook covering a continuous period of at least 12 weeks
  • Loan interest or lease details
  • All maintenance expenses
  • Registration and Insurance
  • Fuel Expenses- keep receipts or estimate based on odometer records at start and end of year
  • Once completed, the logbook works usage percentage may be used to calculate your vehicle expense claim for up to five years
12% of cost of vehicle If your business travel exceeds 5,000km each year
  • Ownership
  • Cost of Vehicle (your purchase price, not original purchase price if bought 2nd hand)
  • Details of how you calculated your km usage
One-third actual expenses If your business travel exceeds 5,000km each year
  • Ownership
  • Loan interest or lease details
  • All maintenance expenses
  • Registration and insurance
  • Fuel expenses- keep receipts or estimate based on odometer records at start and end of year
  • Details on how you calculated your km usage
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Corporate Beneficiaries – an effective tax strategy?

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Today’s strategy is one targeted specifically at business owners who operate a successful and profitable business through a discretionary or family trust. Operating the business through a family trust with a corporate trustee is one of the most common structures for family businesses. When used to it’s greatest strength this structure can provide a great deal of tax effectiveness (refer to our recent article on Trustee Resolutions) and maintain asset protection for non business assets.

One of the key tax requirements of a discretionary trust is that any money not distributed to nominated beneficiaries will attract tax equal to the highest tax rate payable by individuals. Therefore it would only be in rare circumstances that any family would consciously decide against distributing all the trust profits each financial year. The problem here can be that if a business is performing well, if an individual taxpayers personal taxable income exceeds $80,000 the marginal tax rate is 39% including medicare levy (and even higher if the taxpayer has a HECS liability or doesn’t have Private Health Insurance).

We have a number of successful business owners who would like to take a proportion of their business profits and invest these in wealth creation assets. However sometimes this can trigger higher personal income which in turn attracts higher taxation obligations. An obvious alternate strategy is to make lump sum superannuation contributions which can be very tax effective. The two potential limitations of this strategy are the preservation rules (where any taxpayer is limited from accessing the funds for a number of years) and the contribution caps (limits on the amount of tax deductible contributions that can be made in any year).

So, in working through this with a number of clients who have this situation we have developed a strategy known as “Corporate Beneficiary Solutions”. In a nutshell this involves setting up a Company that will act as an Investment Company and generally is owned by a Discretionary Investment Trust to increase the tax effectiveness of the strategy. Annually, when making the trust distribution from the business trust a nominated amount will be distributed to the Investment Company. This company then uses these funds to build an investment portfolio (whether it be property, shares or other assets) to create wealth for the family.

The tax is capped at the company tax rate (30% for 2014/15 and then 28.50% for the 2015/16 year per the Budget proposals) on all income and capital growth received by the company. Unlike superannuation funds, in Corporate Beneficiary Solutions, there are no preservation rules, contribution caps or limits on borrowing arrangements that the company can enter into. The price paid for this freedom is the higher tax rates of companies compared to superannuation funds and limitations on some capital gains tax concessions.

When the taxpayer wants to access funds from the Investment Company this is done by way of Fully Franked Dividend to the Discretionary Investment Trust so the prior tax paid is a benefit that can be streamed through the family group.

As you can tell, this strategy is not for everyone and advice prior to entering such a structure is an absolute necessity. For those who have been able to put this plan in place, there can be significant financial benefits in both the short and long term but we do reiterate specific advice is critical prior to establishing any structures.

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Getting Trustee Distributions Right Equals Best Tax Outcomes

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We trust you’re enjoying our tax planning series and are taking away some ideas that you can implement to provide you with improved financial outcomes. Remember, we love doing tax planning for our clients so please take up our offers during this series.
A warning about today’s topic – we get a bit more technical than we’d like and probably more than our readers would like. However, we have consciously decided to take this path as we know that Trust Resolutions prior to 30 June each year are a relatively new concept that is enforced by the ATO. One benefit provided by discretionary trusts is the distribution of income to various beneficiaries – get it right and the tax savings are very significant, but get it wrong and beware the outcomes.
If you are a client and have an existing trust most likely you’ll have already received some correspondence from our office in relation to this process of resolution. If you haven’t please contact Angela Corby on 03 9744 7144 who will be able to help.
For those readers who aren’t clients or don’t have trusts you may find this Question & Answer document interesting as it speaks to the nuances that go with Discretionary Trusts. This gives an indication of the thought processes that trustees should undertake to get the most from a trust when looking at tax efficiency on a year to year basis. We hope you enjoy it and would like to thank Change GPS who have helped us pull this technical document together.

