The majority of adult Australians will be well aware that a Federal Election is looming in the coming months.
By their very nature, elections bring about change – regardless of whether the incumbent party is returned to office or the voters decide on a fresh start. Recent history and commentary suggests the latter outcome, installing our first Labor government since the Rudd/Gillard/Rudd days that ended in September 2013.
As the lead-up to the election gathers momentum, both major parties are disseminating their policies for change (improvement) across key areas – employment, education, environment, health, welfare and more – to win the minds and votes of the population. In the lead-up to this election there have been some major changes proposed by the Labor Party across the areas of tax, negative gearing and superannuation and these involve a lot of complexities to truly understand their impact.
From a taxation and financial impact perspective, we sit as very interested observers of the possible changes if the election results in a change of government. Here we assess the proposed changes (as have been made public by various Labor spokespeople to date), who will be affected and the potential impact.
Tax on Trust Distributions
It has long been a tax-effective strategy to operate a small to medium size family type business through a family trust.
If it wins government, Labor has announced it will introduce legislation to increase the effective tax rate on income earned by family trusts to “make them pay a fair share of tax”. From the media reporting, this measure would mean that adult beneficiaries of family trusts will pay a minimum tax rate of 30% on any income distributed. For many small businesses and small investors that operate through a family trust structure, it would mean that distributions would not get the benefit of the tax-free threshold and could end up increasing their effective tax rate.
For example, Michael and Anne run a small business through a family discretionary trust. They both work in the business and make no other income during the year. At the end of the year, the trust makes a distribution of $37,000 to each of them ($74,000 in total).
Under Labor’s plan they would each have to pay tax of $11,100 ($37,000 x 30%) instead of the $3,572 under the current tax laws in which they are able to access the tax-free threshold. Note that distributions above $37,000 will be further taxed at normal marginal rates.
If they were to operate their business in a company they would pay 27.5% tax and if they ran the business in a partnership (or invested in joint names), they would still be eligible to access the tax-free threshold and lower personal tax rates. Under the proposed changes there would be a lot of inconsistency in the tax rates of small business owners or investors, depending on which tax structure was used for the business or investment. There are also important differences between the structures for asset protection purposes that need to be carefully considered when deciding on a business and investment structure.
As this example highlights, small business owners who operate through a family trust structure may potentially pay significantly more tax under the proposed changes to family trusts, further adding to an already challenging small business environment.
MOST IMPACTED: Small and family business operators trading through a family or discretionary trust and investors holding investment assets in a family or discretionary trust.
Capital Gains Tax
The Labor Party proposal is to reduce the Capital Gains Tax discount from 50% to 25%.
Under current rules, an investor who holds an asset (such as shares, property, land, managed funds etc) for more than 12 months pays tax on 50% of any capital gain (at their marginal tax rate) when the asset is sold. This means that an individual who is paying tax at the highest marginal rate of 47% (45% plus 2% Medicare Levy) pays an effective tax rate of 23.5% on a gain.
If there is a change of government and the proposed changes go ahead, only 25% of the gain will be exempted, so that tax at the marginal rate will apply to 75% of a gain. For an investor paying tax at the highest rate of 47%, the effective tax rate will rise to 35.25%.
With the top marginal tax rate set to rise by a further 2% to 49% (see below), the effective tax rate will be 36.75%. For those on a marginal tax rate of 39% (which is a lot of Australia’s middle class families that own a rental property), the proposed changes would change the effective tax rate on capital gains from 19.5% of the total gain to 29.25% (a tax increase of 50%).
The tax paid on a capital gain of $1,000 of $235.00 will increase to $367.50, a substantial increase of 56.4%.
It is important to remember with capital gains that the investor will be taxed on the whole profit in the year they sell the asset, and this could result in pushing them into a much higher tax rate than they normally pay - while the actual gain itself had been building up over the total ownership period of the asset (which could be a number of years).
The reduced discount rate won’t be applied retrospectively, so that investments made before the effective date of the change (reportedly “sometime after the election”) will not be impacted.
MOST IMPACTED: Any individual who owns or is looking to purchase investment assets (property, shares, managed funds etc.) either personally or in a trust.
Top Tier Tax Rates
Higher income earners will recall the Coalition's “budget repair levy” of 2%, which was imposed on taxpayers on the highest marginal tax rate of 45%. The levy expired on 30 June 2017.
If elected, a Labor government proposes to re-instate the levy of sorts, by making a permanent increase of 2% to the top tax rate. The top tax rate would increase to an effective 49% (47% plus 2% Medicare Levy).
