Osobase M.

Ehizua
3481250
Tax Strategies in Financial Planning
TABL5527

Monday 19, May 2014

4000

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

Abstract
This research paper takes an in-depth analytical description of Australian personal
wealth accumulation vehicles from a legislative and tax strategy perspective. It
compares superannuation fund, negative gearing, residential housing and sale of
small business asset.
It considers the tax advantages of each saving vehicles. In particular it provide a
support to residential housing as a preferred retirement vehicle in terms of tax
benefits, It assess the benefit of investing heavily on residential housing, actively
managed small business, negatively geared investment. The modelled after tax
outcomes of these alternatives are compared with superannuation.
For the benefit of an appropriate comparison with non-superannuation structure
this research focus on the taxable component of superannuation fund and after tax
income, our analysis provides new benchmarks for evaluating how each of these
asset accumulations are taxed and put a price on the liquidity premium of
superannuation investments. While this paper acknowledged the favourable
taxation treatment of the four accumulation vehicle as Australian government
approach to encourage savings for retirement 1, we further provide critical
argument why they all should not be treated as the same, largely due to their
associated tax differences and unique features of each of the accumulation funds.

This paper does not constitute financial advice or guide to retirement

planning. We encourage you to seek your own professional advice to find out
how the Income Tax Act 1997 and other applicable laws apply to you, as it is
your responsibility to determine your obligations. Examples in this paper are
purely for illustration; they are not exhaustive and are not intended to impose
or imply particular rules or requirements.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

Contents
Abstract.................................................................................................. 2
Introduction............................................................................................ 3
Superannuation Fund............................................................................. 4
Sale of small business assets.................................................................6
Residential housing................................................................................ 8
Negative Gearing................................................................................... 9
Comparison............................................................................................ 9
Application Framework.........................................................................11
Recommendations............................................................................... 12
Conclusion............................................................................................ 14
Appendices.......................................................................................... 16
References........................................................................................... 16

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

Introduction
Personal wealth accumulation vehicles have taken various forms and reforms in
Australia largely due to regulatory and legislative changes in the taxation and
administration of personal wealth and the recent global financial crisis. This
reforms have influence the life cycle approach to investing. Each stages of the life
cycle of investing; accumulation; consolidation; drawdown; and gifting have an
expected lifestyle goal. Therefore, it is appropriate to allocate wealth to achieve
expected lifestyle goals with the best possible tax outcome.
This paper start with a discussion on the unique features of superannuation fund,
negative gearing, residential housing, and sale of small business asset in relation
to applicable tax, liquidity, flexibility, risk, returns and costs 2. The risk-return
relationship is a key component in the analysis of the expected returns of each of
the four investment vehicle. Earnings in investment are subject to various forms
of tax such as capital gain tax, income tax for sale of small business, residential
housing, negative gearing and earnings on accumulations of superannuation
funds. It further examined legislative provisions for tax treatment of each of the
2

Tax includes all possible tax implications such as income tax, capital gain tax,
franking credit, allowable deductions and offset. Liquidity refers to the time
and cost involved in accessing assets as cash or other used. Flexibility
consider the variability within an investment vehicle, risk reflects the volatility
associated with investment vehicles or assets, returns is the reward for an
investment, and costs involved expense relating to an investment vehicle.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

four personal wealth accumulations vehicle. In particularly, tax offset; allowable

deductions; Franking credit and tax concession.
Followed by a comparison of each of the investment vehicle and an analysis of
which funding vehicle is the better investment vehicle in terms of tax benefits. In
determining the better vehicle among the four accumulation vehicles we analysed
the vehicles using various investment scenarios with after tax income, and taking
into considerations applicable fees and preservation cost of superannuation
investment, residential housing, negative gearing and sale of a small business
assets using the Real Effective Tax Rates (RETR), Liquidity premium and
discount function analysis. It is of vital essence in portfolio construction to
consider the explicit and implicit cost an investment vehicle against its tax benefit.
In addition, we identify legislative provisions within the Income Tax Assessment
Act 1997 to justify the tax differences in the each of the investment vehicle.

