franking credits tax

Minimising tax with franking credits

31 Mar, 2017

If you’re a shareholder with an Australian company, any dividends you receive will be classed as either ‘franked’ or ‘unfranked’. Franking credits indicate whether or not the company has already paid tax on the profits used to pay the dividends.

 

What are franking credits?

Franking credits (also called imputation credits) were introduced in 1985 to make sure that tax is only paid once on the funds, either by the issuing company or the shareholder.

If the company has already paid tax on the funds, this tax can be imputed to shareholders by way of franking credits attached to franked dividends. Shareholders may then offset this amount against any tax due on their assessable income.

Only franked dividends come with franking credits since unfranked dividends are still subject to tax.

 

How are franking credits calculated?

Franking credit values are calculated as follows:

Franking credit = franked dividend paid × company

tax rate ÷ (100% − company tax rate)

Although many companies have been enjoying a lower tax rate since 1 July 2015, the standard company tax rate of 30% should apply to this formula, meaning it can be simplified to:

Franking credit = franked dividend × 30 ÷ 70

To see how this works, let’s imagine that Sally receives a dividend payment from a company in which she owns shares on 15 February 2016. The payment includes a fully franked dividend of $700 and an unfranked dividend of $500.

Sally’s assessable income from this dividend for the 2015–16 tax year will look like this:

 

Unfranked dividend $500
Franked dividend $700
Franking credit ($700 × 30 ÷ 70) $300
Total assessable dividends $1,500

The franking credit counts as assessable income and must be included in your income tax return. Your marginal tax rate will apply to all of these payments but the franking credit can then be offset against any tax due. 

Once you have disclosed your income from franking credits the ATO will automatically include it in your assessment and apply the offset. This offset can be used to reduce the amount of tax payable on any form of income and from net taxable capital gains.

If your franking credits exceed your total tax liability, you won’t lose the credit amount but will instead receive a refund.

Continuing with Sally’s example, her tax assessment for the year including the dividend payment may look something like this:

 

Total assessable dividends $1,500
Other assessable income $78,500
Taxable income $80,000
Tax on taxable income $17,547
Add: Medicare levy (2%) $1,600
Less: Franking tax offset ($300)
Net tax payable $18,847

 

Should I buy franked or unfranked dividends?

When it comes to buying shares, you’ll get a better yield after tax from companies that pay fully franked dividends since you receive a 30% credit for the tax already paid by the company. If your income is below the minimum threshold of $80,000, your dividend payments are effectively tax-free. Of course, this should not be the only factor in deciding which company to invest your money in.

In order to be eligible for the franking tax offset, under the ’45-day holding period’ rule, you must continuously hold shares ‘at risk’ for at least 45 days (90 days for preference shares) around, and including, the ex-dividend date. Small shareholders are exempt from this rule, so it does not apply if your total franking credit entitlement is under $5,000, which equates to a fully franked dividend of around $11,666 under the current 30% tax rate.

If you wouldn’t usually be required to lodge a tax return but are eligible to claim a franking tax offset, you can complete the form Application for a refund of franking credits for individuals (NAT 4098).

 

To summarise:

  • Franking credits let you, the shareholder, claim an offset for any tax a company has already paid on dividends you receive (thereby avoiding double taxation on those funds)
  • A standard company tax rate of 30% is applied to a franked dividend to calculate the associated franking credit value
  • You must declare all dividend payments, including franking credits, as assessable income on your tax return, but the franking credit amount will be offset against any tax due (or, if the credit is greater than any tax due, you will receive a refund)
  • In this way, franked dividends provide a better post-tax yield than unfranked dividends, particularly if you’re in the lowest marginal tax bracket so don’t pay income tax

 

minimising capital gains tax

Minimising capital gains tax (legally)

29 Mar, 2017

If you purchased or acquired a property after 19 September 1985, any profit you make when you sell it on may be subject to capital gains tax (CGT). Any capital gains will be added to your taxable income and taxed at your marginal tax rate, so minimising capital gains tax is something most people are interested in.

CGT can add up to tens of thousands of dollars, so it’s worth doing some careful planning, particularly around the timing of your sale.

 

Calculating and minimising capital gains tax on a rental property

When calculating capital gains on a rental property, you first need to establish the cost base of a property. This is made up of:

  • the original purchase price
  • incidental costs associated with acquiring the property (such as legal fees and stamp duty)
  • incidental costs associated with disposing of the property (such as legal fees and real estate agent commissions)
  • improvements made to the property (less any depreciation previously claimed)

The cost base is subtracted from the capital proceeds on the property and any subsequent gains will be subject to CGT.

