|Summary: Plans by the government of Cyprus to levy a fee on personal bank account savings sent shockwaves around the world. Although Australia is far removed, government taxes here also take their toll on personal wealth. “Legislative diversification” may be one way to reduce a grab on your funds.|
|Key take-out: Regardless of which government is in power after September, expect more tax changes to help to fill the revenue-spending gap.|
|Key beneficiaries: General investors. Category: Portfolio management.|
Diversification, or spreading your wealth across multiple assets and investments to reduce risk, is a basic tenet of finance.
The phrase “Don’t put all your eggs in one basket” is a reminder of this, although perhaps we need to give credit to Ecclesiastes 3,000 years ago, who wrote in the Old Testament and Hebrew bible “But divide your investments among many places, for you do not know what risks might lie ahead”.
The recent confiscation and entrapment of wealth in Cyprus has raised concerns about what indeed lies ahead, and makes me wonder whether one day we need to think about “legislative diversification”? I’ll explain more on this concept, but only on the condition you understand the following:
- As a family wealth advisor, my job is to consider all future possible scenarios that might impact my clients’ financial security. While I worry about the state of global finance, the Australian financial system is sound and you have plenty of time to ponder – unless, perhaps, you have assets in peripheral European countries.
- Secondly, the quality of lifestyle we enjoy in Australia demands that we all pay our fair share of tax. Tax avoidance is an offence! However, on the subject of tax minimisation, Kerry Packer famously said: “Of course I am minimising my tax. And if anybody in this country doesn’t minimise their tax, they want their heads read, because as a government, I can tell you you’re not spending it that well that we should be donating extra!” (Click here to watch the video).
The debt-democracy disconnect
The current global financial problems arise from a single disconnect: debt and democracy don’t mix. Debt is a convenience that allows populist governments to spend beyond their means and to do so long enough until nearly intractable problems emerge later. For now, highly indebted governments like the US, UK and Japan can postpone dealing with these problems (including through money printing), but smaller and weaker peripheral countries can’t. Australia’s capacity to do so, were it to get into debt trouble, lies somewhere in between.
That the Cypriot government met with trouble and its banks failed was not surprising. What was surprising was the insistence that depositors “bail in” the failing Cypriot banks, and that “Eurocrat-friendly” bondholders were not to be initially punished. That all depositors were to be taxed also made a mockery of the European-wide deposit insurance scheme that was supposed to apply on deposits of less than €100,000. While the terms of the bail-in were adjusted and the pain was shared more fairly, we learned the European Central Bank’s “whatever it takes” promise to shore up failing European member states has limitations. That is, the richer northern European countries may not always be willing to “lend” support to their southern neighbours. In lieu of money printing, which the continental Europeans so far have been reluctant to embrace, individuals including bank depositors might expect to “bail in” a failing bank or sovereign.
Another consequence of the events in Cyprus may have been the recent dramatic fall in gold the price. After making its way up to a record level of $US1923 an ounce just over 18 months ago, the price of the precious metal went into a gradual decline – until just over a week ago. Suddenly, gold went into free-fall, with the spot price dropping 13% in two trading days – the sharpest slump in three decades. Why? There are numerous theories, but one of the chief suspects was the government of Cyprus (also see Alan Kohler’s latest Weekend Briefing) and other governments of the world now being forced to sell gold. I also have a time for the conspiracy theory that gold prices are being manipulated to weaken its position as a safe haven.
Is Australia immune?
Fortunately our challenges in Australia are far less severe than elsewhere in the developed world. However, if the federal government continues to materially spend more than current and new tax revenues raise, it is only a matter of time before we create our own debt-security problems. It’s not in the interest of populist governments to remind you of this, nor the pain needed to address this. In my opinion, regardless of which government is in power after September, expect more changes to tax laws seeking your help to fill this revenue-spending gap. Indeed, perhaps expect more changes from a Liberal government, which might feel more responsible about not increasing debt.
While it is wrong to connect the coincident introduction of new taxes in super in Australia with bail-ins in Cyprus, both prompt you to think about what is the most prudent way for you to allocate your wealth amongst different asset classes, countries and tax structures. This is especially so with growth assets that you intend to hold for the long term, as taxes like capital gains and stamp duty can make changing ownership prohibitive later if circumstances change.
A super tipping point?
