April 2019 Newsletter

April 2019

Growing concerns about a slowdown in global economic growth preoccupied financial markets in March. The US Federal Reserve now forecasts no rate rises in 2019 instead of the two it previously planned. US 10-year government bond yields fell below 3-month yields on the news. This ‘inverted’ yield curve is viewed by markets as an historical predictor of recession.

In Australia, economic growth slowed to 0.2 per cent in the December quarter, for an annual rate of 2.3 per cent. This was reflected in the more cautious mood of business and consumers. Both the weekly ANZ-Roy Morgan consumer confidence rating and the monthly Westpac-Melbourne Institute survey of consumer sentiment fell below their long-term average in March. While the NAB business confidence index fell to a 3-year low of 2.0 point in February.

On a positive note, unemployment fell to a 10-year low of 4.9 per cent in February. Australia’s trade surplus rose to a 2-year high of $4,549 million in January, with exports up 5 per cent and imports up 3.3 per cent. Our trade surplus with China reached a record high, due largely to a 33 per cent increase in iron ore prices over the past year to around US$86.50 a tonne. Corporate Australia is also doing well, with record profits up 10.5 per cent in the year to December. The Aussie dollar rose slightly to US71c.

Franking credits on the chopping board

What started as an issue few people understood and even fewer cared about has suddenly become a flashpoint for self-funded retirees as we head into a federal election. Yes, we’re talking about cash refunds of franking credits.

Even if you’re not directly affected it’s worth paying attention, because it’s an $8 billion issue that affects us all.

What is being proposed?
The policy the opposition Labor Party is taking to the election proposes abolishing cash refunds of franking credits on share dividends ‘to make the tax system fairer’. It argues that closing this ‘tax loophole’ will soon save the budget $8 billion a year, which is more than we spend on public schools, childcare or the Australian Federal Police.

Pensioners and allowance recipients will be exempt, as will charities and not-for-profits including universities. Self managed superannuation funds (SMSFs) with at least one pensioner or allowance recipient before 28 March 2018 are also exempt.

If Labor wins the election the policy will take effect from 1 July 2019.

How did we get here?
Dividend imputation was introduced by the Hawke/Keating Government in July 1987 to end the double taxation of company profits. Before then, companies paid tax on their earnings and shareholders were taxed on the dividends paid out of profits at their marginal rate.

Under dividend imputation, companies pass on a tax credit to shareholders for tax already paid at the company level. Shareholders can then use these imputation credits or franking credits to offset tax liabilities on other income, including salary.

The system was made more generous in July 2000 when the Howard/Costello Government allowed excess franking credits to be paid as a cash refund. This meant that people who pay no tax can claim a full refund from the ATO.

The Labor Party proposal effectively restores the original tax treatment of dividends prior to July 2000.

How does it work?
Say an Australian company makes pre-tax earnings of $1 a share. It pays tax at the company rate of 30 per cent, or 30c a share, and returns the remaining 70c to shareholders as a fully franked dividend.

When shareholders complete their tax return, they add the 70c dividend to the 30c franking credit and declare $1 of taxable income. They then pay tax on the $1 of taxable income at their marginal rate.

If you are on the top marginal rate of 47 per cent (including Medicare levy), then tax is 45c but after the 30c tax credit you pay tax of just 17c.

If your marginal tax rate is zero, as is the case for all but the wealthiest retirees, you receive a 30c cash refund from the Australian Taxation Office even though you pay no tax.

Under Labor’s proposal, there will be no refund for shareholders who can’t use the full 30c credit unless you are a pensioner or allowance recipient.

Who is most affected?
Labor argues that 80 per cent of the benefits of the current system of franking credit cash refunds go to the wealthiest 20 per cent of retirees, and that 92 per cent of taxpayers won’t be affected by the change.

However, critics say the proposed changes unfairly target retirees with their own self-managed super funds. Labor does single out SMSFs on its campaign website arguing that the top one per cent of SMSFs received an average cash refund of more than $80,000 in 2014/15.

Self-funded retirees argue that the policy is unfair for people who saved and planned their retirement income around one set of rules, only to have the rules changed when it’s too late to rearrange their affairs.

But whoever wins the election, share dividends will remain an important source of income for retirees. The dividend yield on Australian shares is currently around 4.4 per cent (5.7 per cent with franking credits), compared with interest of around 2 per cent on term deposits. Shares also have the potential for capital growth over the long run, while term deposits do not.

If you would like to discuss your retirement income strategy, give us a call.

How to make tax time less taxing

Tax time comes around with alarming regularity, so why is it that we tend to wait till the 11th hour to get all our affairs in order?

Good tax planning is about more than simply maximising deductions. It enables you to focus on the big picture so you can arrange your business and personal affairs in the most tax-effective way, make the most of our services and tax updates throughout the year.

Not only will it reduce stress as June 30 approaches, but you could end up better off as you won’t have forgotten anything in the last-minute scramble.

Make sure that you take a holistic approach and review your tax strategies for your personal income tax, your business and your superannuation.

Personal income tax
For instance, where personal income tax is concerned, do you have money invested and pay tax on that interest?

If so, and you still have a mortgage, consider a mortgage offset account to deposit your savings. That way you won’t pay tax on the interest earned and the extra money in that offset account will lower the interest you pay on your home loan.

Also, tax brackets are lowering from July this year, so consider loading deductible expenses into this year’s return. Next year those earning $87,000 to $90,000 will move from a 37 per cent tax rate to 32.5 per cent.

