© National Core Accounting Publications Chapter 28 Tax Planning © National Core Accounting Publications

© National Core Accounting Publications Overview Tax planning can be essentially defined as the process of organising a taxpayer's affairs within the law so as to minimise liability to tax Tax planning is only one aspect of the overall planning of a person's business and/or personal financial arrangements © National Core Accounting Publications

© National Core Accounting Publications Types of tax planning Tax planning arrangements may be classified into two categories: Structural planning Procedural (transactional) planning © National Core Accounting Publications

© National Core Accounting Publications Types of tax planning Structural planning Structural tax planning involves the consideration and selection of the type of business structure most suitable to the taxpayer to reduce overall tax liability e.g. sole trader, partnership, company or trust © National Core Accounting Publications

© National Core Accounting Publications Types of tax planning Procedural (transactional) planning Procedural tax planning relates to day-to-day decisions and planning in matters such as: the maintenance of records to ensure that deductions can be substantiated the valuation of trading stock at the end of the year the most tax-effective way of financing the business enterprise © National Core Accounting Publications

© National Core Accounting Publications Overview Tax planning requires a comprehensive and up-to-date knowledge of: income tax law - Statute law, case law, ATO rulings and practices corporations law accounting and business practices and conventions other commercial law © National Core Accounting Publications

© National Core Accounting Publications Terminology Tax Avoidance Tax avoidance is basically the organisation of a taxpayer's affairs so that the minimum tax liability arises whilst, at the same time, complying with the letter of the law (i.e. tax avoidance is legal) There are, however, a range of anti-avoidance provisions within the legislation © National Core Accounting Publications

© National Core Accounting Publications Terminology Tax Evasion Tax evasion is the non-payment of tax that would otherwise be payable if the taxpayer had made full and true disclosure of all assessable income and deductions In other words, not complying with the law © National Core Accounting Publications

© National Core Accounting Publications Terminology Tax Planning A further distinction is often made between tax avoidance and tax planning The difference is that whilst tax avoidance involves complying with the letter of the law, tax planning is concerned with both the letter and the spirit of the law i.e. the social and moral aspects as well as the strict legal application of the law © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Minimising tax liability can be achieved by: Reducing Assessable Income Increasing Deductions and Tax Offsets Reducing Rate of Tax/defer payment of tax Diverting Income Select the tax planning "vehicle" © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Reducing assessable income avoid receiving income by diverting assessable income to other family members “salary packaging” i.e. where taxpayers sacrifice some of their salary in return for employment related benefits which are not assessable income of that taxpayer, but which may be instead subject to Fringe Benefits Tax payable by the employer © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Salary Packaging Typical salary packaging arrangements involve wages or salary being sacrificed in return for benefits such as: Superannuation (because superannuation is not subject to FBT)   Concessionally taxed fringe benefits such as cars under the Statutory Formula method © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Salary Packaging Superannuation Concessionally taxed fringe benefits such as cars under the Statutory Formula method Benefits which are exempt from FBT such as tools of trade, portable electronic devices Expenses payment fringe benefits (e.g. child care costs, school fees or loan repayments) © National Core Accounting Publications

Salary Packaging and Superannuation A salary packaging arrangement for superannuation must satisfy all of the following arrangements for it to be considered as being “effective”:   There must be an agreement between the taxpayer and the employer. The arrangement must be made before the taxpayer is entitled to payment. There must be no access to the sacrificed salary amount. © National Core Accounting Publications

Illustration 1: Salary packaging and superannuation Lisa commenced a new full-time job on 1 July 2012 and was offered a remuneration package of $50,000 p.a. including superannuation. The package comprised $45,000 gross salary plus $5,000 superannuation.   Instead, Lisa negotiated an effective salary packaging arrangement with her employer where $5,000 of her gross salary is sacrificed into her complying superannuation fund, so that her gross salary becomes $40,000. Required: Comment on the tax implications of the salary packaging arrangement. Ignore effect of the Medicare Levy and Low Income tax offset. © National Core Accounting Publications

Illustration 1: Salary packaging and superannuation Solution: Lisa’s taxable income becomes $40,000 instead of $45,000, thus reducing her income tax liability by $1,625 (i.e. $5,000 x 32.5% plus Medicare Levy). The superannuation contributions would be considered employer contributions and, therefore, taxed in the superannuation fund at 15%. Therefore, Lisa has saved $1,625 less (15% x $5,000) = $875. © National Core Accounting Publications

Illustration 2: Salary packaging and superannuation In 2012/13 Ravi currently has a gross salary of $100,000 and makes personal contributions of $6,150 p.a. to his superannuation fund. He has adequate private health insurance.   Ravi is considering investing $10,000 p.a. into his superannuation via a salary packaging arrangement. However, he wishes to retain approximately the same take-home salary. Required: Calculate the benefit (if any) arising from the proposed salary packaging arrangement. © National Core Accounting Publications

Illustration 2: Salary packaging and superannuation Current Option (i.e. no salary sacrifice) Salary Packaging Option (i.e. elect to salary sacrifice) Salary $100,000 Salary sacrifice contributions nil $10,000 Gross salary $90,000 Income tax payable $24,947 $21,247 Medicare Levy $1,500 $1,350 Net salary after tax $73,553 $67,403 Post-tax superannuation contributions $6,150 Nil Take-home salary Superannuation invested Ravi’s contributions Employer contributions (9% under Superannuation Guarantee) 1. $9,000 $18,100 Total invested $15,150 less Contributions tax (15% of employer’s contributions) 2. $2,715 Net superannuation invested $13,800 $15,385 © National Core Accounting Publications