As an Australian investor, you many claim a 50% discount on any capital gains you make providing you have held the asset for over a year, so you may stand to save a lot by simply holding on to a property until the 12-month mark. This discount is not available to non-residents who hold taxable Australian property.

If you buy a property to renovate and sell straight on (as opposed to making money from it long-term as a rental property), even if you hold it for over 12 months it may be classed as a ‘profit-making scheme’ meaning it is not eligible for the 50% discount.

 

Ways to reduce CGT

Timing is everything when it comes to minimising capital gains tax.

If you are planning to sell a profitable asset, such as shares or property, consider postponing the sale exchange until the next financial year. This will give you an extra year to pay any CGT liability on the sale, meaning your money can earn interest for an additional 12 months until the payment is made.

Note that CGT is applied in the year that you exchange, rather than the year that you settle, so to make this strategy work you must exchange on the property after 1 July.

You should also consider your other sources of income when timing your sale. Since any capital gains are added to your annual income and taxed at the applicable marginal rate, you may be able to reduce the rate of tax on your capital gains by selling your investment property in a year when your income from other sources will be less, meaning you fall into a lower tax bracket. This is especially true for investors nearing retirement age who will soon be earning little or no income.

If you expect to make a capital loss, this can be offset against gains on other assets in the same tax year, so again you can play this to your advantage by timing it correctly.

 

Renting out a property you used to live in

There is no CGT to be paid when you sell your principal place of residence (the home you live in). It’s possible to claim this exemption for up to six years after you move out, even if you’re renting it out in the meantime, so this is a tax-efficient strategy that may work for some people. If you don’t sell your property within six years of moving out, CGT will start to apply.

If you have a granny flat in the back of your property which you rent out while you live in your home (or vice versa), the two residences will be treated separately for CGT purposes. You can only claim exemption on one of these as your primary residence, and it makes sense to do this on whichever property has the greatest potential for growth (probably the main house). You’ll need to work out whether the potential rental income is enough to offset any costs you’ll incur from income tax and CGT. For any periods that you occupy both residences at the same time, CGT will not apply.

The ATO’s Personal investors guide to capital gains tax (NAT 4152) has more useful information about CGT.

 

In short:

  • Capital gains tax (CGT) applies to the profits realised from the sale of property acquired after 19 September 1985
  • Any capital gains are added to your income for the year and taxed at the relevant marginal tax rate
  • For a rental property, CGT is calculated by subtracting the cost base of a property (which includes some legal fees and other costs) from the capital proceeds from the sale
  • Investment properties held for over a year receive a 50% discount on capital gains provided they’re not classed as a ‘profit-making scheme’
  • Timing your sale so you exchange at the beginning of a financial year means the CGT money stays in your pocket (and earns you interest) for longer
  • If possible, time your sale so it coincides with a year when your other income is low, so you fall into a lower marginal tax rate
  • Capital losses can be offset against gains on other assets in the same tax year
  • After you move out of a property you may rent it out tax-free for up to six years before CGT kicks in
  • A granny flat will be subject to CGT if you rent it out while living in your main house, and vice versa

 

trade support loans

Understanding the Trade Support Loans program

27 Mar, 2017

The Trade Support Loans (TSL) program started up in 2014 with the aim of encouraging more young people to commence a trade and complete their qualification.

Australian apprentices who are eligible for the program can receive a loan of up to $20,000 (indexed with inflation from 1 July 2017) spread over four years to help cover everyday costs as they complete their apprenticeship.

 

Eligibility for Trade Support Loans

There is no age restriction for applying for Trade Support Loans, but apprentices must:

  • reside in Australia and be an Australian citizen, or the holder of a permanent visa;
  • be undertaking a:
    • Certificate III or IV level qualification that leads to an occupation on the National Skills Needs List; or
    • Certificate II, III or IV agricultural qualification; or
    • Certificate II, III or IV horticulture qualification while working in rural or regional Australia; and
  • meet the eligibility criteria that is assessed by the Australian Apprenticeships Centre on receipt of a Trade Support Loans Application Form.

If you are deemed eligible, you may access up to $8,000 in your first year, $6,000 in the second, $4,000 in the third and $2,000 in the fourth year. If the lifetime limit of $20,000 is not reached after four years, up to $2,000 may be paid in subsequent years.

A 20% discount on the loan will be awarded upon successful completion of an apprenticeship.

