Investment tax strategies

Minimising the tax you pay on investments is all about good planning
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  • Updated:3 Feb 2006


Below the following Tax investment strategies are discussed:

  • Make the most of your home
  • Share franking
  • Bonds and education plans
  • Split your income
  • Borrow to invest
  • Agribusiness or film schemes?

Make the most of your home

  • For most of us, the mortgage is still one of the biggest investments we’ll ever make and thankfully, it’s both tax-effective and provides some of the best returns you’re likely to receive.
  • It’s not subject to Capital Gains Tax if you make a profit when you sell, and if you play your cards right, you can use it to minimise your income tax on other earnings as well.
  • Making extra mortgage repayments can be beneficial, as instead of earning money, in the form of interest, it reduces the amount of interest you pay. Another investment needs to be paying 7% post-tax (or equivalent to your home loan interest rate) to provide the same net return. Very few investments can offer that without exposing you to significantly more risk.
  • Holding extra finances in a mortgage offset account or in a mortgage with a redraw facility (as opposed to a normal bank account) means you maintain flexibility and won’t have to pay income tax on interest that would have been earned. The money also works to reduce the principal of your home loan so you pay less interest.

Share franking

  • Shares can provide both capital growth and income so you may have to pay income tax on dividends and CGT on any profit you make when you sell.
  • You can reduce your end-of-year tax liability by investing in shares that pay fully-franked or partly-franked dividends, where tax has already been paid.
  • Dividends are fully franked if they have been paid out of the company’s profits on which tax has already been paid at the company rate of 30%. They can also be partly franked, where only part of the dividend carries franking credits.
  • Around 52% of companies included on the Australian Stock Exchange 200 Accumulation Index (the largest 200) pay fully-franked dividends.
  • Because the dividends have already been taxed, they will have a credit attached to them that you can offset against other tax liabilities. If your marginal income tax rate is lower than 30%, you will receive tax back, and if it’s higher, you will only be liable for the difference.

Bonds and education plans

  • If you have a long enough timeframe (10 years to get the full benefit) insurance and friendly society bonds offer some tax benefits. During the investment period, the company issuing the bonds pays tax on earnings at 30%, so you receive all earnings at the end of the period ‘tax paid’.
  • Investing through bonds is mostly useful for high-income earners (on rates above 30%), but they’re also useful for people on the 30% marginal rate because earnings don’t have to be declared as income during the investment period.
  • Education savings plans are another tax-effective investment structure. They can provide for your children’s or grandchildren’s education and, if the money is used for educational purposes, you generally don’t have to pay tax on the earnings.

Split your income

  • Income splitting is a useful way for couples to minimise tax and it applies to most investment options, from term deposits and debentures through to shares and property.
  • For simple investments, income splitting is making investments in the name of the person in the lowest income tax bracket. By doing this, earnings will be taxed at the lowest possible tax rate.
  • The opposite can apply if you gear (borrow) to invest. Hold negatively geared investments in the high income earner’s name so you are able to take better advantage of deductions at their higher tax rates.

How does it work?

Peter earns $30,000 pa and Mary earns $70,000. If Peter and Mary inherit a lump sum of $100,000, they’re better off making non-geared investments in Peter’s name so earnings will be taxed at his marginal rate.

That is, if their investments earned them $10,000 and were invested in Mary’s name they would be subject to tax at 42% ($4200 tax), whereas if they were made in Peter’s they would be liable for tax at only 30% (or $3000).

Conversely, if Peter and Mary decided to make a geared investment and were able to claim deductions of say $12,000 for interest or other costs, they would have tax reduced by $5760 if invested in Mary’s name, but only by $3600 if invested in Peter’s.

Borrow to invest

  • You might consider using the equity in your home to fund other investments.
  • You take out a loan using your home as security and purchase other property or shares with the borrowed money.
  • You may be able to borrow without using your home equity, via a margin loan or investment loan. With a margin loan the shares you purchase can be held as security and you may be subject to margin calls. With a loan for an investment property, the actual property is used as security by the lender.
  • The advantage of gearing to invest is that you can offset the costs of investing, including loan interest, accounting costs, bank charges and other related deductions against your other income tax liabilities to reduce your overall tax bill.
  • If your investment costs are greater than your income in a financial year, you’re negatively geared. This is only sustainable if you have enough income from other sources to cover the investment loan repayments and if the capital value of your investments is growing at a rate that would cover your holding costs, inflation, and the CGT payable on the investment when you sell.

If you can afford to, paying interest on an investment loan in advance prior to the end of the financial year can enable you to claim for that interest a year earlier than if you wait until after 1 July, so plan ahead.

Consider tenants in common

The way in which you hold an investment property, as specified on the title deed, determines how you must declare any income, and claim for deductions. It can pay to hold the property in one person’s name; or instead of owning it as joint tenants (with an equal share and equal deductions) you can purchase it as ‘tenants in common’, and claim the interest and costs in different proportions according to your marginal tax rates.

Agribusiness or film schemes?

  • Managed investments promoted as being “tax-effective”, such as agribusiness and film investments, have had a shaky reputation in the past but the industry has been cleaned up somewhat is recent years. They ‘re still generally high risk, but can have some tax benefits.
  • Invested money is used for a variety of purposes including specific agricultural schemes (such as growing trees or olives) or film production. Some schemes also borrow to pay for their film or agricultural enterprises.
  • Some schemes have long gestation periods so your returns will depend on the level of activity in the particular market (in olives, for example) five years into the future.
  • Assuming the investment goes well, you can be eligible for deductions as a primary producer if it’s an agricultural investment, or deductions under the film industry incentive scheme if it’s a film investment.
  • The Australian Taxation Office (ATO) advises that for a scheme to provide legal tax benefits, it must have a product ruling. Product rulings are the ATO’s way of letting you know that it has looked at the scheme, and as long as it operates as specified, you will get the available tax deductions (if it doesn’t operate according to the product ruling, you can lose the benefits). It doesn’t assess the likely performance of the scheme.
  • The area is also monitored by the Australian Securities and Investment Commission (ASIC), and companies have to meet the same disclosure, reporting and regulatory requirements as other companies offering financial products.
  • If you’re worried about a scheme that has been offered to you, ATO has a section on taxpayer alerts and information on class and product rulings. You should also ask the company to provide you with a copy of the product ruling for your records, and have it checked by your accountant.
  • As all legitimate schemes have to be registered with ASIC, it should have product disclosure documents, and information about the company should be available on the ASIC website.
  • Remember, taxpayers in Australia are responsible for their own tax returns being correct, so be wary of any advice you receive. Be wary of any scheme which sounds too good to be true, and make sure you don’t invest in anything solely for the purpose of avoiding tax. 

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