Illustration 2: Salary packaging and superannuation Notes: $100,000 x 9% = $ 9,000 $90,000 x 9% + $10,000 = $ 18,100 $9,000 x 15% = $ 1,350 $18,100 x 15% = $ 2,715 Conclusion: By entering into the proposed salary packaging arrangement and making his superannuation contributions from his before-tax salary, Ravi invests an extra $1,585 p.a. in superannuation after tax. In addition, he still retains exactly the same take-home salary. © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Increasing deductions and tax offsets contributions to superannuation funds negatively geared investments leasing or hiring plant donations to Deductible Gift Recipients undertaking approved research and development projects (if a company) maximising dependant tax offsets © National Core Accounting Publications

Negatively Geared Investments Negative gearing is the process where a person borrows money to invest and the costs of the investment are greater than the income received. Ideally, however, the asset would grow over time to add value to the investment. The most common investments that are negatively geared are real estate, shares and managed investment trusts. © National Core Accounting Publications

Negatively Geared Investments Tax Benefits Negative gearing is a strategy that provides immediate tax benefits while also offering the promise of long-term gains in the form of capital appreciation. © National Core Accounting Publications

Superannuation Co-contribution Amount of co-contribution For 2012/13 the maximum superannuation co-contribution amount that a taxpayer can receive is $500. This amount is reduced by 3.333 cents for each $1 of total income over $31,920. The co-contribution phases out completely where the taxpayer’s total income is $46,920 or more. © National Core Accounting Publications

Illustration: Calculation of Superannuation Co-contribution James’ total income is $40,000 of which more than 10% comes from his employment. Required: Calculate the maximum superannuation co-contribution. Solution: Therefore, his maximum superannuation co-contribution is: $500 – [($40,000 – $31,920) x 0.03333 = $ 230.69   If James contributes $200 to his superannuation fund, he will receive a superannuation co-contribution of $200 x 100% = $ 200. Alternatively, if James contributes $1,000 he will still receive a superannuation co-contribution of $230.69 (i.e. the maximum). © National Core Accounting Publications

How is the co-contribution claimed? A taxpayer does not need to apply for the superannuation co-contribution. If they are otherwise eligible, all they need to do is make personal superannuation contributions to their superannuation fund and lodge an income tax return. © National Core Accounting Publications

How is the co-contribution claimed? Superannuation Co-contribution Process ATO receives all information to calculate co-contributions. ATO makes payment within 60 days to the taxpayer’s superannuation fund. ATO provides written advice to the taxpayer. © National Core Accounting Publications

Accelerating Deductions Deductions can be maximised by ensuring that bad debts are written off before the end of the year of income. © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Reducing tax rates/deferring payment Derive franked dividends to benefit from the franking tax offset Taking advantage of the averaging provisions (primary producers, authors, inventors, sportspersons) Timing the derivation of capital gains so as to be eligible to use the 50% Discount method Maximising dependant tax offsets. Ensuring medical expenditures are incurred within one year. © National Core Accounting Publications

Delaying the Derivation of Income Methods of deferring receipt of assessable income include: • Adopting the cash method of accounting for income derivation. • Ensuring that pre-payments for goods and services are not assessable until the income has been earned. • Planning payments for long service leave or retirement benefits to fall due when assessable income is reduced. • Rolling over superannuation lump sums into Approved Deposit Funds (ADFs). • Deferring profit on forced disposal of trading stock or partnership reconstructions. • Selecting the lowest value for the closing value of trading stock. © National Core Accounting Publications

© National Core Accounting Publications Tax planning methods Diverting income Income splitting or diverting income from a "high-rate" taxpayer to a "low-rate" taxpayer is probably the most common tax planning technique used to reduce the average tax rate paid by a family unit. © National Core Accounting Publications

Transfer of Income-Producing Assets A high-rate taxpayer may transfer income-producing assets such as shares, rental properties, or cash to a low-rate taxpayer. © National Core Accounting Publications

Payments to Associated Persons Another means of income splitting is to contract with low-rate taxpayers for the provision of services, property or goods. It is important to ensure that, in such arrangements, payments made by the high-rate taxpayer are deductible. © National Core Accounting Publications

Select the Tax Planning “vehicle” Recipients of Diverted Income: Family members Family partnerships Family companies Family trusts © National Core Accounting Publications

Anti-avoidance legislation Specific provisions There are many sections of the income tax legislation that specifically target avoidance of tax e.g. sections 26-35, 26-55, 108, 109, 94, Division 6AA ITAA36, and the substantiation rules © National Core Accounting Publications

Anti-avoidance legislation General provisions Part IVA ITAA36 applies to avoidance schemes which are of a "blatant, artificial or contrived" nature. The term "scheme" is so broadly defined in it appears to cover almost anything done by a taxpayer that s.177A ITAA36 must be considered. © National Core Accounting Publications

Anti-avoidance legislation General provisions The taxpayer must have actually obtained a tax benefit in connection with the scheme A tax benefit arises if: the taxpayer escapes assessment on income, or obtains a deduction not otherwise allowable had the scheme not been entered into © National Core Accounting Publications

Anti-avoidance legislation General provisions Thirdly, the scheme to which Part IVA ITAA36 applies must have been entered into for the sole or dominant purpose of obtaining a tax benefit If it is found that Part IVA applies the ATO can cancel the tax benefit © National Core Accounting Publications

Anti-avoidance legislation General provisions Part IVA usually only applies to an arrangement if the answer is “yes” to the following questions: Was there a tax benefit from the scheme? Was the scheme entered into for the dominant purpose of obtaining that tax benefit? If so, the ATO can cancel the tax benefit © National Core Accounting Publications