 

TSL repayments

Just like HELP loans for tertiary students, you’ll start repaying your loan once you’re earning over a particular threshold. Repayments are made through the tax system, meaning your employer will withhold payments and final calculations will be based on your income tax return.

The repayment rates and thresholds are the same as those for (HELP) loans – for the 2016-17 income year that means a minimum repayment threshold of $54,869 at which point you must start repaying 4% of your income towards your loan.

The Trade Support Loans program is administered by the Australian Apprenticeships Centre and the Department of Industry. More information is available at www.australianapprenticeships.gov.au.

 

In short:

  • The Trade Support Loans program provides eligible Australian apprentices with a loan of up to $20,000 to help them through their qualification
  • To qualify you must be an Australian citizen or hold a permanent visa. The loan is only available for certain qualifications and you must meet other eligibility criteria
  • The loan will be paid in instalments over four or more years and a 20% discount is offered if you successfully complete your apprenticeship
  • The repayment structure is the same as with HELP loans – your repayments start once you’re earning over a certain threshold

 

employer superannuation contributions

Compulsory employer superannuation contributions

24 Mar, 2017

If you are employed by a company, you receive employer superannuation contributions, a mandatory payment made by your employer on your behalf into a complying super fund. These contributions are called superannuation guarantee (SG) contributions. They were introduced in 1992 and have, not surprisingly, resulted in a sizeable increase to Australians’ superannuation balances.

 

Your entitlement to employer superannuation contributions

Your employer pays SG contributions at a minimum of 9.50% of your ordinary time earnings, subject to limits set by the maximum contribution base. From 1 July 2021, the SG percentage will increase by 0.5 basis points each financial year until it reaches 12% in 2025–26.

The maximum contribution base puts a limit on the amount of super support that employers are required to provide to an employee each quarter. It’s indexed annually, but for the 2015–16 year employers only have to pay SG contributions on $50,810 of an employee’s salary per quarter (this equates to annual earnings of $203,240). Employer superannuation contributions may continue to be paid beyond this limit, but this is not a legal requirement.

Payments for employer superannation contributions are included in your concessional contributions cap. You may be allowed to choose which super fund these contributions are paid into, providing it complies with the ATO’s requirements.

 

Who is entitled to SG contributions?

You’re entitled to SG contributions from your employer if you’re 18 years or over and you earn at least $450 pre-tax in a month. Your employment status and resident status are irrelevant. If you’re under 18, you must be working over 30 hours per week in order to qualify for super contributions paid on your behalf.

If you’re a contractor paid wholly or principally for your labour, you’re considered an employee for SG purposes and the company you work for must contribute 9.5% on your behalf just as it would for regular employees.

Your SG contribution amount will be calculated according to your ordinary time earnings. This is the amount you earn during your ordinary hours of work, including allowances, bonuses, commissions and any over-award payments. Annual leave loadings, expense reimbursements and any overtime payments are excluded from ordinary time earnings.

 

Your employer’s responsibilities

Your employer must include information on your payslip which shows the next date they intend to make superannuation payments on behalf of employees, as well as the last date that contributions were paid.

If you have concerns that your employer isn’t contributing the right amount to your super fund, first of all you should check this with them directly. Unresolved queries can be escalated to the ATO, who may conduct an investigation into your employer’s affairs.

 

To summarise:

  • If you earn more than $450 per month pre-tax and are 18 or over (or under 18 and work over 30 hours per week) you can benefit from employer superannuation contributions. This means that your employer is required to make contributions to a superannuation fund on your behalf – these are called superannuation guarantee (SG) contributions
  • Employer superannuation contributions are currently a minimum of 9.5% of your earnings but from 2020-21 this percentage will increase incrementally to 12% in 2025-26
  • The maximum contribution base puts a limit on the amount the employer has to contribute – it’s currently capped at $50,810 of earnings per quarter
  • SG contributions are based on your ordinary time earnings – this is the amount earned during your normal hours of work but excludes annual leave loadings, expense reimbursements and overtime payments
  • Your employer should show on your payslip the date the last SG contribution was paid and the scheduled date for the next one
  • Any queries should be addressed with your employer but may be escalated to the ATO if unresolved

 

salary sacrifice superannuation contributions

Salary sacrifice superannuation contributions: what you need to know

22 Mar, 2017

One of the most tax-effective ways to build the value of your super fund is via salary sacrifice superannuation contributions. This involves an agreement with your employer whereby some of your salary is paid into your super fund rather than directly to you. If you earn over $18,200 (and therefore pay income tax of 20.5%), you stand to retain more of your earnings overall through a salary sacrifice contribution. Any money you put towards your super in this way will count towards the concessional contributions cap.