Superannuation Fund
Superannuation fund is an investment structure which is commonly referred to as
a retirement saving vehicle. In addition to the Corporation Act 2001 the
Superannuation fund is administered in accordance to the legislative provisions in
the Superannuation Industry Supervision Act 1993 (SIS Act) and the
Superannuation Contribution Tax (Collection and Assessment) Act 1997.
Superannuation fund returns is determine by the fund asset allocation. The SIS
Act governs the way superannuation funds are invested and how assets are
allocated in order to protect members. Superannuation investment is considered to
be an illiquid-flexible investment3. Superannuation fund is illiquid due to it long
term time horizon and restriction placed by its preservation rule4, and flexible
because various assets class are available and investors can easily switch assets
around.
From inception, superannuation fund have been designed as a tax structure for
retirement savings that provides a tax heaven for retirement capital. The
regulation of Superannuation fund has gone through a series of regulatory
reforms. Prior to 1983, Superannuation experienced a very low tax rate 5. Then,
tougher tax regime was introduced in 1983 such as the deferred tax system on
individual savings, the change to accrual tax basis on contribution and income in
19836, and the introduction of superannuation surcharged in 1996 7; as a result of
these measures superannuation structure became unattractive.
In a drive to ensure superannuation funds meet its main purpose of providing tax
concessional retirement savings, the Government introduce the Better (Simpler)
Super Scheme which provided super changes in the areas of taxation treatment of
3

A. Young, Principles of Retirement and Superannuation; A Fundamental

Approach, International Institute of Technology, Melbourne, 2013, p.7.
4
The Superannuation Industry Supervision Act 1993
5
Tax on accumulation where tax on deferred basis, contribution received a tax
deduction and 5% of the lump sum was tax on retirement based on the
individual marginal tax rate.
6
Savings where tax at a rate of 15%
7
Contributions of high income earner where tax at 30%

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

superannuation benefits, flexibility and choice and improved incentives for

superannuation funds.
Taxation Rules for Superannuation
For superannuation funds to enjoy the tax concession benefits, it needs to be a
complying superannuation fund, to meet the status of a complying fund,
superannuation funds need to satisfy the sole purpose test 8. For the benefit of an
appropriate comparison with non-superannuation structure9 this research focuses
on the taxable component of superannuation fund.
Legislative provisions
Tax Laws Amendment (Simplified Superannuation) Act 2007 (9 of 2007) sch 1
pt 1 amending Income Tax Assessment Act 1997 div 292.
The simplified superannuation Act was designed to encourage people to save,
benefit from lower-taxes and long-term investment returns. 10 The Act was
formulated and assented to on the 15th march 2007 to amend the taxation of
superannuation sch 1 of the ITAA 2007. Sch 1 pt. 1 of the Act includes the main
superannuation amendment relating to Income Tax Assessment Act 1997 div 292.
Div 280 provides a guide to the superannuation provisions and div 295 provide
the provisions for the taxation of superannuation fund. Tax Laws Amendment
(Simplified Superannuation) Act 2007 (9 of 2007) sch 1 pt 1 amending Income
Tax Assessment Act 1997 div 292 applies to the 2007-2008 financial year and
later years11.
This act provides guidelines to taxation implication in superannuation fund, in
particular, how superannuation is taxed at accumulation phase. It will further
provide justification on the difference in taxes with other structures and valuable
insight to determine if superannuation is a better tax vehicle. The following
Divisions of the act will be particularly useful;12

div 290 relates to superannuation contributions and sets out rules for
claiming deductions and eligible tax offsets.
div 292 relates to excess tax for certain level of contribution above cap.
div 295 set provision for the taxation of superannuation fund
div 301 tax implication for superannuation benefit payment.

Superannuation tax table

Fund must be established and maintained solely for purpose of the provision
of benefits to members or their dependants in the event of retirement or
reaching the preservation age or death/Total and Permanent disablement.
9
Negative Gearing, Residential Housing and Sale of a small business assets
10
Mr Costello (Treasurer), Tax Laws Amendment (Simplified Superannuation)
Act 2007 (Ministers second reading speech made in - House of
Representatives on 7 December 2006 - Senate on 26 February 2007).
11
Tax Laws Amendment (Simplified Superannuation) Act 2007 (9 of 2007) sch
1 pt 1(2)(1-3).
12
Ibid sch 1 pt 1

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

The taxable component of the superannuation fund includes tax paid on earnings
and benefits. Superannuation funds are taxed at 15%, income offset by franking
credit and depreciation credit on accumulation phase and a 10% on capital gain
tax.

