For investors, this year’s Federal Budget is one of the most consequential for decades.
The entire Australian investment universe literally changed in one fell swoop, with the result that there will need to be a lot of short- and long-term changes made to preserve and grow wealth.
Some of the old, tried and true wealth builders like negatively geared investment properties and family trusts have been crippled by tax in the Budget or at least made much less attractive.
So, to get our minds around the changes, let’s start with two rolled gold investments that have only become more important due to the forest of announcements.
Your Own House Rules Supreme
Unlike other forms of property investment, the principal place of residence (PPOR) or family home remains without peer—an untouched island of capital gains tax and land tax freedom amid a sea of tough-to-avoid, higher capital gains taxes.
From the smallest unit to the largest mansion, the PPOR sits on a pedestal with no capital gains tax to worry about and with the only negative being an inability to deduct interest costs.
You can even buy a bigger or better house than you need and then downsize it close to retirement and stick some of the profits into super as a downsizer contribution.
Which brings us to the other great opportunity left alone by this Budget—superannuation.
Super Shielded from Changes
While the capital gains tax base was effectively broadened through minimum 30% charges and concessions to be cut across the board, superannuation arrangements were left totally unchanged.
Capital gains tax remains quite low with a one-third discount within super and in retirement the payments are absolutely tax free—a dream scenario compared to just about everything else.
The only real negative is that everybody needs to wait to get access to their superannuation until reaching a condition of release—either retiring or reaching the age of 65.
Another consideration is the extra 15%-division 296 tax that applies to balances above $3 million, although that won’t apply to too many people.
The comparison between holding assets in super and other ways of holding assets is quite stark, as follows.
Family Trust Days Numbered
With around a million family trusts in Australia, it seems bold to predict their demise but many of the reasons for having one have been dissolved by this Budget and its 30% tax on all trust distributions.
Discretionary or family trusts will still have their uses for things like holding family farms or for estate planning but the days of aggressively using such trusts for reducing income tax are now really numbered.
That is particularly the case for the much spruiked use of bucket companies to scoop up extra distributions, given that there would be a 30% tax on the distributions on the way in and another similar tax on the way out of the company.
Expect to see a lot of re-organisation of trusts in the next couple of years as the past advantages in using trusts to distribute earnings to family members on lower incomes disappears.
Negative Gearing Changes
The changes to negative gearing on properties are a clear attempt to steer investment towards new builds – which can still be negatively geared – and away from existing buildings, which can’t.
Grandfathering existing negatively geared properties is probably a good idea to prevent a really large flood of housing on to the market, although it should be noted that the less generous inflation indexed CGT will start to apply proportionately over time to these investments.
In a further concession, investors buying newly built homes get to choose between the existing 50% CGT discount or inflation indexation when they sell the property, enabling them to choose whatever gets the best result for them for tax purposes.
This measure will probably work in stimulating more building over time but will leave high income taxpayers scratching their heads to find opportunities to reduce their tax bills.
Share Market Changes Will Hurt
While the Budget was framed in terms of inter-generational fairness, it was far from clear how younger generations are expected to save a deposit over a long period to finally break into the property market.
While property prices might grow more moderately due to the tax changes, using the share market as a vehicle to save for a deposit became less attractive through the CGT changes.
Interestingly, the Australian share market now shares the dubious distinction of offering one of the most generous tax treatments of dividends in the world through franking credits with one of the most onerous capital gains taxes on sales.
That may lead to a bias towards fully franked dividend paying companies such as banks and big miners and away from faster growing companies that hold the promise of potentially higher capital gains.
It may also lead to an increase of the home town bias towards Australian companies paying franked dividends and away from US and European companies that may offer lower yields but higher growth.
Still, I think that with the demise of many negatively geared property opportunities and the ability to negatively gear shares unaffected, this particular strategy could gain strength.
Also, the concept of holding a “forever” portfolio of dividend paying shares becomes quite attractive, despite higher CGT.
The Unexpected Tax Bite
Without doubt the biggest shock from the Budget for investors was the announcement of a 30% flat minimum CGT on all asset sales irrespective of actual income brackets in the tax year of sale.
Many retirees have built up share or property portfolios safe in the knowledge that they can gradually sell them down when retired and marginal tax rates are much lower than when they were working.
That strategy was literally blown out of the water by these changes, with capital gains built up over many years now to be treated more like income with a minimum tax rate built in even if they have no other taxable income to report in the same year.
That was the real inter-generational sucker punch delivered by the Budget, although there is surprisingly little in the way of a meaningful redistribution to younger generations in the form of lower income taxes.
How Will the Grown-Ups React?
The interesting thing to consider is how older generations will react to these changes.
Some might have a knee jerk reaction to sell while others might consider simply holding these investments forever, leaving the following generation to deal with the tax consequences when they eventually die.
Another surprising decision that didn’t seem to be leaked before the Budget is that assets bought before the capital gains tax was introduced on September 20,1985 will now be included in calculating CGT for the first time.
These assets – primarily property or shares – will now be swept into the CGT net for the first time from July 2027.
Time for Investors to Think Carefully
With such a large volume of changes to consider, it is important that investors think very carefully and get good advice as to their best way to navigate the changes.
Most of the changes include some time for alterations and restructuring to be made so knee-jerk asset sales or purchases are probably best avoided until the experts have examined the reformatted taxes in minute detail.
It is certainly a time to be alert and not alarmed by a lot of tax changes arriving in a hurry.
New strategies to build wealth will emerge and in some cases the tax to be paid on selling assets may prompt other strategies to release value including asset backed loans rather than a sale.
Thinking clearly and in a considered way has always been the key to long-term investing and if anything, these changes make that even more important.