If you earn less than this, you’re better off taking your full salary and saving your money elsewhere as the 15% super tax rate applies regardless of your income tax bracket. You’ll end up paying 15% tax on money that would otherwise have been tax-free.

 

Benefits of salary sacrificing

A number of factors working together mean sacrificing some of your salary into superannuation is a great way to legitimately minimise the amount of income tax you pay. Here are some of the benefits:

  • super contributions are deductible for your employer
  • you’ll pay less income tax, potentially at a lower marginal rate, due to reduced assessable income
  • you only pay 15% tax on money you put into super, as opposed to your marginal rate which could be as high as 49%

 

Downsides of salary sacrificing

Of course, salary sacrificing doesn’t come without some negatives, too:

  • Your reduced salary will be used to calculate any super guarantee payments (although you may be able to negotiate otherwise)
  • The amount you salary sacrifice will count towards your employer’s super guarantee obligations, meaning the amount they are required to contribute themselves is reduced
  • A maximum of $30,000 ($35,000 for over 50s) can be contributed to your super each year at the reduced rate of 15%. The goes up to 30% if you earn more than $300,000
  • Any salary sacrificed amounts will count as reportable employer superannuation contributions – they are included on your payment summary and will impact the results of income tests for the Medicare levy surcharge and some government benefits
  • You generally can’t access your super fund until you retire
  • If a company is in financial trouble they may neglect to pay employees’ superannuation, potentially putting your money at greater risk

 

Making salary sacrifice superannuation contributions work for you

Let’s consider an example so see how this works in practice. Say that in the 2015–16 financial year, Liz and Sam both work at the same company earning $68,000 a year each. Sam decides to sacrifice $30,000 of her earnings into her super fund via a salary sacrifice superannuation agreement with her employer, but Liz opts out of any such scheme.

Here we can see how this decision impacts their assessable incomes for the year and the amount of tax they ultimately pay:

 

Example of salary sacrifice superannuation benefits

  Liz Sam
Gross salary $68 000 $68 000
Less super salary sacrifice $30 000
Assessable income $68 000 $38 000
Deductions $1000 $1000
Taxable income $67 000 $37 000
Income tax $13 322 $3 572
Medicare levy (2%) $1 340 $740
Tax on super contribution (15%) $4 500
Less: low-income tax offset $445
Total tax paid $14 662 $8 367

Source: © Australian Taxation Office for the Commonwealth of Australia.

 

You can see that in this example, Sam saves more than $6,000 in tax compared to Liz. Of course she also has considerably less to live on from her salary, but she’ll be grateful for it when it’s time to retire.

Although salary sacrifice is fairly straightforward to implement, make sure you do your sums first so you can be sure it will benefit you in your current situation. If your contributions exceed any caps in place you’ll end up paying tax at higher rates so there may be no value in sacrificing your salary beyond a certain level.

 

In short:

  • Having a salary sacrifice agreement with your employers means that you forego part of your salary and your employer pays it into your super where it will be taxed at 15% rather than your marginal income tax rate
  • If you earn more than $18,200 (and therefore pay income tax) you may stand to save on tax by sacrificing some of your salary (especially if this puts you in a lower tax bracket)
  • Any salary sacrificed contributions count towards your concessional contributions cap and your employer’s super guarantee obligations
  • There are limits in place on the amount you can contribute at the 15% tax rate. After this, the rate shoots up so it’s important to crunch the numbers for your situation to work out what’s best for you

 

 

personal services income rules

Understanding tax on personal services income

20 Mar, 2017

The personal services income (PSI) rules apply to contractors or consultants who earn the majority of their income for the labour they complete, as opposed to for materials supplied or tools needed to complete the work.

Whether you operate your business as a partnership, a company or a trust, you need to satisfy the PSI rules to avoid being personally liable for tax on income from the business. The rules may also affect the tax deductions you are eligible to claim.

 

Personal services income (PSI) rules tests

Results test

The results test determines whether your income was received after achieving a specific result or outcome.