This represents somewhat of a contrast to the present government’s 10 Year Enterprise Tax Plan to reduce tax rates, albeit focussing on business tax rates – while also lifting the income tax rate bands.
MOST IMPACTED: Taxpayers earning more than $180,000 annually in taxable income.
There has been a lot of speculation around negative gearing for several years now. Negative gearing occurs when the income earned from the investment asset for that year exceeds the deductions for that asset during the year.
Bill Shorten and Chris Bowen have now stated the Labor Party position on negative gearing, in that it will be limited to “newly constructed housing”. The commencement date will be announced after the election, with investments made before this date being grandfathered.
The change will also apply to other assets including shares which are purchased with the assistance of a margin loan, or an investment in a business using borrowed monies. While interest will still be deductible, it will only be deductible to the extent that the income and the allowable deductions are fully offset – you won’t be able to claim a ‘net’ investment loss against other forms of income such as salary and wages income.
Although grandfathering will help existing investors, all property owners could be impacted if investors withdraw from the market and house prices fall. Rents could increase, as investors will require higher returns to compensate for the loss of the tax benefit.
MOST IMPACTED: Any individuals who borrow money to purchase investment assets.
Share Dividend Imputation (Franking Credits)
If elected, a Labor government would plan to remove the cash refund if a shareholder has franking credits greater in value than the income tax owed in a given year. The change would apply to dividends paid from 1 July 2019.
Attached to share dividends paid by companies such as Telstra, Woolworths, BHP, the major banks as well as privately owned companies including those that operate small businesses, the franking credits act as a tax offset and if not used, are currently refunded in cash by the Australian Tax Office.
Known as the “retiree tax”, this change will potentially impact 900,000 investors. While the impact will vary, a typical example sees a self-funded retiree drawing a pension of $60,000 p.a. from their SMSF being around $10,000 p.a. worse off.
Other low rate or 0% taxpayers, such as a non-working spouse who owns shares, will also be impacted. This could include small business owners who operate their business in a company and pay dividends from company profits.
In an amendment to the initially-announced policy (which creates great inconsistency in the overall policy), persons receiving a government benefit such as the aged pension, or an SMSF where one member was on a government benefit on 26 March 2018, will be exempted from the change. However, there is no plan to grandfather the policy to protect existing investors or small business owners.
MOST IMPACTED: Self-funded retirees, SMSFs without a pension member, low-income earners, small business owners operating in a company structure.
Superannuation has often been a vehicle for tinkering through the Federal Budget for a number of years now. Labor has announced further changes it would implement if elected.
The cap on non-concessional contributions to super – those contributions using your own ‘after tax’ money – would be lowered to $75,000 annually. In the past two years the cap has been reduced from $180,000 to $100,000 p.a.
A further cut in the cap will reduce the ability to make a large “one-off” contribution to super which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. By using the ‘bring-forward’ rule, a person under 65 can make 3 years’ worth of non-concessional contributions in one year. Under current policy, a person can get $300,000 into super in one hit while a couple can potentially contribute up to $600,000. Under a Shorten led government, this will fall to $225,000 or up to $450,000 for a couple.
MOST IMPACTED: People with surplus funds wanting to invest further funds into superannuation to increase their retirement savings.
Another superannuation move mooted by Labor applies to Division 293 tax - a higher tax rate (effectively 30%) on concessional (pre-tax) super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000.
Labor proposes to lower the threshold to $200,000, meaning that persons on incomes of $200,000 and above will have their concessional super contributions taxed at 30% (rather than 15%).
For savers and those planning to fund their own retirement (as opposed to the Government via welfare), this is another proposed change that makes the super system less attractive.
MOST IMPACTED: People with taxable annual income of $200,000 to $250,000 as those over $250,000 are already paying an effective 30% contributions tax.
The table below summarises the projected budget savings and revenue gains over 10 years if the key Labor financial and tax policies are implemented post-Election 2019.
|POLICY IMPACT (savings over 10 years)|
|Franking Credits||$55 billion|
|Negative Gearing/Capital Gains||$33 billion|
|Trust Distributions (min. 30% Tax)||$22 billion|
|Superannuation Concessions reduced||$33 billion|
|Limit Tax Deductions||$6 billion|
|Top Tier Tax Rate 49%||$6 billion|
|Repeal income tax cuts for high earners||$122 billion|
|Source: AFR, Westpac Economics|