Sale of small business assets

According to the Australian Taxation office, a small business entity is a
business, partnership, company or trust with an aggregate turnover of
less than $20 million and the sale of small business assets results is
not more than a capital gain of $6 million net value. The sale of a small
business is considered a capital gains event (CGT) Events 13. Small
business assets include all assets across different assets classes. A CGT
event is when a capital gain or capital loss is made as a result of the
occurrence of a capital gains event. The Australian Government aims to
assist owners of small businesses grow and save for retirement. The
government provides small business owners concessions and CGT
Discount in the event of a capital gain. In the event of a capital loss, a
capital loss can be carry forward to reduce a capital gain in subsequent
years. These concessions are known as Capital Gain Tax (CGT) Small
business Concession. The Australia Taxation office provides guidance
for small business owners through it Advanced guide to capital gains
tax concessions for small business 201213.
CGT Discount
Capital gain tax discount is applied to CGT asset acquired at least 12
months prior to making a claim. The discount reduces a capital gain
made by small business owners by 50%14.
Small Business Concessions
In addition to CGT Discount, there are four CGT concessions available
to small business15. The CGT concession provides the means for capital
gains tax on small business to be reduced or disregard. These
concessions apply to CGT events that happen after 2 September 1999.
The small business CGT concession overrides the CGT discount when
the condition of sub div 152-B 15 year exemption rule is satisfied.
To be eligible for both the CGT Discount and Small business
concessions the following eligible test must be passed;
1.
2.
3.
4.
5.

CGT Events
CGT Asset
Small business entity test
Maximum net value
Active asset test

13

ATO, Advanced guide to capital gains tax concessions for small business
201213.
14
Ibid
15
Ibid

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

Legislative Provisions

Tax Laws Amendment (2011 Measures No. 9) Act 2012 amending Income Tax
Assessment Act 1997 subdiv 152-10.
This amendment offers tax reliefs through CGT concessions to small
business which are enacted in s 152-10 of the Income Tax Assessment
Act 1997. The Income Tax Assessment Act S152-10 provides basic
conditions that need to be satisfied in order to benefit from the tax
concessions.
The following subdivision contains guide governing various small
business concession; 16

Subdivision 152-B 15 year exemption rule

This provision provides total CGT exemption of capital gain for asset
owned for more than 15 years, and when the small business owner is
55 years old or older, and permanently retired or incapacitated.

Subdivision 152-B 50% reduction on CGT

Provides a 50% reduction of a capital gain

Subdivision 152-B retirement concession

Provides an exemption of capital gains up to a lifetime limit of

$500,000 for small business owners below 55 years of age, when the
capital gain is contributed into a complying superannuation fund or
Retirement savings account (RSA).

Subdivision 152-B rollover rule: Allows for capital gain tax to be

deferred for a period of 2 years or more, if a small business
owner acquires a replacement CTG asset or improved CTG asset.

Residential housing
Residential housing is one of the largest sources of capital accumulation for
retirement income. The rate of home ownership has remained stable due to the tax
concessions available to owner- occupied housing. Tax free returns like potential
capital gain and imputed rent17 makes owner-occupied housing a favourable
retirement saving vehicle. Generally direct property investments have remained
the least flexible among all other asset class and tax structure 18. Holding cost such
as interest and maintenance are not tax deductable.
Among other benefits, first home buyers benefit from Government first home
buyer grant, first home savers accounts (this has been abolished in the new
16

Income Tax Assessment Act 1997 s 15210.

Imputed Rent is the benefit to owner-occupier for not having to pay rent on
their dwelling.
18
The marketability, indivisibility and non-tax related transfer cost.
17

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

budget, effective from 1 July 2014), state government home purchase assistance,
are exempt from asset tests19
Legislative Provisions
Income Tax Assessment Act 1997 s 118105

This tax assessment provides the authority and conditions for tax concession on
residential housing. The act provides explicit definitions and special rules for
dwellings 118-115, ownership interest s118-130, and ownership periods s 118125.20