To pass this test you must, for at least three quarters of the year, satisfy these three criteria:

  • your income is paid for achieving a specified result or outcome
  • to perform the work you provide the necessary tools and equipment as contracted
  • it’s your responsibility to rectify any defects in the work

 

The 80/20 rule

If you fail the results test, you can try with a second rule, called the 80/20 rule. To qualify under this, you can’t receive more than 80% of your income from one client and, in addition, you must meet one of these conditions:

  • your income is from two or more clients who are not connected or related (unrelated clients test)
  • in order to complete the work you employed or contracted others (employment test)
  • you used a separate premises exclusively for business (business premises test)

If you fail both of these tests you may apply to the ATO for exemption but this will only be granted in exceptional circumstances.

 

Non-PSI obligations

If you pass neither the personal services income results test nor the 80/20 rule you must:

  • pay any retained profits from PSI as a salary and wage to the individual who performed the services
  • comply with the additional PAYG obligations
  • include a completed PSI schedule with your tax return
  • not claim deductions against PSI – such as council rates, interest or rent for your home office, or payments to your spouse for secretarial work – since you are not entitled to them

 

To sum up:

  • If you are a consultant or contractor who earns more money from labour than from materials or equipment, you should check whether you pass the PSI tests
  • The results test determines whether the income was paid for achieving a specific result or outcome
  • The 80/20 test requires you to receive no more than 80% of your income from one source
  • If you fail both the tests you will be personally eligible for income tax and will miss out on some tax concessions

 

super co-contribution

Taking advantage of super co-contribution

17 Mar, 2017

The government put the super co-contribution initiative in place in 2005 to give low- and middle-income earners a hand with their savings. Perhaps it’s the confusing name that puts people off, but surprisingly few eligible individuals actually take advantage of what is, essentially, a chance to get some free money from the government.

 

What is super co-contribution?

Under the super co-contribution scheme, anyone earning under $51,454 will have their personal super contributions ‘topped up’ by the government. The exact amount of the co-contribution will depend on how much you contribute and what your income is, but it can be as much as a 50% bonus of $500 on a $1,000 contribution.

 

Who is eligible for a super co-contribution?

There are two income tests you must satisfy for the ATO to apply your super co-contribution:

  • the income threshold test
  • the 10% eligible income test

 

The income threshold test

The ATO will calculate your total income as your assessable income, plus reportable fringe benefits, plus reportable employer super contributions, minus allowable deductions. If this comes in under the lower income threshold of $35,454, any post-tax super contributions you make up to $1,000 will be matched at 50% by the government. This amount reduces by 3.333 cents per dollar you earn over the lower threshold, reaching the higher income threshold of $50,454 at which point you no longer receive a co-contribution.

 

The 10% eligible income test

The ATO stipulates that at least 10% of your total income (calculated as above) must come from employment-related activities or carrying on a business in order for you to be eligible. If all of your income is from share dividends and fringe benefits, for example, you won’t receive the co-contribution.

Let’s look at the example of Adam, who works as an employee. His assessable income, reportable fringe benefits and reportable super contributions come to $39,000 for the year. He makes personal super contributions of $3,000 during the 2015–16 year.

Adam’s co-contribution from the government will be $382, worked out like this:

$500 – [($39,000 – $35,454) × $0.03333]

He isn’t eligible for the full $500 since his income is above the lower income threshold.

In addition to these two tests, you must be under 71 years of age to be eligible for super co-contributions. There is no lower age limit as long as you satisfy the other criteria.

 

How do I claim a co-contribution?

You don’t need to do anything to claim the co-contribution, if you qualify, other than make your own personal super contributions and lodge your income tax return. As long as you make the contribution into a complying super fund and you don’t claim it as an income tax deduction, the ATO will automatically calculate and apply the co-contribution. Your super fund will be able to tell you how to make such a contribution, if you’re unsure.

Make sure your super fund has your TFN, otherwise you won’t be able to pay any personal super contributions. There is no additional tax to pay on these contributions.

 

Savings tip

Instead of scrabbling around for a spare $1,000 at the end of the tax year, plan ahead and ask your employer’s payroll department to automatically deduct $20 from your pay each week (or $85 each month) as a post-tax super contribution. This shouldn’t make too much difference to your spending but you’ll get to the end of the year and find you’ve already hit the $1,000 mark in super contributions.

 

To recap:

  • Under the super co-contribution scheme, low- and middle-income earners may receive a super contribution from the government when they make their own personal super contribution
  • The government will match a payment of up to $1,000 by 50% for people with income below $35,454, with the percentage reducing as income increases up to the higher threshold of $50,454
  • Your income is calculated as your assessable income, plus reportable fringe benefits, plus reportable employer super contributions, minus allowable deductions
  • At least 10% of your income must be from a business or employment-related activities for you to be eligible
  • To receive your co-contribution you just need to make personal contributions during the year and complete a tax return
  • Making regular weekly contributions of $20 will be easier than trying to find $1,000 at the end of the year

 

small business tax deductions

Small business tax deductions for home-based businesses

15 Mar, 2017

Many business owners, particularly in the early stages, will find great benefits in running their business from home. Flexibility, no travel time and extra small business tax deductions are just some of the things that make working from home an appealing prospect. It also negates the need to pay rent on office space.