Trust Distributions 2015 – before 30 June
If you are a trustee and you make beneficiaries of a trust entitled to trust income by way of a resolution, it is important you read the following information. It will help you to make sure you are correctly complying with all the necessary requirements when you make your resolutions.

Do you have a complete copy of your trust deed?
A resolution must be consistent with the terms of your trust, so make sure you have a complete copy of your trust deed, including amendments. You need to ensure that any resolution you make to distribute your trust’s income for the year is made in accordance with the terms of the trust deed.

When do you have to make your resolutions?
All trustees who make beneficiaries entitled to trust income by way of a resolution must do so by the end of an income year (30 June). This resolution will determine who is to be assessed on the trust’s taxable income.

If your trust deed requires your resolution to be made at a date before 30 June, you should comply with the requirements of the deed – for example, if the trust deed requires your resolution to be made by 28 June, then you should make your resolution by that date.
If your trust deed requires an earlier resolution, all references we make to 30 June should be read as the earlier date required by your deed.

Is there a standard format for a resolution?
No. As there are a wide variety of trust deeds with different requirements for trustee resolutions, we cannot provide a standard format.
The important thing is that your resolution must establish, in one or more beneficiaries, a present entitlement to the trust income by 30 June.

Does a resolution have to be in writing?
Whether the resolution must be recorded in writing will depend on the terms of your trust deed. However, a written record will provide better evidence of the resolution and avoid a later dispute, for example with us or with relevant beneficiaries, as to whether any resolution was made by 30 June.
A written record will be essential if you want to effectively stream capital gains or franked distributions for tax purposes – this is because a beneficiary can only be specifically entitled to franked dividends or capital gains if this entitlement is recorded in writing in the records of the trust either:
• by 30 June for franked dividends, or
• by 31 August for capital gains.

A beneficiary cannot be made specifically entitled to a capital gain included in the income of the trust estate after 30 June if, as a result of the operation of the trust deed, another beneficiary (including a default beneficiary) was presently entitled to it.

Who can you appoint income or capital to?
Check the trust deed to ensure that the intended beneficiaries are within the class of persons who can benefit from an appointment of trust income (or of trust capital, if you intend to stream a capital gain that is not income of your trust) and not listed as excluded beneficiaries. For example, sometimes a deed will specifically exclude a beneficiary if they are the trustee of the trust.
If you make an appointment in error to someone who is not a beneficiary, the default beneficiaries (if there are any) or you as trustee, may be assessed on a corresponding part of the trust net (taxable) income.

Has the trust made a family trust election?
If so, then check whether the intended beneficiaries are within the family group of the individual specified in the election. Appointing trust income or capital to a person outside the family group will result in a tax liability to you (as trustee).

Has the trust vested (come to an end)?
Check the trust deed to ensure that the trust has not yet vested. If it has, then entitlements to income will already have vested in those beneficiaries entitled to the trust fund on the vesting date.

Is the wording of your resolution clear and unambiguous?
Check that your resolution is unambiguous and robust enough to deal with all eventualities.

Example 1
A trustee resolves to distribute the trust income as follows:
A – the first $100
B – the next $100 to B
C – the balance of the income
D – the balance of the income.
The trustee may have been intending to appoint to C and D 50% of the income remaining after the specific appointments to A and B. But on one reading, all of that income was appointed to C, so that there is nothing which can be distributed to D.

Example 2
A trustee simply resolves to distribute all of the trading income to a beneficiary. But the trustee, in carrying on a business, has derived some interest income – this interest income would not be dealt with by the resolution. Depending on the wording of the particular trust deed, the result would be that some of the net (taxable) income of the trust would be assessed to the trustee or default beneficiaries.

Are conditions on the entitlements fully effective by 30 June?
A resolution would not be effective if it states that entitlements of beneficiaries would change in the event of a future adjustment by the Commissioner of Taxation. This is because such a resolution would not have been effective to create an entitlement before 30 June.