Negative Gearing
Negative gearing has been a widely acceptable tax structure for investment in
Australia. Negative gearing is derived from gearing strategy21 in relation to tax
planning. Gearing allows investors to access a larger investment which their
equity alone cannot acquire. Gearing is associated with high risk profile and
growth assets.
Gearing has the advantage of increasing returns. The level of gearing is
determines using the Loan to Value Ratio (LVR) 22. When the income from the
geared asset is below the holding cost of the asset it considered to be a negative
gearing. The loss from a geared investment is use to offset future gains or gains
from other source, in addition to imputation credit. Hence, is used as a means to
reduce income tax.
Negative gearing is commonly associated with investment property, capital
protected equity loans and tax deferral and pre-paid investments.
Legislative Provisions

Income Tax Assessment Act 1997 s 8-1

Section 8-1 of the Income Tax Assessment Act 1997 provides legislative authority
to the practice of negative gearing in Australia, and in particular, it includes
provisions relating to deductions for expenses incurred in earning accessible
income.

19

First home savers account are tax at 15% rate on earnings, a minimum of
$1000 for four years are required to be eligible and a yearly contribution cap
of $5000 and a lifetime contribution cap $75000 is allowed. Owners home
occupier benefit from government aged pensions and allowance as their home
are not consider for the Centrelink aged pension asset test.
20
Income Tax Assessment Act 1997 s 11810.
21
Gearing is the used of borrowed fund to invest in asset.
22
LVR = borrowed funds/Total Asset Value x 100.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

Comparison
Flexibility

Superannuation - Relatively flexible, because funds can be

moved within different asset classes.
Sale of Small Business - Sale of small business is relatively
not flexible as can take some time to sell a business, and owners
cant just easily change businesses due to cost associated with
the building of a new customer base etc.
Residential Housing - Residential housing is usually not
flexible in terms of what can be done with the funds already
invested in the residential property, but options include draw
down facility in terms of existing equity in the property or as
collateral.
Negative Gearing - This is a relatively broad concept, the
flexibility will be based on what the funds are invested in, usually
growth assets, and they can range from equities to investment
properties or a combination of assets.

Liquidity

Superannuation - Not liquid, legislation

preservation age, stringent exemptions apply.

Sale of Small Business - Relatively liquid as businesses can be

sold as a whole or broken down as the assets liquidated by piece
meal.

Residential Housing - Not liquid as it takes some time to sell a

property and it cant be sold by piece meal.

Negative Gearing - Again this depends on what the funds are

invested in, this will determine the relative liquidity of the
strategy.

to

hold

until

Tax rate

Superannuation - Taxed at 15 %.
Sale of Small Business - This will depend on the business
structure partnerships are taxed at marginal tax rates and
companies are taxed at 30%.
Residential Housing - Residential properties are not taxed and
they are usually exempt in in many asset based tax
assessments.
Negative Gearing - Taxed based on marginal tax rates

Tax offset

Superannuation - Imputation credit, depreciation credit,

allowable deductions.
Sale of Small Business - Imputation credit, depreciation
credit, and allowable deductions.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

10

Residential Housing - No tax offsets.

Negative Gearing - Imputation credit, depreciation credit
and, allowable deductions.

Cost

Superannuation - Very high cost - MER23 and Administration

fees, and cost of preservation Implicit cost.
Sale of Small Business - High operative Cost.
Residential Housing - Attractive cost and high associated
holding cost.
Negative Gearing - Cost attractive.

Unique features

Superannuation - Capped contribution and limited earnings

potentials.
Sale of Small Business - Includes instant asset write offs,
limited earnings potentials.
Residential Housing - It is exempt from most asset based tax
assessments.
Negative Gearing - It has a magnifying effect, it can maximize
gains, but in the same breath it can also maximized losses, and
its effectiveness will be based on the tax strategy.

Analysis Result
23

MER Management Expense Ratio.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

11

Our analysis uses after tax income to better compare the four investment options.
Residential, Sale of small business assets and Negative gearing start-up capital are
solely dependent on after- tax income with the exception to superannuation where
before tax capital are used for investment within the superannuation fund.
Our analysis assume the following;
1. After tax income are used to invest across the four investment vehicle
inclusive of superannuation.
2. Taxation concession are available to all vehicle.
3. All vehicle invest in growth related asset Property and equities.
4. The absence of market and legislative risk
5. Available tax offset deduction for holding cost and imputation credit is
5%
6. Investment timeframe is 35 years.
7. Returns on investment is 15% inclusive of 4% capital growth
8. Compound annually
9. Interest rate and inflation remain stable at 2.5%
10. Liquidity premium is 5%
11. Individual tax structure - Marginal tax rate of 45%
12. Taxes are brought forward
The result
Investment scenario.
John Abbot, 30 years old NAB associate director, invested $100, 000 across four
vehicle.
Superannuatio
n
up -$100, 000

startCapital
Total revenue
Incomes
Capital growth
Income Tax
CGT
Tax offset
Liquidity
premium
After
tax
returns

