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NEWS - PLANNING
Never too early for tax planning
4/6/2006
Old-fashioned tax schemes have faded over the past few years but there are plenty of ways to cut a tax bill without attracting the ire of authorities. The art of tax planning is alive and well, even if the end-of-financial year hyperactive scramble for tax-driven financial products has died. It might only be March but anyone who leaves tax planning much longer is likely to miss out on the chance of a healthy return.
Even if you're just completing last year's tax return, take some time out to think ahead. If you're visiting a tax adviser to sign some papers, start talking to them about strategies for the current year, suggests Deloitte tax and superannuation partner John Randall.
Previously, sellers of tax products claimed they had a magic bullet to kill a tax "problem" but now it is acknowledged there is no special cure for tax bills. It's a more healthy belief given that many of the tax solutions of yesterday were challenged by the Australian Taxation Office and investors who had to repay tax.
"People who believed their tax bill could be largely wiped out through some exotic product-driven strategy were living in dreamland," PKF Australia's director of taxation, Lance Cunningham, says. Products that looked too good to be true often turned out to be just that.
Today, tax planning is more hard-nosed and, for individuals and family businesses, starts with the basics. In previous years, Smart Money has advocated a three-tiered tax strategy, an approach that is hard to go past for simplicity and effectiveness.
Tier 1 focuses on the basics such as including all the tax deductions to which you are entitled. Tier 2 looks at opportunities that are a result of your personal circumstances, perhaps the scope to claim tax-deductible superannuation contributions or offset capital gains on investments with capital losses. Tier 3 strategies revolve around financial products. Today, the main ones include rural schemes, margin loans, protected equity loans and instalment warrants. A close examination shows that the principal tax strategy in all these products is the same: the ability to pay 12-months' interest in advance and claim it as a deduction.
Some opportunities in tier 1 are often missed by the average taxpayer and tax practitioners. Horwath Tax Sydney director Les Szekely points to medical expenses as one example.
"For many, medical expenses may be their third- or fourth-largest annual expense, especially when you include the cost of pharmaceuticals," he says.
People who pay more than $1500 in doctor, dentist, optometrist and chemist bills for which they have received no health fund reimbursement, can claim a 20per cent tax rebate against the extra amount.
"If you crank up $3000 worth of unreimbursed medical expenses in a year, which is not hard to do for a family or those who are older, this could give you a $300reduction in your tax," Szekely says. You can't claim the first $1500 of unreimbursed expenses but you can claim a 20per cent tax rebate on the remaining $1500, which comes to $300. The challenge is having the receipts that substantiate your spending, especially at the chemist. If you make a donation to a charity, you tend to keep the receipt but how many people keep their chemist receipts? This is despite most people spending more on pharmaceuticals than on donating to tax-deductible causes. If you patronise one chemist, you may be able to identify past expenditure but it is more difficult to account for spending on medicines when you're away from home.
Cosmetic treatments are no longer able to be claimed as a medical expense, including facelifts that involve an operation. Other expensive treatments can be entitled to a deduction, such as laser surgery on eyes - a procedure that can cost more than $6000. Dental treatment to improve your smile may not be claimable - unless you can prove the treatment was necessary to correct your bite, Cunningham says.
These examples highlight that tax planning need not be exotic. Also remember that many exotic financial products, such as geared shares, agricultural and film schemes, involve an investment decision that is far more important than the potential tax deduction. As Ernst & Young tax partner Patrick Broughan points out, such investments come at a cost and carry the risk of capital loss. It is also important to work out if it is worth prepaying interest just to get a deduction. How much a deduction is worth depends on your personal tax rates.
If your taxable income is greater that $95,000 this financial year, you will pay the top tax rate of 48.5¢ for every dollar above that amount. If you prepay $10,000 in interest, you get a deduction of 48.5per cent of that amount, or $4850. The balance of $5150 will need to come out of your pocket. It will be income that is not available for spending and is thus a cost that must be earned by the investment to make it worthwhile. The top tax rate will rise to $125,000 on July1, so any prepaid interest should have greater clout this financial year.
The numbers don't work as well for lower tax rates. If your tax rate is 31.5per cent, for instance, $10,000 in prepaid interest will create a tax benefit of $3150. You will need to find the remaining $6850 for the investment.
Reproduced from the Australian Financial Review - 25 Mar 2006
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