Tax with Max: Avoiding a future tax on super

Preparing for Labor’s super policy, understanding franking credits and making changes to a margin loan.

Summary: Savers who are concerned about the Labor party’s proposal to tax super earnings above $75,000 may consider withdrawing some funds from super into their personal names. But a number of steps should be taken first: assess the likelihood that this proposed policy will become law, even out members’ balances and sell investments with large unrealised capital gains.

Key take-out: If a saver remains exposed to any tax after taking these actions, they could consider growth investments or tax advantaged managed funds. Also, if a super fund could earn 6 per cent on investments rather than the 3 per cent bank interest rate, even after paying a tax on income, returns would still be higher.

Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Avoiding a super tax

If super is taxed by the next parliament, after we have saved assiduously to be independent of government pensions, can a couple take out maybe $500,000 each into personal names? At 3 per cent interest that will generate $15,000 each. This should still mean we will be under the current minimum taxed personal income level for each individual and therefore not have income over $75,000 taxed in our SMSF.

Answer: Before taking any action you must first assess what the likelihood of this proposed superannuation policy is of ever becoming law. Given that this would be a policy that the Labor party must take into the next election, and that this would be the first ever retrospective change to the taxation of superannuation, it would be hoped that the policy is either dropped by the Labor party or they would fail to win government.

The other important consideration is that for a couple to have the income earned by superannuation pension accounts taxed, with an income earning rate of 6 per cent, the superannuation fund would need to have more than $2.5 million.

Before taking large lump sums out of superannuation, if this taxation of super fund pension income became law, there are a number of steps that should be taken. The first will be to even out members’ balances when one member’s account is considerably higher than another. The second will be to sell investments under the current tax system that have large unrealised capital gains.

If the size of a super fund would still leave a saver exposed, after taking these actions, there are a number of other strategies that could be used rather than just taking a super payout and earning bank interest.

After taking account of the low income tax offset an individual can earn just over $19,500 before paying any tax. At a 5 per cent earning rate a couple could withdraw $780,000 from superannuation and not pay any tax on the income earned.

One strategy would be to invest in lower income earning growth investments where the tax payable on capital gains can be managed. Another would be to invest in tax advantaged managed funds such as unlisted direct property trusts. These investments can have earning rates as high as 8 per cent with a high percentage of the income earned being tax-deferred.

Before taking any action in relation to the threat posed by this possible superannuation tax change you should seek professional advice to make sure that you will not be worse off. It is also important to take into account that if a super fund could earn 6 per cent rather than the 3 per cent bank interest rate, even after paying the 15 per cent tax on income over $75,000, the net after-tax earning rate would be 5.1 per cent.

Explaining franking credits

I have an investment company and have recently gotten into a discussion with my accountant about how a franked distribution from a trust should be taken up. I believe that my distribution should be exactly what is mentioned on the annual tax statement provided i.e. $100 franked distribution with $30 franking credits.

My accountant however is of the opinion that this distribution should be grossed up for its franking credits i.e. $130 franked distribution with $30 franking credits. I am unable to find any legislation or information surrounding this; would you be able to clear this up?

Answer: I do not believe that your accountant is correct. This is because income distributed by managed funds, as detailed in the annual tax statement, is what must be shown on the tax return of the investor. From an accounting point of view adjustments need to be made to arrive at the taxable income of your investment company. This is because of the differences between income actually received and taxable income that must be declared.

For example many managed funds pay income that is a mixture of franked income and capital gains, and in some cases foreign income can also be received. The process must be followed is the net profit of your investment company is reduced by the managed fund cash income received, and then this adjusted net profit has added to it the various components detailed on the annual tax statement, to arrive at the taxable profit.

As a part of this reconciliation process franking credits and credits for foreign tax paid are also taken into account. Unfortunately as the investment would be owned by a company all of the capital gain shown on the tax statement must be included without the benefit of the 50 per cent general discount available to individuals.

Making changes to a margin loan

I have operated a margin loan to fund a share portfolio for a number of years and claimed the interest as a tax deduction on the dividend income earned. I wish to sell a part of the portfolio and withdraw some of my equity. I have a vague recollection of reading somewhere that the amount withdrawn must be deducted from the loan value when calculating the amount of interest that can be claimed as a tax deduction.

If this is the case I don’t understand the reasoning as I am not borrowing the money for personal use but merely accessing my own money.  In reality all that is happening, is the total amount of the loan continues to fund the share portfolio but at an increased level of gearing.

A simple example would be a share portfolio of $600,000, with a loan of $300,000, results in gearing of 50 per cent. Sell $100,000 of shares, which is paid off the loan bringing it down to $200,000. With $500,000 of shares left, and a loan of $200,000, the gearing drops to 40 per cent. If I then withdraw $100,000 from the loan it increases to $300,000, and the gearing increases to 60 per cent. If I did this would I only be allowed to claim the deduction for the interest on $200,000?

Answer: Under taxation law the deductibility of interest paid is not dependent upon the asset used as security for the loan, but how the cash produced from the loan has been spent. In your example if the $100,000 produced from the sale of shares was paid off the margin loan, and then $100,000 was redrawn to fund private expenditure, the interest on that $100,000 would not be tax-deductible.

I do not believe that there is any taxation requirement that the proceeds of the sale of shares must be first used to pay down a margin loan. The only situation I believe this would apply is if the value of the shares is reduced after the sale to be less than the margin loan. Knowing the way that margin loans work this could not happen.

Effectively by selling shares that increases the gearing percentage an investor is only taking profit or repaying some of their own capital used when originally purchasing the shares. This means if an investor sold the $100,000 of shares, and the finance company providing the margin loan allowed the investor to use the full sale proceeds to fund private expenditure, the tax deductibility of the interest on their margin loan would not be affected.


Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs. Also go to www.smsfsurvivalcentre.com.au.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Max? Send an email to askmax@eurekareport.com.au