Small business strategies
There are a number of strategies for those with a small business, starting with the recently enhanced immediate asset write-off.

The government has announced that the write-off will increase by $5,000 to $25,000 effective immediately, subject to parliamentary approval. It also proposes extending the measure by another year to 30 June 2020. If you buy an asset costing less than $25,000 you can claim an immediate deduction provided your company has a turnover of less than $10 million.

If your business has a turnover of less than $2 million or, together with affiliates, has a net asset value of less than $6 million then you may be able to take advantage of the small business capital gains tax concessions.

If you are selling an active business you’ve owned for at least 15 years, are aged 55 or more and retiring, you won’t pay any CGT on its disposal. You can then contribute up to $1.48 million from the sale into your super fund without it counting towards your non-concessional contributions cap.

There are other CGT concessions for those who don’t qualify for the 15-year exemption, but it’s a good idea to talk with us as the process is complex. For example, you may be able to contribute up to $500,000 from the sale your business into your super.

Super strategies
Another super strategy is to make a personal deductible contribution or salary sacrifice up to the concessional contributions cap of $25,000 which includes compulsory contributions paid by your employer. You might also consider a spouse contribution and claim a tax offset if their income is less than $40,000 a year.

If you are aged 55 or over, you could boost your super with a transition to retirement strategy. However, given such income streams are no longer tax-free, and the maximum you can concessionally contribute to super each year is capped at $25,000 regardless of your age, this strategy is less attractive than in previous years, especially for those younger than 60.

On the other hand, if you are struggling to meet that $25,000 cap, you can now carry forward any unused cap amount for up to five years if you have less than $500,000 in super. This new measure is particularly helpful if you are out of the workforce for a time, perhaps on maternity leave.

For those with a family trust, it is vital you distribute earnings before the end of the financial year to avoid punitive tax on undistributed income.

As the old adage says, fail to plan and you plan to fail. Taking the time to work out what needs to be done before the financial year closes will go a long way to ensuring you make the most of your money.

How to speak 'real estatese'

First-home buyers (and even second- and third-home buyers) are often baffled by the jargon used by real estate industry professionals. This can result in expensive misunderstandings unless you take the time to learn the lingo.

Here are some frequently misunderstood terms and concepts you should familiarise yourself with before you begin searching for your dream home.

Conveyancing involves transferring the ownership of a property from the seller to the buyer. Both the buyer and seller use a conveyancer or solicitor, who makes sure their legal rights are protected – and obligations met – during the transaction.

Lender’s Mortgage Insurance
Borrowers often mistakenly believe Lender’s Mortgage Insurance is designed to protect them, when in fact it protects the lender.

Lenders prefer borrowers to have a 20 per cent deposit. This provides a buffer for the lender if you stop making repayments and they sell your property for less than its original value.

Lenders generally only provide mortgages to those with less than a 20 per cent deposit if they pay for Lender’s Mortgage Insurance. This involves the borrower paying premiums on an insurance policy that guarantees the lender won’t be out of pocket if the borrower stops making repayments.

If you want a policy that protects you, the borrower, you’ll need to take out mortgage protection insurance. This will cover your repayments if you become ill or unemployed.

Cooling-off period
Cooling-off periods are not the get-out-of-gaol-free card people often imagine them to be. If you put in an offer that’s accepted (i.e. start a ‘private treaty’ sale), you’ll typically have 3-5 business days to change your mind without incurring any major costs. (Depending on where the property is, you will usually still have to pay 0.2-0.25 per cent of the purchase price as a penalty for backing out.)

The exception is Western Australia and Tasmania; neither currently have cooling-off periods – you’re on the hook for the full amount as soon as you sign the contract.

There is also no cooling-off period with auctions. If you’re the successful bidder, you’ll have to provide a 10 per cent deposit immediately and the remainder within the timeframe specified in the contract.

Offset vs redraw
Once you’ve bought your home, your mortgage lender may offer the option of a mortgage offset account, redraw facility or both.

An offset account involves your mortgage account functioning as a transaction account. Let’s say you have a mortgage of $400,000 and you and your partner are jointly paid $15,000 a month. When your salaries are deposited in your offset account, it reduces (offsets) your mortgage to $385,000. This means you pay less interest on that lower amount – at least until money starts coming out of the account to cover your monthly expenses.

A redraw facility allows you to put extra money into your mortgage then withdraw (‘redraw’) it later. For example, you could put an annual bonus of, say, $20,000 on your mortgage. You can leave the money there to stay ahead on your repayments or later redraw all or part of that $20,000 to, for instance, buy a new car.

Fixed vs variable rates and split loans
Most lenders offer borrowers fixed or variable rates or a combination of both. A fixed rate means you pay a set interest rate and a set amount of money for an agreed amount of time. This provides certainty for borrowers on a tight budget or the ability to lock in a lower rate if you think rates will rise. A variable rate fluctuates depending on market interest rates, with the flexibility to make additional repayments and redraw.

You may like to hedge your bets with a split loan, which means a fixed interest rate applies to a certain proportion of your loan and a variable interest rate to the rest.

Interest rate vs comparison rate
The headline interest rate is not necessarily the rate borrowers actually pay. The comparison rate accounts for any fees and charges on top of the advertised rate.

Buying your first home can be a steep learning curve. If you’d like some help preparing your finances for a first or subsequent property purchase, please call us.