How should you calculate the income of the trust?
Make sure that you understand how the income of your trust is calculated and that your resolution reflects this definition – for example, if the income of your trust is defined to be equal to its net (or taxable) income, your resolution should not distribute accounting income.
If your deed equates the trust’s income with its net (or taxable) income, you should note the Commissioner’s view set out in Draft Taxation Ruling TR 2012/D1External Link that income cannot generally include notional amounts such as franking credits.
Income of the trust needs to be reported on the trust tax return, along with each beneficiary’s share of income of the trust. This information is needed to work out each beneficiary’s share of the trust’s net (taxable) income.

Are you ‘streaming’ capital gains or franked distributions?
If you are ‘streaming’ capital gains or franked distributions (making particular beneficiaries entitled to them), firstly check that you are not prevented from doing so under the terms of the deed. Then check that you have complied with the relevant legislative requirements relating to the creation and recording of these entitlements.
For example, in a trust where income is equated with net income, a resolution distributing that part of the income attributable to a discount gain will only create an entitlement to 50% of the financial benefits that arise from the capital gain – that is, the discount component of the capital gain being non-assessable will not form part of the income from the trust.
To create an entitlement to all of the financial benefits referable to the capital gain, the trustee would also need to distribute that part of the trust capital attributable to the discount component of the gain.
While the tax law allows until 31 August to record the specific entitlements relating to capital gains, such entitlements cannot be created or carried over any amount that has already been dealt with – for example, any capital gains forming part of trust income that was already dealt with by 30 June.

Are you seeking to ‘stream’ other types of income?
The tax attributes of other types of income besides capital gains and franked distributions cannot be separately streamed to different beneficiaries in the way that capital gains and franked distributions may be streamed. Under the general trust-assessing provisions in the tax law, each beneficiary is taxed on a proportionate share of each component of net income and cannot be treated as having a share of net income that consists of one category of income.
It is only under separate provisions, such as those dealing with capital gains and franked dividends, where a beneficiary may be taken to have derived income of a particular character. The tax effectiveness of streaming particular types of income to particular beneficiaries will depend on the effect of relevant tax law provisions

Our planning sessions come with a guarantee that if we can’t produce legal tax savings from our suite of options that exceeds 200% of your investment with us the session will be FREE so there is no financial risk to you for participation in these sessions.

To participate in a tax planning session specific to your needs and requirements please contact our office on 03 9744 7144 to book a session with one of our tax specialists.

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ATTENTION BUSINESSES- A Guide to Understanding the $20,000 Immediate Write Off

Tax planning

 

We have received a number of questions about the $20,000 immediate write off since budget night and almost every conversation has started with the same question – is it as good as it sounds on the Harvey Norman ads?  Here’s the best guide yet to understanding the good, bad and ugly of the budget announcement provided by renowned tax experts Knowledge Shop.  Please remember that this is general advice and you should consult your tax professional before making any decisions.

Does your business make a profit? Deductions are only useful to offset against tax. If your business makes a loss then a tax deduction is of limited benefit because you’re not paying any tax. Losses can often be carried forward into future years but you lose the benefit of the immediate deduction. Small businesses with a turnover of $2m or below make up 97.5% of all Australian businesses. The latest Australian Taxation Office (ATO) statistics show that well under half of these businesses paid net tax. That means that the $20,000 instant asset write-off is useful to less than half of the Australian small businesses targeted. So, if your business makes a loss and you start spending to take advantage of the immediate deduction, all you are likely to do is to increase the size of your losses with no corresponding offset.

Immediate deduction not yet law. The $20,000 instant asset write-off is not yet law. The ATO only has the capacity to assess on current law not announcements. Don’t forget that many of last year’s Budget measures have not been enacted. While we think it is highly unlikely that the other political Parties will block this measure, there is always a small risk that things will change. So don’t spend more than your business can afford.