While I am a huge fan of superannuation and expect it will always be a relatively better place to “shelter” your assets than through other structures, we may be at a tipping point where it may not be prudent to hold all of your assets in super. For the ultra-wealthy this isn’t a controversial statement, as limits prevent them from over-using super. For others, recent generous tax-free thresholds mean income of $18,000 for a single person under pension age and up to $58,000 for couples above this age, can be earned tax free. This equates to interest income on nearly $500,000 to $1.5 million based on a 4% deposit rate.
I used to say “don’t buy assets that might appreciate outside super, because you’ll pay capital gains tax that you could avoid by having them in super”. If recent proposals become law, I can no longer say that. In my opinion, the introduction of capital gains tax in superannuation also reduces the case for borrowing to invest in property in super – the relatively low deductibility of interest losses are no longer offset by elimination of capital gains tax.
For wealthy families, I used to be a big fan of consolidating wealth often into just two structures – a self-managed super fund for retirement savings and a family-trust for non-super “ordinary” money (and, for some, thirdly into a private charitable fund).
I wonder now with this new paradigm of thresholds on income whether it makes sense to spread your superannuation amongst multiple super funds, given possible implementation difficulties consolidating member information? Also, under current rules, having say two super funds would let you enjoy the deposit guarantee with the Commonwealth Bank twice rather than having to spread deposits amongst more banks, which up until 2011 could have included the Bank of Cyprus Australia. It is more likely you will benefit where you can equalise balances between members and minimise the taxable history of monies.
For assets outside of superannuation, perhaps it will become wiser to hold assets in multiple individual’s names rather than in one family trust. However, I would never recommend holding assets in other’s name for fear of loss, perhaps like Paul Hogan (click here), and nor in a child’s name unless you want to pay tax at an initial 66% tax rate. Incidentally, super funds are at the top of the list of the most regulated entities in Australia, followed perhaps by companies, and then other trusts. Note, if you feel it necessary to spread the ownership of assets amongst multiple entities, then it is necessary you spend more effort and money on administration, tax compliance and estate planning.
Asset allocation and a case for collectables?
Back in Cyprus, if you had €1 million in the bank, you likely would have lost more than half of it and could not transfer the balance out of the country. However, if you had an equally valuable Picasso painting, you still own all of it and could take it out of the country. This raises questions about asset allocation and whether we’ll see greater worldwide demand and price rises for collectables like blue-chip art, gold and other precious metals and stones, antiques, stamps and other items – including, maybe, rare share and bond certificates that I collect? There is evidence the prices of collectables are rising with these concerns (click here).
While you can sell a property in Cyprus, you can’t take the proceeds out of the country. Property is an immovable asset and, as such, worldwide it is a softer target for revenue-hungry tax authorities. Locally, investment and commercial property is the only investment asset in Australia that is taxed on its asset value, via state land and municipal taxes. Like all other assets, the net income from property and realised capital growth is taxed. So, by type of tax, property is the most taxed asset in Australia and perhaps the most vulnerable to further taxation. As for owning property offshore, like with most foreign investments made by Australians, expect to pay tax on income and a realised gain, but deduct a credit for foreign tax paid. While it makes sense to take steps to protect your purchasing power from a fall in the Australian dollar, choose carefully where you invest offshore in case you expose yourself to bigger problems.
It is surprising that Cypriot share investors were not targeted by that country’s wealth tax, except for those who own now worthless shares in the bankrupt banks. Through its CHESS system, incidentally, the Australian government knows the ownership of all shareholders and through co-operation with the unit registries it could easily tax the value of shares in a crisis. However, since that discourages foreign investment and upsets friends, governments don’t have a history of doing this.
Big brother is always watching
History suggests it is the depositors who are the easy target for quick money raids by desperate governments. With regards to other assets, through state revenue offices, your government knows the ownership of all property in Australia and can easily up the taxes on those. While I don’t believe the government knows the balance of your bank account, it probably could guess it from interest income reported, or it could just ask the banks. Note, while collectables are not heavily regulated, the sale of art worth over $1,000 now must be recorded and royalties paid (click here). Also, gold can only be purchased with identification (including from the largest gold retailer in Australia, the government-owned Perth Mint). In short, it’s not possible in the world of big data to be a money launderer or tax evader. So don’t even think about it.
I must admit to still being unsettled by the financial disaster that fell on many innocent savers in Cyprus, and apologise for going off topic wondering what one could do to prepare for that. As I mentioned, I suspect this isn’t a terribly relevant concern for most Australians. However, we live in interesting times despite what a lower price of gold might suggest.
Dr Doug Turek is managing director of family wealth advisory firm Professional Wealth (www.professionalwealth.com.au), and is a paid professional worrier.