High earners will avoid new tax “like moths to a flame”

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High income earners will be like “moths to a flame” and flock to avoid paying the extra tax rate, known as the temporary budget repair levy, that was introduced to the federal budget last night.

Those earning over $180,000 a year will now pay a personal tax rate of 49% for the next three years starting 1 July – a 4% increase from the previous top tax rate of 45%.

But advisory William Buck said it’s not so much the increase that’s the problem, but rather the created arbitrage between that and the company tax rate, which has been cut to 28.5% from 1 July 2015.

Tax director Greg Bonthorne told Wealth Professional that the differential between the two rates will now be 20.5%, up from the current 16.5%. He said this disparity will cause high earners to seek clever ways to decrease their bills.

“They’ll try and keep their funds inside companies or other structures. The very simple thing people will do is not pay dividends to themselves and not pay themselves until June 2017 [when the tax hike ends],” he said. “An arbitrage like that is ridiculous. It’s like moths to a flame - you won’t be able to resist that rate.”

Bonthorne said Australia hasn’t seen a similar disparity since the 1980s, but even then the government enforced the payment of dividends. He called this latest move “backwards”.

The most worrying potential consequence of the temporary budget repair levy is that the levy alone makes up 10% of the overall planned budget reduction.

“The government are trying to reduce the deficit by $30 billion over four years, and $3.1 billion of that is coming from this one measure,” Bonthorne said. “If we find dysfunctional behaviour it could make a real hole in that 10% because a lot of high net worth individuals will be able to legally defer.”

Furthermore, the new levy has had a terrible knock-on effect on the fringe benefits tax rate that applies to businesses providing extras like company cars, which has now also been raised to 49%.

This will likely have an impact on individuals making use of salary sacrifice arrangements regardless of their marginal tax, Bonthorne said.

“It’s slugging far more people than just those earning over $180,000 – it’s not just the rich being impacted, it’s anybody.”

Implementing broader based taxes, much in the way that the new fuel levy will function, is a far better solution and will raise just as much over the same time period but without arbitrage, he said.
 
Treasurer Joe Hockey has indicated that the reason the budget repair levy is temporary is in order to avoid the very deference that Bonthorne feels it will encourage.

“It seems the government is hoping that by saying it’s just a three year levy, the high income earners will just cop it. I don’t think they’ll just cop it.”

According to Bonthorne the decision also severely damages business confidence, especially considering the government promised to reel in red tape and increase certainty, but has done neither.

“They can call it a levy all they want, but it’s a tax, and it’s a broken promise,” he said.

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  • viewsxew on 14/05/2014 10:09:45 AM

    With due respect to the view expressed in this report, there are some provisions of the tax legislation that I thought might make some of the attraction to flame quite applicable: some of the hoards that are predicted to move in this way will expose themselves to be burned: and seriously.

    The 2% levy will cost a taxpayer on an income of $300,000 just $2,400 a year: any guess as to the cost of restructuring to avoid this levy? The implication is that there will then be a structure in place that will survive the three year restricted term - and in respect of 'its purpose' (avoiding the levy), will thereafter be redundant. What will the cost of unravelling the structure then be?

    May clear heads prevail as we work towards fixing the debt and deficit crisis that we risk bequesting to our children!

  • Jim on 14/05/2014 3:17:58 PM

    Not every high income earner operates their own private company -and would an extra $2,400 on an income of $300,000 really motivate one to make wholesale changes to their tax structures? I agree that this is a broken promise, but I think we might as well get used to that.

  • Innocent Observer on 14/05/2014 9:54:12 PM

    I agree with @viewsxew.

    Mr. Bonthorne's comments have a decidedly sensationalist tinge to them…. It reminds me of many discussions I have with accountants who are so focused on "day 1" tax benefits that they tangle their clients up in overly complex and expensive structures for little or no actual net benefit.

    Anyway, so what if a few businesses hoard cash for a few years to avoid a bit of tax? If that's the best they can do to "manage" tax I'd suggest they find another adviser.

  • Innocent Observer on 14/05/2014 10:02:28 PM

    This is one reason that I doubt the "rich tax" is going to trigger an avalanche of tax-dodgers….

    Say your client has the option of earning 4% on retained income within her business. If she is earning $280k p.a. but decides to defer $100k of her income for 3 years to avoid the "extra" debt levy, then after all is said and done, after 3 years she will end up with roughly $59,620 in her pocket after tax. By comparison, if she just "sucked it up" and copped the extra tax, she would end up with $51k today and would have the benefit of doing whatever she pleases with the money (she's ahead if her cash earned 5.3% or more, not to asset protection issues etc etc). For many of my clients in this category they (much to my chagrin) still have hefty personal debts (mortgages etc)…. makes it very easy to explain their options...

    I'm not sure what everyone else's experiences are with business owners, but personally the overwhelming majority I work with understand that "a bird in the hand is worth two in the bush": they'll happily cop a little extra tax for the sake of having the cash. Having seen many businesses fail over the years, I firmly agree with the prudence of this approach.

    Anyway…that's my two cents.

  • Bemused on 16/05/2014 10:58:12 AM

    A mature age worker earning a low income will do more 'heavy lifting' than someone earning $200k in terms of the proposed changes.
    A $200k earner will be $400 worse off, reduction of LITO and removal of MAWTO will see the person earning very little $645 worse off.

    Of course, this is assuming the $200k earner doesn't have an account or financial planner to partake in any of the many available tax deduction strategies.

    On a side note, the FBT correction to match is delayed by 9 months compared to the levy, giving the rich 9 months to partake in FBT benefits to avoid the increase of their tax.

    Sharing the pain... sure :/

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