2019 is a new year for all of us and one in which all Australians will return to the polls to vote in a federal election. Politically, 2018 was a horror year for the present government, with over 40 consecutive losses in the opinion polls, a leadership spill, hypocritical and puerile antics from the Coalition’s partner, the National Party, along with two ex-leaders who seem determined to re-write history on their own administrations.
Given the antics of the Coalition it would seem that a Labor government is almost a forgone conclusion. Irrespective of Opposition Leader Mr Shorten’s poor polling individually, the Labor party are well ahead of the coalition in the two-party preferred, and are short odds favourites to lead the country later this year.
COMMENTARY ON POLICY
It’s important to note that most of the changes proposed by the Labor party are not law yet. Many of the proposed changes have been via public announcement only (legislation by media release). Election promises, as we all know, can and do change once the party is in office and it is highly unlikely that the Labor party will have control of the Senate, thus meaning that whilst Labor may propose to legislate many new taxation reforms, it will (likely) be significantly limited by the Senate. Many of the independent senators are more sympathetic to Coalition policies than those of the Labor party and “watering down” of proposed changes is common. So, bearing in mind that it is my opinion that the Senate will hinder Labor’s plans for taxation reform, let us explore the key “proposed” reforms.
NEGATIVE GEARING – RENTAL PROPERTIES
Negative gearing, for taxation purposes is allowing a deduction for losses incurred in owning an investment property and allowing the application of those losses as a tax deduction against ordinary or business income. This therefore reduces overall taxable income and, in the case of a salary and wage earner, often results in a cash refund of Pay as You Go (PAYG). This cash refund is used by the salary and wage earner to offset the costs in holding the property. Without this deduction and cash refund of PAYG, many investors would not be able to afford to invest. Key terms of the proposed Labor overhaul of negative gearing legislation are as follows:
- Restricting the ability of claiming negative gearing losses to new properties (“new” yet to be defined).
- Quarantining (but accruing) losses on a second-hand rental property until such time as the property yields a profit, at which point the losses could then be utilised.
- Reducing the Capital Gains Tax discount from 50 % to 25 % on rental properties.
Our overarching concern about removing negative gearing deductions in Australia relate to the economics of supply and demand. The last attempt to stop negative gearing was undertaken by the Hawke / Keating government in July 1985. This Initiative lasted a very short time and was repealed in 1987. Broadly, it resulted in Sydney, Melbourne and Perth experiencing double digit rental increases annually, and property value devaluation over this period. Ironically, the postcodes most likely to experience a rental increase if this happens again are Labor electorates rather than those held by the coalition, given higher percentage of owner-occupier dwellings in coalition electorates.
REFUNDABLE FRANKING CREDITS
Dividend imputation has existed in Australia since 1987 (a Labor initiative). The dividend imputation system works to eliminate double taxation on dividends. If a company make $100 profit, it would hypothetically pay 30% tax (assuming a large company) and have $70 leftover. When paying a dividend the company pays a nett cash dividend of $70 and passes on the franking credit of $30 with it. The taxpayer declares the dividend and the franking credit, grossing their income up to $100, with a franking credit of $30 attached to it. If the taxpayer therefore has an effective rate of tax less than 30%, they would get a refund of the difference between their tax payable and the $30 franking credit. It should be noted that this was not always the case and was a Howard-era reform in 2000. The proposed change would not allow this refund of excess franking credits.
In context, the Australian imputation regime is one of the most generous in the world with this issue being of critical importance to self-funded retirees. Many retirees having structured their entire retirement and investment strategy around refundable franking credits and income streams. It’s of less importance to individual taxpayers in receipt of other income, or not receiving pension streams as their income tax rates are higher than tax-free pensions. This is broadly seen as an attack on wealthy self-funded retirees who always vote for the coalition. It’s a vote winner for the Labor party and seen by many as a Robin Hood strategy.
TAXATION OF DISTRIBUTIONS FROM TRUSTS TO BE A MINIMUM 30%
Many businesses across Australia utilise service trusts and trading trusts in the running of their businesses. In a global context these Trusts are effectively fiscally transparent entities with profits having to be distributed to beneficiaries and taxed in their hands. The proposed taxation of trusts has been poorly articulated by the Labor party. Under current legislation if a trust were to distribute $18,000 to an 18 year old family member with no other income, the 18 year old would pay no tax on the distribution, as their taxable income is below the tax free threshold. Under the proposed regime the 18 year old family member would pay 30% tax on the distribution.
Labor do not and have never understood trusts. In our commercial experience most trusts operate within family businesses and distribute profits only within family groups; they aren’t a vehicle for tax avoidance and exist principally for asset protection and investment purposes. Trusts that own farms may be a carve-out. Practical solutions will likely present themselves to still make trusts worthwhile in family wealth and asset protection structuring, however one of our chief concerns is that this may create a legislative labyrinth that is unnavigable.
- Reducing the Capital Gains Tax (CGT) discount to 25% for assets acquired after a certain date.
- Super Guarantee Charge (SGC) on paid maternity leave payments.
- Banning borrowing for Self-Managed Superannuation Funds (SMSFs).
- Roll back company tax cuts.
- Limiting deduction for fees paid to accountants and tax agents for managing taxpayers’ affairs.
- Union access to workplaces.
- Attacks on Franchise operators.
- Death and estate taxes.
As you can see from above there are a raft of proposals from the Opposition most of which are squarely aimed at raising tax. As noted,the Senate will likely provide a very difficult pathway to approve legislation with the Opposition, assuming it wins the election, needing to negotiate any changes they want to make. Some of the proposals, in context of international reform, are highly likely to go through with little to no opposition, franking credit refunds and SMSF reform are two of these. With trust reform and other workplace reform it will likely mean the cost of running a business will increase, and compliance overlay for business will get ever more onerous. The most dangerous reform is negative gearing. Owning property is part of the Australian dream, it’s part of the Australian mind-set and most debt funding is dependent upon property ownership and being able to leverage that property. Tinkering too much with this aspect of the Australian property market could prove disastrous for renters, rental property owners, developers and employed Australians in the building industry along with making it much more difficult for Australian Banks to lend in the way they do now. The results of a constriction in lending would be disastrous so we hope further thought is given to more comprehensive tax reform rather than just blatant revenue raising.
Heath Stewart, CA, B.Com, M.Tax, CTA, Dip.FS (FP)
Chartered Accountant and Director