 

Small business tax deductions

The following ‘running’ costs can be claimed as a small business tax deduction but you must first determine the business-related proportion of each one:

  • depreciation of furniture, fittings and equipment such as computers and desks used in your home office (small businesses may be able to claim the full cost of certain items under $20,000)
  • heating, cooling and lighting of your home office
  • home telephone
  • internet access
  • printer and printer cartridges
  • repairs to furniture and fittings in your home office
  • stationery

You may even be able to claim a portion of your mortgage interest or home rent as a deduction, according to the proportion of floor space used for your business. The ATO will need to see evidence that you genuinely operate a business from the property in order for you to claim these home-office ‘occupancy’ costs.

Read more about maximising your home office tax deductions.

 

Capital gains tax liability

In some cases, running a business from your home can cause the property to become liable for capital gains tax. If this is the case for you, it may work out cheaper in the long run to pay for a separate office space rather than face a big tax bill further down the line. You should consult with a tax adviser to check your personal situation.

 

To recap:

  • One of the benefits of operating your business from your home is claiming small business tax deductions on various expenses you incur
  • ‘Running’ costs such as depreciation, heating/cooling, internet, and stationery are tax deductible
  • You may be able to claim ‘occupancy’ costs for the portion of your mortgage interest or rent that relates to business use, but the ATO can be strict with these claims
  • Running a business from your property can mean you later have to pay capital gains tax, and this may end up costing you more than renting office space elsewhere. Consult with a tax adviser if you’re unsure how this applies to you

 

capital losses to minimise tax

Realising capital losses to minimise tax on investments

10 Mar, 2017

It’s no secret that you can reduce the amount of capital gains tax (CGT) due on any gains you make in a particular financial year by offsetting your profits with your losses on other investments. However, it’s not enough to simply complain to your friends about how poorly your investment portfolio is performing. In order for any losses to be deductible, they must be crystallised (or realised) – this involves you officially disposing of the asset. Let’s look at how you can realise capital losses to minimise tax.

 

Crystallising capital losses to minimise tax

Even if your shares plummet in value, you can’t claim any loss until the financial year in which you sell them.

As an investor you should keep a close eye on the market, particularly in an unpredictable environment, as you may well have the opportunity to reduce your tax liability on gains made earlier in the year by disposing of a few non-performing shares before the financial year end.

By way of an example, let’s say Christina sells some shares in July 2016 and makes a $6,200 capital gain. As it stands, that full amount would be subject to income tax (depending on her marginal rate). Later in the year, some other shares which she bought for $10,000 fall to $4,000 in value. If she sells those before the end of the financial year (30 June 2017), she can realise a $6,000 loss which reduces her capital gain to just $200 and makes her tax bill much more bearable.

 

Know your portfolio

Make sure you track the performance of your shares using a spreadsheet or some other program where you can see the cost base and market value of each element of your portfolio. This will make it easier for you to work out which investments are running at a loss and could be sold to offset any taxable gains.

Of course, if you have no taxable gains in the year then there is not such an incentive to crystallise any losses you are currently carrying.

Do be aware, though, that realised capital losses can be carried forward from year to year until they have been used in full. This means that if your losses are greater than your gains in a particular year, the excess loss amount can be applied to any gains the following year, and so on. Your tax returns will show you whether you’re still carrying a loss from the previous year.

 

Capital gains discount

Shares or other investments held for more than 12 months will be eligible for a 50% discount on capital gains before tax is applied. If you have a loss to offset against your gains, this will be applied before the discount.

So say you have a capital gain of $1,000 on shares held for over 12 months; this would usually be eligible for a discount of $500. But if you also have crystallised losses of $700 on another investment in the same year, this will be deducted from the gain first, meaning that the 50% discount only applies to $300 of your gain. Still, you will only have $150 of assessable income instead of $500.

 

Buying back shares

You might be wondering what’s to stop you from selling shares at a loss, realising the capital losses to minimise tax, and then buying them back from the company. Although there has been no official court ruling against this practice of ‘wash sales’, the ATO has warned against it since it could be considered an avoidance of income tax under Part IVA of the tax legislation. If found guilty of this you’ll be hit with some sizeable penalties.

