One of the principles of a good tax system is that of “neutrality” which means that you should never have to consider tax consequences when making any investment decision.
As neutrality is not currently present in the Australian tax system it is imperative to take account of the tax implications when investing. So what factors should you consider when holding investments?
- Establishment costs
- Type of investments
- Family characteristics such as age, income and dependants
- Capital gains tax (CGT) when selling the investment
- Negative gearing
Stamp duty and capital gains tax can add substantial costs when transferring existing investments into a new structure. You should consider structure before investing as this has important consequences on your final tax position.
Owned individually or jointly
Holding investments individually or jointly can be effective for taxpayers who have no adult children for income splitting; are on the top marginal tax rate and intend negative gearing and/or prepaying interest on loans at year-end; and where asset protection is not a primary concern. Any capital gain on the sale of an investment (held for more than 12 months) is eligible for the 50% capital gains tax discount and is shared with your spouse (where owned jointly). Salary sacrificing rental property expenses can be highly effective in minimizing tax.
Because companies are taxed at a flat rate of 30%, holding cash investments in a company may be appropriate. However, because companies are not eligible for the 50% CGT discount (where assets have been owned for more than 12 months), they are not recommended for investments that will be subject to CGT.
Family discretionary trusts are a popular vehicle for holding investments. Trusts offer asset protection, the ability to distribute income to adult children, and provide discretion in the distribution of income so as to reduce tax. The 50% CGT discount applies to assets held for more than 12 months.
A disadvantage of trusts is that negative gearing losses are “locked” in the trust so taxpayers are not able to get an immediate benefit from any such loss. Franking credits are also “lost” where a trust is negatively gearing a share portfolio and incurs an overall loss.
Corporate beneficiary of a family trust
Establishing a corporate beneficiary (company) enables a trust to distribute to the company and be taxed at 30% rather than at top marginal tax rates.
In a self-managed superannuation fund income is taxed at 15% and offers significant asset protection, however they are not able to borrow to finance investments. Withdrawals from the fund cannot be made until retirement age.
It is always recommended that you consult with your tax advisor before starting any business.