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This month’s business quote which is particularly relevant to to small and medium business is:
“YOU GOTTA BE FIRST, BEST, OR DIFFERENT”
Budget Opportunities
Most readers would be aware of the Federal Budget Tuesday 9 May.
Commentary in relation to the budget announcements is contained within all of the major newspapers. We have therefore decide to instead focus on some of the opportunities that we feel would have appeal to our clients as a consequence of the proposed changes announced by the Treasurer in his budget speech.
Superannuation
It is proposed that with effect from 1 July 2007 that all drawings (pensions or lump sums) without limit will be exempt from tax. This announcement probably shocked most of the financial community as it was certainly unexpected and particularly generous. Superannuation funds earnings will continue to be exempt from tax in relation to member account balances supporting the pension drawings.
Ultimately, a reduction in the level of contributions that can be made to funds will arise:
• Undeducted contributions will be limited to $150,000 per annum;
and
• Deductible contributions (which will be deductible in full for both self employed persons and employers) will be capped at $50,000 per annum subject to some shading in provisions for taxpayers that are currently over 50.
Contributions can continue to be made up until age 75, which represents a relaxation of the rules as they currently apply.
Depreciation
With effect from budget night, the effective rate of depreciation has increased by one third. For example, a depreciation rate of 15% is now depreciation of 20% when the diminishing value method is used. Diminishing value is the most common method of depreciation and therefore for taxpayers (other than STS taxpayers) looking to acquire plant and equipment, the rate of which such equipment is written off has increased.
Personal Tax Rates
Although in the previous budget the government had already announced decreases in income tax for individuals, those changes have been scrapped and replaced with more generous concessions. Set out below is a comparison of the current tax rates with the rates that will apply from 1 July 2006:
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Relief For All
The New Tax Brackets
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Current Tax Thresholds
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Tax Thresholds from
1 July, 2006
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Income
Range
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Tax Rate (%)
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Income
Range
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Tax Rate (%)
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0-6000
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0
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0-6000
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0
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6001-21,600
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15
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6,001-25,000
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15
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21,601-63,000
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30
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25,001-75,000
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30
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63,001-95,000
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42
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75,001-150,000
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40
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95,000+
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47
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150,000+
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45
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If possible, deferral of income to later year may result in a permanent saving.
Reasonable Benefit Limits
As part of the sweeping changes to superannuation, the government has proposed that the RBL system applicable to superannuation payouts be abolished. As many clients would know, the RBL system as it currently operates limits the amount of lump sums that can be withdrawn at concessional tax rates to $648,986 and the amount of a member account balance supporting a pension that can be withdrawn and satisfy the conditions for a pension rebate to $1,297,886. For clients that are looking to soon retire, deferral of retirement until after 1 July 2007 is most likely to give rise to taxation savings. To qualify for the tax free withdrawal, it will be necessary for the recipient to be aged 60 or over. For existing pension recipients, it would appear that the government’s proposal is that no tax will be payable in respect of future pension drawings after the new regime commences.
Withdrawals for persons aged under 60 (which in a practical sense would mean persons between 55 and 60 as a consequence of the preservation rules) will be tax free up to approximately $129,000 and taxed at 15% thereafter. Pension payments for persons aged under 60 years of age but over 55 years of age will continue to to be taxed in the way that they are currently taxed. An illustration is set out below.
Example
John (age 60) has $800,000 in super (all pre/post 1983 components). He began working for his employer on July 1, 1975 and has not received any superannuation benefits in the past. The following comparison shows how much tax John would pay if he took his super benefit in cash this year versus making this withdrawal after 1 July 2007.
Cash out today
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ETP
components
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Tax payable
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Excessive *1
Pre-1983 *3
Post – 1983
Total
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$151,054
$168,179
$480,767
$800,000
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$63,189 *2
$3,658
$57,918 *4
$124,765
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Net benefit
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$675,235
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Cash out after 1/7/07
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Super benefit
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$800,000
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Nil
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Net benefit
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$800,000
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Saving
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$124,765
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By deferring the withdrawal of this super benefit until after 1 July 2007, John will save almost $125,000 in tax.
Notes:
*1 Assumes that the standard lump sum RBL ($648,946 for 2005/06) applies at the time of the withdrawal.
*2 The post-’83 portion of the excessive component ($111,907) is taxed at 39.5 per cent, while the balance ($39,147) is taxed at 48.5 per cent.
*3 Assumes that John pays tax at a marginal rate of 43.5 per cent (including a 1.5 per cent Medicare levy).
*4 Assumes that the post – ’83 low tax threshold ($129,751 for 2005/06) applies at the time of withdrawal.
The calculation of pensions will also be simplified. For a pension recipient aged between 55 and 65, 4% of the account balance is to be taken by way of pension. Between 65 and 75 the amount increases to 5% and to 6% for persons aged between 75 and 85. Again this represents a simplification of the pension calculation system and these amounts simply represent a minimum. Any amount above these amounts could be drawn.
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Capital Gains for Concessions
The limit on assets to gain access to the small business CGT concessions will increase from $5 million to $6 million. If you are looking at selling a business, deferral of the sale until the new rules apply (proposed to be 1 July 2006) may lead to reduced taxation.
Equally attractive is the proposal that the level of equity is an entity conducting a business that is required to be held to access these concessions is to reduce from 50% to 20%
Gearing Into Equities
With the reduction in the personal tax rates set out above a gearing strategy involving borrowing funds to invest in shares paying fully franked dividends has an increased taxation attraction from effect 1 July 2006 when the tax rates fall. If any of the strategies above are of interest to you or if you require any further clarification of any of the announcements you have heard about in respect of the budget please let us know.
Break for Students
Full time students can earn $6,000 tax free in the first year after they finish studying. Before July, students who finished studying halfway through the year would only qualify for half the tax-free threshold, or $3,000. The change also means students who receive distributions from family trusts will pay less than in the year they finish studying. It will cost $2 million a year.
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