Cashflow First! Cashflow is more important than an immediate deduction. Assuming your business qualifies for the deduction, the most important consideration is your cashflow. If there are purchases and equipment that your business needs, that equipment has an immediate benefit to the business, and your cashflow supports the purchase, then go ahead and spend the money. The $20,000 immediate deduction applies as many times as you like so you can use it for multiple individual purchases. But, your business still needs to fund the purchase for a period of time until you can claim the tax deduction and then, the deduction is only a portion of the purchase price. Let’s take the example of a small bakery. The bakery is in a company structure and has a taxable income for 2014/2015 of $49,545. The owner purchases a new $13,750 oven on 2 June 2015 and installs it straight away. The cost of the oven is claimed in the bakery’s 2014/2015 tax return resulting in a tax deduction of $13,750. So, for the $13,750 spent on the oven, $4,125 is returned as a reduction of the company’s tax liability (i.e., 30% company tax rate in the 2015 income year). For the bakery, they need the cashflow to support the $13,750 purchase until the businesses tax return is lodged after the end of the financial year. With the $4,125 reduction of the company’s tax liability, the business has fully funded the remaining $9,625. From 1 July 2015, the bakery would also receive the small business company tax cut of 1.5%. If the business also had taxable income of $49,545 in the 2016 income year, the tax cut would provide a reduction of $743. It’s important not to rely on the advice of the person you are purchasing from. There is a lot of misinformation out there in the market right now and it’s important to know how the concessions apply to you.

Is your business eligible? To use the instant asset write-off, your business needs to be eligible. The first test is that you have to be a business – not just holding assets for investment purposes. The second is the aggregated turnover of your business needs to be below $2m. Aggregated turnover is the annual turnover of the business plus the annual turnover of any “affiliates” or “connected entities”. The aggregation rules are there to prevent businesses splitting their activities to access the concessions. Another entity is connected with you if: • You control or are controlled by that entity; or • Both you and that entity are controlled by the same third entity.

What has changed? In general, a deduction is available for purchases your business makes. What has changed for small businesses under $2m turnover is the speed at which they can claim a deduction. Before the Budget announcement, small business could immediately deduct business assets costing less than $1,000. On Budget night, the Treasurer announced that the threshold for the immediate deduction will increase to $20,000 at 7.30pm, 12 May 2015 for small businesses with an aggregated turnover less than $2 million. The increased threshold is intended to apply until 30 June 2017. For small business, assets above $20,000 can be allocated to a pool and depreciated at a rate of 15% in the first year and 30% for each year thereafter. If your business is registered for GST, the cost of the asset needs to be less $20,000 after the GST credits that can be claimed by the business have been subtracted from the purchase price. If your business is not registered for GST, it is the GST inclusive amount.

How do I make the most of the immediate deduction? There are a few tricks to applying the instant asset-write off:

Second hand goods are ok. It does not matter if the asset you are buying for your business is new or second hand. So, you could still claim the deduction on say, second hand machinery you have bought.

What is not included. There are a number of assets that don’t qualify for the instant asset write off as they have their own set of rules. These include horticultural plants, capital works (building construction costs etc.), assets leased to another party on a depreciating asset lease, etc. Also, you need to be sure that there is a relationship between the asset purchased by the business and how the business generates income. For example, four big screen televisions are unlikely to be deductible for a plumbing business.

Assets must be ready to use.  If you use the $20,000 immediate deduction, you have to start using the asset in the financial year you purchased it (or have it installed ready for use). This prevents business operators from stockpiling purchases and claiming tax deductions for goods they have no intention of using in the short term.

Business and personal use.  Where you use an asset for mixed business and personal use, the tax deduction can only be claimed on the business percentage. So, if you buy an $18,000 second hand car and use it 80% for business and 20% for personal use, only $14,400 of the $18,000 can be claimed.

Summary. Again, we reiterate that this is not yet a legislated item and hence any specific advice is nigh on impossible because at this stage we only have a budget announcement. We fully expect this to be passed as law – the questions are really about when and the specific details. No doubt the legislation itself will answer the queries but we don’t expect that to be implemented by 30 June, 2015 so our general advice is proceed with caution and use common sense in taking advantage of this opportunity.

To participate in a tax planning session specific to your needs and requirements please contact our office on 03 9744 7144 to book a session with one of our tax specialists.

Our planning sessions come with a guarantee that if we can’t produce legal tax savings from our suite of options that exceeds 200% of your investment with us the session will be FREE so there is no financial risk to you for participation in these sessions.

