21 Feb 2011 | Capital Gains Tax
There are many options on how you own investments, if you make the wrong choice it can have a huge effect on how much after tax income is produced. Many people invest in their own name without a full appreciation of the tax consequences. Of even more concern are those that choose to invest through a company without a thought of the disastrous capital gains tax effect.
The first options involve the investment going into either an individual’s or in joint names as a couple. If borrowings are involved, such as with margin lending or the negative gearing of a property, the investment should go in the name of the person with the highest taxable income. By doing this the tax benefit of the negative gearing will be at its greatest.
The downside to this is when the investment is sold all of the gain will be made by the person again with the highest tax rate. There are tax planning measures that can be taken to reduce the impact of this, such as salary sacrificing the maximum amount, so the marginal tax rate is reduced for the capital gain.
Where the investment is placed in joint names the investment loss for the person on a lower income can be offset against other income. This can result in a larger dependant spouse tax offset. Also when the investment is sold half of the capital gain will be taxed at their lower tax rate.
Where a considerable amount is being invested, and there are going to be different investments, a discretionary family trust should be considered. A trust will cost approximately $500 to set up, if you use individuals as trustees, but is the most flexible and tax effective structure you can have. This is because it enables the income to be distributed among the family members. This means tax is paid at the lower tax rates for each individual family member.
The amount of tax saved by distributing to family members will depend on how many are over 18 or working full time. A family with a husband and wife and two children under the age of 18 will mean a trust is only marginally more tax effective than having investments in joint names. This is because non-working children under 18 can only receive approximately $416 and pay no tax.
If the children are over 18 and not working, possibly because they are still attending school or university, a trust can be very tax effective. For example a trust in this situation that earns investment income of $20,000 could distribute this to the two children and pay no tax.
It must be remembered that income distributed to children is rightfully theirs. To ensure that this does not create too large a loan owing to them costs, such as education fees, tax on income distributed, and car expenses, should be paid by the trust instead of the parents. By doing this the loan owing to each of the children will not keep increasing and there may even be a situation when money is owed back to the trust by the children.
Companies should be avoided to own investments. Many people have been drawn to a company structure in the mistaken belief that they would pay less tax. The truth is companies at best delay paying tax at the cost of more capital gains tax than necessary being paid. Companies do not get the benefit of the 50 per cent general discount that individuals get. When a trust owns the investment the individual beneficiaries receive the capital gain and thus get the 50 per cent discount.