Sale
of
Business
-$100, 000

Small Residential
Housing
-$100, 000

Negative
Gearing
-$100, 000

$13,317,552.32
$12,784,850.23
$532,702.09
-15%
0%
+5%

$13,317,552.32
$12,784,850.23
$532,702.09
-45%
0%
+5%

$13,317,552.32
$12,784,850.23
$532,702.09
0%
0%
0%

$13,317,552.32
$12,784,850.23
$532,702.09
-45%
-45%
+5%

-5%

+5%

-5%

+5%

$11,319,919.47

$8,656,409.008

$12,651,674.70

$8,603,138.80

Our findings
Its interesting to know that for an individual like john residential housing may be
the better investment vehicle in terms of tax benefits even tho residential housing
do not enjoys various tax offset associated with other investment.
Liquidity premium

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

12

The concept of liquidity for most wealth accumulation vehicles is almost straight
forward. For superannuation, legislation and stringent release conditions make it
very illiquid. This means that the funds are generally only assessable upon
meeting those conditions. Sale of business is only relatively liquid, due to the fact
that the different underlying assets of the business will be of different asset
classes, and can be carved up and sold by piece meal, but selling the business as a
whole generally takes longer, therefore, further reducing its liquidity potential.
Residential property is illiquid because it takes a relatively long time to sell a
property, and unlike a sale of business parts of the residential property cant be
carved up and sold by piece meal making it more illiquid than sale of business as
a wealth accumulation vehicle. The liquidity of Negative gearing is not as clear
cut as the rest, the liquidity of this mechanism will depend on the investment
underlying the strategy, if the investment underlying this strategy is in shares or
equity or units for (property trust) then these investments are relatively more
liquid because of the existence of a relatively deep secondary market. If the
underlying investment of a negative gearing strategy is investment property then
this poses the same illiquidity problems as residential property.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

13

Conclusion
What the paper demonstrates is that owners-occupied housing have access to
taxation concessions for retirement funding on exactly the same terms or a partial
terms as Superannuation fund, Negative gearing and, Sale of small business asset
but stands differently in after tax retirement benefits to investors.
Most importantly residential housing have a modern flexible and non- restricted
access to retirement funding when needed compared to the locked in effect of
superannuation funds. It has a very unique investment features.
In general, the differences in taxation of the accumulation phase of each vehicle
are largely a function of available taxation concession and the time and rate at
which such concession is available. Largely, our analysis have conclude that the
income tax assessment act 1997 provides a clear justification for the differences in
taxation and raise the questions of why not all taxation concessions are consistent
with the goal of providing sufficient capital for retirement?
Our findings are not surprising, as the government have identified the excessive
benefits or rather tax loops hole of the uncapped earnings potential and taxation
benefits residential housing provides home owners. The recent budget and the
debate for capped concessions for residential housing have further strengthens our
findings. A detailed analysis of residential housing as the better private wealth
accumulation vehicle in terms of tax benefits is recommended.

References

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

14

A. Young, Principles of Investment Planning; A Fundamental Approach,

International Institute of Technology, Melbourne, 2013, p.7.
Australian Government, Australian Taxation office, Calculators and Tools, via
http://www.ato.gov.au/Calculators-and-tools/?sorttype=SortByTopic, viewed 07
April 2014
P. Costello, Treasurer, Tax Laws Amendment (Simplified Superannuation) Act
2007 (Ministers second reading speech made in - House of Representatives
on 7 December 2006 - Senate on 26 February 2007).
Tax Laws Amendment (Simplified Superannuation) Act 2007 (9 of 2007) sch 1
pt 1(2)(1-3).

Tax Laws Amendment (Simplified Superannuation) Act 2007 (9 of

2007) sch 1 pt 1.
Income Tax Assessment Act 1997 s 15210.
Income Tax Assessment Act 1997 s 11810.

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

15

Appendices
Tax analysis excel spread sheet

Osobase M. Ehizua; Tax Strategies in Financial Planning; Assignment 2

16