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Superannuation Contributions-proceed with care before June 30

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Right now we are conducting a number of really valuable tax planning sessions with our clients and so far the results have been amazing with many thousands of tax dollars saved through our various strategies.

Over the past few weeks we have been running a series of editorials outlining just some of our tax planning strategies.  Our editorials continue today with a look at Superannuation Contributions and why you should proceed with care before 30th June

 

With the 2014/2015 year coming to a close you may be considering making changes to your superannuation contributions and taking advantage of the tax savings in this area. Today we take you through a few of the options available and some of the detail that you would want to be aware of in this decision making process.
Superannuation is without doubt the single most tax effective plan and opportunity available to most Australians – the trade off taxpayers are offered by the Government is that for that tax benefit there a number of very specific rules. Mostly these are to do with tax deductibility, contribution limits and access to funds. In the lead up to 30 June we have a focus on tax deductibility and contribution limits.
Contribution Strategies in a Nutshell.
Four year end strategies are outlined below in point form. If any or all of these take your interest we have a more detailed discussion below on the first three topics further on in this editorial. If the last item is of interest we strongly recommend a discussion with your accountant prior to commencing this strategy as issues of Capital Gains Tax, Stamp Duty and Contribution Limits need to be carefully considered prior to execution of this strategy.
• Consider increasing your salary sacrifice to the maximum amount permitted concessional cap or, if eligible, making a lump sum concessional contribution prior to 30 June
• Consider contributing any spare cash that is in your personal name into the super fund as a personal contribution up to the non concessional cap prior to 30 June
• If you are a low or middle income earner consider putting in a $500 personal contribution into your Super fund prior to 30 June to access the Government Co-Contribution as an effective way of increasing your retirement savings
• If you have a Self Managed Superannuation Fund (SMSF) consider what shares and commercial property you own out side of the SMSF and consider if this can be placed inside the SMSF. It requires expert advice to execute this strategy and should not be undertaken before speaking to your accountant.
Strategy 1 – Concessional Contributions and the Caps:
What it means?
Concessional contributions include:
• Employer contributions (including contributions made under a salary sacrifice arrangement); and
• Personal contributions claimed as a tax deduction by a self-employed person or a person who is not employed at all (eg: retirees, stay at home spouses, passive income earners)
• Personal contributions claimed as a tax deduction by a substantially self-employed person or a person who is not substantially employed, this is subject to the 10% deductibility rule as per below.

Concessional contribution caps:

Concessional contribution caps

10% Deductibility Rule:
If you are substantially self-employed, or substantially not employed, but also an employee, you can claim a tax deduction for a super contribution when your income as an employee is less than 10 per cent of your total income.
• Total income for the purposes of the 10 per cent rule is assessable income (gross income before tax deductions) plus salary sacrifice contributions (also known as reportable employer super contributions) plus reportable fringe benefits.
• You’re eligible to make tax-deductible super contributions when your employment income is less than 10% of your total income. Note that Superannuation Guarantee contributions do not count towards total income or employment income.

Strategy 2 – Non-Concessional Contributions and the Caps
What it means?
Non concessional contributions include personal contributions for which you do not claim an income tax deduction.
Non-concessional contributions cap for a given income year:

Concessional contribution caps
Non-concessional bring-forward cap:
People aged under 65 years on 1 July in a financial year may be able to make non-concessional contributions of up to three times their non-concessional contributions cap over a three year period. This is known as the “bring forward” rule.
The bring-forward cap is three times the non-concessional contributions cap of the first year. If you brought forward your contributions in 2014/15, it would be 3 x $180,000 = $540,000
Strategy 3 – Government Co-Contribution:
What it means?
The super co-contribution is designed to assist eligible individuals to save for their retirement. If you are eligible and make personal super contributions during a financial year, the government will match your contribution with a super co-contribution up to certain limits.
Government co-contributions

If you have missed any of the previous editorials you can view them at http://www.mcmahonosborne.com.au/www/content/default.aspx?cid=1010 or if you wish to book a tax planning session with one of our tax planning specialists call Lynda on (03) 9744 7144 or email lynda@mcmahonosborne.com.au

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Capital Protected Investments – A short guide

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Capital Protected Investments are a very effective way to legally reduce your tax whilst gaining some exposure to equity markets. There are a number of different types of Capital Protected Investments and each has different features and carries different risks. Importantly, the tax benefit from this investment is available to both those in business and those who have an income primarily from a salary.

