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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