In a scenario like this, if you’re concerned about balancing your portfolio, it would be more sensible to buy shares from a different company in the same industry. At the very least, purchase back a different number of shares from the number you originally sold.

 

In short:

  • You can offset capital gains tax (CGT) on any profits from your investments in a particular year by realising a loss on other investments
  • To realise (or crystallise) a loss, you must dispose of the asset – the loss is recorded in the financial year in which the disposal is completed
  • Crystallised losses may be carried forward to the next financial year and offset against any gains until fully utilised
  • Keep track of your share portfolio on a spreadsheet or other program so you can track your gains and losses and make the most of any offset opportunities
  • You can claim a 50% discount on capital gains from shares held for more than 12 months, but any capital losses must be deducted before this discount is applied
  • Selling shares at a loss for CGT purposes and then buying them back again – known as ‘wash sales’ – may viewed by the ATO as a tax avoidance measure and penalised accordingly

 

lending providers

Options for lending providers when sourcing a home loan

10 Mar, 2017

When it comes to choosing the right home loan, one of the big decisions you’ll have to make is which lender to borrow from. With so many different lenders now in operation it can be difficult to know where to begin, so let’s take a look at the different types of lending providers available and the pros and cons of each.

 

Banks and Building Societies

When you think about taking out a loan you might automatically turn to a bank or building society because these are considered transitional lending providers. These institutions have traditionally been the primary lenders for housing, and many of Australia’s major building societies have now become banks, meaning the proportion of home loans held with banks has increased further.  Since the deregulation of the financial system, there is very little difference between the ways that banks and building societies operate.

Before deregulation began in the early 70s, banks and building societies were obligated to lend at below-market rates, so they limited their loan funds, giving priority to customers who held substantial savings with them. At one stage, you were required to have saved a deposit of at least 25% to 35% with the bank if you wanted them to lend you money for a house purchase.

Fortunately the requirements have now relaxed, although the GFC instilled a greater level of caution in lending providers again. Interest rates are also experiencing a period of record lows, but as a borrower you must be prepared for these to alter at a moment’s notice. Expecting them to remain stable for the 30-year term of your loan would be foolish.

Banks and building societies now offer an innovative range of products and services, such as offset facilities and reverse mortgages, to suit a wide range of individual needs. These are covered in a lot more detail in a separate article here.

In this age of internet banking you may rarely set foot inside a branch any more, but it is still worth making an effort to get to know your bank manager. If you run your own business and hold business loans with the same bank, this may put you in a better position when it comes to getting a mortgage. There is also no harm in contacting your bank manager a few months, or even years, before you plan to take out a mortgage to find out what criteria will be applied when the time comes.

One benefit of borrowing directly from a bank or building society is that you should be able to obtain pre-approval on your finance, or even a certificate verifying that you have a certain level of finance approved. This can put you in a better bargaining position as it offers the seller peace of mind that the sale won’t later fall through because of your failure to obtain finance, so use it to your advantage to negotiate a lower price.

 

Mortgage Brokers

Gone are the days when in order to get a loan you had to make an appointment to see the bank manager and then humbly plead your case. Consumers have much more choice now, and lending providers are in fierce competition with one another.

If you’re not tied to a particular bank and want to get an independent opinion of the best loan for you, you may consider using a mortgage broker (more later on why you should take their ‘independence’ with a pinch of salt).

Mortgage brokers have access to a wide range of products through banks, building societies and other lending institutions. They usually work on a commission basis so you don’t have to pay a fee for their services but they make their money from the lender you eventually choose. This doesn’t cost the lender extra overall as they save money through not having to have so many staff in their branches (some may have no branch network at all).

In a market overrun with lending providers offering you all the products under the sun, one big benefit of using a broker is they can help you pinpoint the right product according to your situation.

There are many online comparison sites which can do some of this work for you, but they lack the specialist knowledge of an expert who can offer personalised recommendations.

For example, someone intending to buy a home but upsize after a few years would require a loan that is portable and comes with no exit fees upon payment of the debt.

A person hoping to buy a new home and keep their current one as an investment property might get the greatest tax benefits from a 30-year loan paired with an offset account.

In another situation, an employee may be considering starting their own business. A line of credit loan would allow them to leverage their existing salary before making the move to self-employment where it is much more difficult to secure finance.

Another thing that comparison sites lack is the ability to compare products inclusive of all fees; they often just compare the headline rate and perhaps one or two fees, but don’t allow you to make a fully informed choice.