Many of our clients have used these products effectively over a number of years to help achieve their financial objectives. As these investments are classed as Financial Products, it is imperative that you seek sound financial advice from a licensed financial planner familiar with these offerings before adding one of these products to your investment portfolio.

Amongst the many available investments, one example currently available is the Flexi 100 Trust offered by Macquarie. We have used this product to provide a real life demonstration of these investment options.

Flexi 100 Trust – Features
1. Provides exposure to an equity based investment (either Australian Shares, International Shares or a combination of both) funded by a loan rather than a large capital injection.
2. Offers the opportunity to create a tax deduction this financial year as a key feature is the prepayment of interest before 30 June
3. The product is structured so that the investor is not exposed to any downward market returns due to a capital guarantee feature
4. This product has NO margin calls
5. At each twelve month anniversary an income distribution is payable to the investor which is then used to offset in part the following year’s interest payment – as such this reduces the annual outlay
6. Should the investor wish to exit the investment due to a change in market conditions or personal circumstances they can do so under the “walk away” option on a quarterly basis
7. There is no need for the loan to be secured by any personal assets. Macquarie provide the loan to the investor using no personal security beyond the investment itself.
8. Opportunity for an investor with a large property bias to obtain some diversification in their investment profile through an exposure to shares
9. The absolute maximum exposure to loss is the interest and borrowing costs net of any tax benefits – there is no exposure to loss in value of the underlying assets
10. The investment has been issued an Product Ruling PR 2013/16 by the Australian Taxation Office which confirms that the interest is tax deductible
11. The product is fully compliant with the Limited Recourse Borrowing requirements to be an acceptable investment for SMSFs
12. The investment period is 3.5 years or 5.5 years depending upon the preferred investment category

Who would add Flexi 100 Trust to their investment portfolio?
Flexi 100 Trust certainly is not appropriate for all taxpayers . It can suit a wide range of investors including SMSFs and individuals who want some or all of the following benefits and outcomes:
• to borrow to gain enhanced growth exposure to investment opportunities
• flexibility to exit the investment early should their circumstances or market conditions change
• to deal with potential tax issues such as Capital Gains on the disposal of property or shares
• to deal with potential tax issues resulting from additional profits in the tax year
• an investment with a low capital outlay relative to the investment value
• portfolio diversification
• to re-balance some equity holdings into a protected investment

Case Study – Flexi 100 Trust
Let’s say the following are the underlying assumptions:
• The investor borrow $100,000 to invest
• The interest rate payable is 6.40% per annum
• The chosen investment is the Australian Equity Focus (a basket of 20 equally weighed shares listed on the Australian Stock Exchange invested on a 3.5 year term)
• The borrowing cost is 2% upfront

If the shares growth is 0% or actually falls during this period the maximum exposure of the investor is $15,194 net of any tax benefits. So, for a taxpayer who’s income is between $80,000 and $180,000 – based upon current tax rates the tax benefit over the investment period would be $5,926 leaving a maximum financial risk over the three year term of $9,268 for exposure to $100,000 share investment during that time.

If the annual growth was 8% per annum for each share over that same period, the capital return at the conclusion of the 3.5 year investment period would be in the vicinity of $30,000. Any gains of course will attract tax in the same way that a capital gain on selling a property attracts tax.

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Prepaying Interest Can Reduce Your Tax

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Tips, Traps and a Case Study

Prepayments can be a very effective way to provide tax relief before 30th June each year. There are a number of specific rules around prepayments that are eligible to be a tax deduction when paid and others which are required to be written off over the period of the prepayment. We’re going to focus in this article on the prepayment of interest specifically which has been used by many clients to great effect over a number of years.

Remember, this advice is general in nature and does not cover all situations so you should book an appointment with one of our tax team to obtain specific advice before proceeding with this tax planning strategy.

What interest can be prepaid tax effectively?
A taxpayer who is a small business entity (businesses that turn over less than $2 million and meet the small business entity test) and individual taxpayers who have loans for income generating investments are generally entitled to a deduction for prepaid interest on those loans. The prepayment period is limited to 12 months so if a prepayment exceeds 12 months the benefit of this planning strategy is reduced.

