In the lead up to the federal budget and election, the Federal Government has shared pieces of its tax policy, while the Labor party has shared much (albeit without too much detail).
We expect most of the Government’s tax announcements to be released on the night of the federal budget (2 April 2019) to deliver maximum impact in the lead up to the election (May 2019).
We take this opportunity to consider Labor’s key tax policies, and what could they mean for our financial futures should Labor win the election.
The investment landscape will change
Labor’s three key tax policy announcements, which will affect post-tax returns on investments going forward, are:
- changes to negative gearing
- capping access to franking credit cash refunds, and
- reduction in the capital gains tax discount.
1. Changes to negative gearing
Currently, investors can borrow to fund their property investments or share portfolios, and broadly offset all the interest costs against income from the investments. If there are any surplus losses, these may be offset against other income, such as salary from a day job. Effectively income losses from investments are subsidised through the tax system.
There are existing tax rules that can restrict the use of losses from a primary production business, or other active business, against earned income, but these do not currently apply to losses from investment activities.
Labor proposes to restrict losses on negatively geared assets from offset against other income. The announcement is short on detail, but for assets acquired on or after 1 January 2020, the following changes will be made to the way losses can be offset:
- Negatively geared property losses will only be available for offset against other income if they arise from ‘new’ property
- Offset of losses from other investment activities and second-hand property will be restricted from offset against other sources of income.
However, there are significant unanswered questions in relation to this and until there is greater clarity we do not know how these loss restrictions will be implemented.
We do know that ‘new’ property investments will be excluded from the changes, however the type of new property is yet to be explained. Is new property ‘off the plan’ property only, or will it be applicable to redevelopments of existing land, for example?
Where will the losses arise from affected investments, will the rules operate to pool the losses from all investment activities, or will they restrict losses on an investment-by-investment basis? What income will the losses apply to – salary and wages only, or business income, or both?
With such uncertainty, it is very difficult for advisors to advise their clients on how to make future investment decisions. We suggest that investors should seek to evaluate planned investment or disposal decisions in conjunction with their tax and wealth advisors, taking into account views on the impact on the secondary market of affected asset classes.
2. Restriction on accessing franking credits
The imputation system was introduced in 1987 to avoid the effects of double taxation, where profits made by a company are taxed and then dividends paid to shareholders are taxed again. In simple terms, the system passes the tax paid by a company through to its shareholders as a ‘franking credit’, when those profits are paid out as a dividend.
If the company pays tax at 30 per cent, a top rate taxpayer will need to find an additional 24.29 per cent of the cash dividend to pay the top up tax. The interesting situation arises for taxpayers who pay tax at less than the company tax rate of 30 per cent, as they may be eligible for a refund of the difference from the franking credit.
Labor proposes to restrict the cash refund element of franking credits from 1 July 2019, which is expected to make big savings for the Treasury (estimated to be $6 billion per year and growing). However, there are significant concerns that the removal of cash refunds for charities and low or nil taxpayers will cause considerable hardship for those affected, particularly those individuals that are relying on income from their self-managed super fund.
To reduce the impact of the changes, Labor proposes to continue cash refunds to charities and not-for-profit institutions, as well as to certain pensioners who have self-managed super funds and who have been receiving a government pension since 28 March 2018.
This is a politically controversial area, so we will confine our observations to the following:
- Investors should discuss their investment management strategies with their wealth advisors to examine whether alternative assets classes will provide a better overall return now the tax system will not be subsidising future income needs
- Putting aside these investment considerations, investors may need to fund their income needs through selling capital assets (but noting the increased effective tax rate on capital gains going forward)
- Public or private companies with large franking account balances may choose to ‘front load’ dividends or share buy-backs into the 2019 income tax year so lower rate taxpayers can benefit from the cash refunds while they are still available.
3. Reduction in discount on capital gains
Investing in capital assets often carries risks which are different to those for earning income, and it is generally recognised that taxing capital gains that arise from inflationary increases only is unfair. Where assets have been held for more than 12 months, Labor proposes a 50 per cent discount on capital gains in recognition of these risk factors. Top rate taxpayers would therefore pay an effective rate on capital gains of 23.5 per cent.
Labor proposes to reduce the 50 per cent discount to 25 per cent for assets acquired on or after 1 January 2020, which means an effective rate on capital gains of 35.25 per cent for top rate taxpayers if tax rates stay the same.
Again, we do not yet received detail on the proposals, however we understand that existing assets owned before 1 January 2020 will not be affected, nor will the 33.33 per cent discount for superannuation funds.
While the small business capital gains tax reliefs are not being changed, it is appears the current additional 50 per cent discount available under these reliefs will be less attractive than previous, leaving 37.5 per cent of the gain taxable as opposed to 25 per cent.
It remains to be seen as to what effect this policy will have on the wider investment world over the longer term. While Labor’s policy aims to increase the supply of residential housing through reducing the tax subsidy on gains, there may be a longer term impact on other investment asset classes. A 50 per cent increase in capital gains tax liability, if a post January 2020 asset is sold, could mean decisions to sell these assets are postponed or not made at all.
Coupled with the proposed increase in the top marginal tax rate from 45 per cent to 47 per cent (plus 2 per cent Medicare Levy), the investment landscape may look very different going forward for those who have relied on favourable tax outcomes to boost income and investment returns. Bearing the gross costs of income loss making investments, an across the board 50 per cent increase in capital gains tax and loss of cash refunds topping up income, means a bleaker investment outlook going forward regardless of market conditions.
Contact Bentleys to discuss suitable investment strategies for you and your family, and secure your financial future.
This information is of a general nature only and neither represents nor is intended to be specific advice on any particular matter. Bentleys (Australia) Pty Ltd strongly suggests that no person should act specifically on the basis of the information contained herein but should seek appropriate professional advice based on their own personal circumstances. Although we consider the sources for this material reliable, no warranty is given and no liability is accepted for any statement or opinion or for any error or omission.