Not always impartial lending providers

But while there are definite benefits to engaging the services of a broker, naturally there are downsides as well, mainly stemming from the fact that they’re paid on a commission basis. This may skew them towards the product they will earn the most from, rather the one that best suits you. They will also earn commission in proportion to the amount you borrow. If the computer shows two possible lenders, one offering a $150,000 loan and the other $250,000, a less-than-honest broker may push you towards the latter even if you don’t really need that amount.

To minimise your chances of ending up with a broker who’s acting more in their own interests than yours, make sure you look for someone who represents a broad range of lenders rather than just one or two. You can also ask them how they compare one lender to another. If they seem uncomfortable with this question, it may be a sign they’re concealing the truth.

 

The Bank of Mum and Dad

It’s no secret that it’s harder than ever for first home buyers to secure a place of their own because of soaring property prices. The government has made small steps towards helping young people buy a home, for example by introducing the First Home Owner Grant, but for many this just isn’t enough.

More and more hopeful homeowners are turning to their parents to help finance the purchase, and the banks, never wanting to miss out on potential customers, are now offering special types of loans that allow parents to act as guarantor for their children.

These loans have copped a fair amount of criticism since they often require the parents to re-mortgage their homes, meaning two homes are now at risk if things go bad. If parents are reluctant to put their assets on the line, relationships may get strained as the children feel like they are being unfairly held back.

Still, this kind of loan does have its place, so long as it is used in the right circumstances.

Helping them help themselves

It’s natural for parents to want to help their children get ahead in life, but putting up the security for a deposit isn’t always the best thing for either party.

First, you need to look at why the children are unable to secure a loan independently. It’s probably because of an insufficient deposit, lack of income, a poor credit rating, or any combination of the three.

If it’s down to bad credit, they need to get themselves a better record by learning some basic money management skills before parents should even consider getting involved as guarantors. Equally, if the children have insufficient income, it may well be because of other outgoings that need to first be addressed. Big credit card bills, for example, should be paid off before committing to a mortgage. A change in lifestyle may be required for them to free up some more cash to put towards repayments.

But if your child is merely struggling to gather together a deposit – particularly if they’re already paying rent – helping them out may not be such a bad idea. If they already have the money management skills in place but just need a hand up onto the ladder, you may be saving them a lot of money in the long run. You could, of course, help them out by offering them a rent-free spot back at home, but it’s quite possible that neither of you are particularly keen on that idea.

To illustrate the pros and cons of acting as a guarantor for your kids, here are a couple of examples:

In our first scenario, we have a young couple with secure, well-paying jobs. They spent the last two years working overseas and haven’t saved much as they’ve been making the most of the opportunities to travel, but now they’re back in Australia and serious about settling down. They have a great credit record and their salaries will allow them to make extra loan repayments.

They find a home that costs $400,000 and take out a mortgage for the full amount, securing $80,000 (20%) with a guarantee from their parents secured against the family home. They work hard to reduce the loan amount and after two years they’ve got their debt down to $360,000. The house has, meanwhile, risen in value to $450,000 so they have sufficient equity to for the bank to release their parents from their part of the loan. They’re now on the road to independence and their parents get a warm fuzzy feeling from being able to help.

In scenario two, we have a couple with reasonably secure and well-paying jobs, but who are terrible at managing their money. They have a car loan of $25,000 with three years left to pay and a $10,000 loan from a recent holiday. Their credit card debt is piling up too, as they only ever make the minimum repayments.

Even the most loving of parents would be silly to put their home on the line for this couple. They clearly need to get their finances sorted out first, otherwise the parents can expect a phone call from the bank asking them to hold up their side of the deal.

Parents in this situation should encourage the children to clear their debts and start saving for a deposit and only then, if it’s clear they’ve changed their ways, should the parents consider going guarantor on a home loan.

 

A summary of choosing between lending providers:

  • The traditional lending providers – banks and building societies – can offer benefits if you hold several products or accounts with them
  • They can also give you better bargaining power in the form of a loan pre-approval or approval certificate; this lets sellers know you have the loan ready to go
  • Mortgage brokers can help you find the right borrowing option from a wide range of lending providers and loan products
  • The downside is that they are not always completely impartial and may be swayed by the commission they receive
  • Many banks offer specialist products that let parents offer their homes as security against their children’s loans if not enough of a deposit is available
  • As both homes are then at risk, this should only be done in certain circumstances where the children already practise sound money management principles