Why prepay interest?
If you hold an investment that you plan to retain for the period of the prepayment (let’s assume that’s 12 months for this article) then interest is a cost that you will incur in any case over the next year. So if you are in a position where you have enough cash flow to pay the interest for the next 12 months now why not do it and obtain a tax deduction in the current year – it really is just bringing forward a future tax benefit.

But it’s far more than that – this strategy is particularly effective when you have abnormally income in a particular year that is higher than your regular taxable income. This could come from any number of situations. Some of the most common situations are:

• Capital Gain from the sale of a property
• Capital Gain from the sale of a parcel of shares
• An inheritance that has a taxable element
• A one off bonus payment for performance
• An Employment Termination Payment with taxable components
• A large Trust Distribution or Dividend received

In these types of situations prepaying the interest on an investment loan can both defer and reduce the tax payable as shown in the case study below. Remember, this applies to any investment and in the coming tax planning tips we’ll be showing you a specific technique that works if you don’t currently have a loan in place.

How does it impact my tax?
Quite simply, if you are eligible for this deduction then the tax benefit is brought forward by twelve months (or even longer if you take advantage of the various lodgment dates). Further to this, by applying this strategy to a abnormal high income year it actually reduces your tax liability over the two year period.

For a company with appropriate cash flow this strategy can be particularly effective in the 2014/15 Financial Year. The recent budget announcement provides an opportunity to prepay interest in the 2014/15 Financial Year and receive a tax benefit of 30%, rather than the benefit being only 28.50% as per the Budget announcement.

What are the pitfalls to be aware of?
With any strategy there are always areas of concern to consider before proceeding. Whilst every situation is different, generally these are the four primary issues that you should cover off before proceeding with this strategy.
• The benefit is primarily one of deferring tax, noting however the potential benefit of timing with a high income year. At some time in the future, if there is a year that you do not prepay the interest on the loan you will not be able to obtain a deduction for interest payments in that year.
• If you sell the underlying asset within the prepayment period the interest paid may not be recoverable. So if sale of the asset is being considered caution should be taken with this strategy.
• In order to prepay interest the lender may provide certain covenants – often there is no adverse consequences from these covenants however you should be clear on these before proceeding.
• Cash flow is always the king – like any interest payment the tax benefit is applied at your tax rate so there is a net outgoing. Before proceeding you should ensure there is sufficient cash flow to cover the outgoing interest payment without causing any financial distress.

What are the next steps?
If this is a strategy that you would like to consider for your current year tax planning there are a couple of key steps to take before taking up this option:
1. Consider this general advice and review the potential pitfalls so that you are comfortable that this option could work for you
2. Contact your lender and find out if they will make this option available for your current lending. If so, you will need to understand the lenders time line to make this happen prior to 30 June. If not, you should ask the lender what would be required to avail yourself of this prepayment option and make a decision whether or not you would like to proceed
3. Finally, arrange a tax planning session with one of the McMahon Osborne Group tax team to confirm that you meet the requirements to obtain a tax benefit and understand the quantum of the tax benefit.

Case Study
Evan is a truck driver with taxable income around $80,000 each year which increments slightly for CPI and occasional overtime work but generally is pretty stable. In September 2014 Evan sold an investment property that he has held for six years and calculated a gross capital gain of $120,000. With the proceeds he paid off his home loan. In March 2015 he purchased a new investment property for $400,000 and borrowed 100% of the costs using the investment property and his home as security. The interest rate on his new loan is 4.50%. The table below shows that by prepaying interest in the 2015 year, Evan reduces his 2015 tax liability by $7,020 deferring his tax payment and also providing an overall tax benefit as his income is unusually high in the 2015 year.

Interest table

Remember, this advice is general in nature and does not cover all situations so you should book an appointment with one of our tax team to obtain specific advice before proceeding with this tax planning strategy.

To participate in a tax planning session specific to
your needs and requirements please contact
Lynda on (03) 9744 7144 or email lynda@mcmahonosborne.com.au
to book a session with one of our tax specialists.
Our planning sessions come with a guarantee that if we can’t produce legal tax savings from our suite of options that exceeds 200% of your investment with us the session will be FREE so there is no financial risk to you for participation in these sessions.
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