Originally published 16 November 2018
Written by Professor Bob Deutsch, CTA, Senior Tax Counsel
Written by Professor Bob Deutsch, CTA, Senior Tax Counsel
The Federal
opposition’s plans to introduce restrictions on negative gearing for investors,
if elected next year, have received some much-needed clarification.
opposition’s plans to introduce restrictions on negative gearing for investors,
if elected next year, have received some much-needed clarification.
Last week, I was
able to confirm with the Labor Party that their proposed changes to negative
gearing would apply across the board to all investments. Previously it was
thought that Labor’s negative gearing restrictions might only apply to property
investment.
able to confirm with the Labor Party that their proposed changes to negative
gearing would apply across the board to all investments. Previously it was
thought that Labor’s negative gearing restrictions might only apply to property
investment.
With this
knowledge, the Tax Institute issued a media release outlining the
good and bad news for investors.
knowledge, the Tax Institute issued a media release outlining the
good and bad news for investors.
Shortly after the
media release was issued, I received feedback from Member 372 (see below) who suggested
that “it is not the Institute’s business to act as spokesman or apologist for a
political party”.
media release was issued, I received feedback from Member 372 (see below) who suggested
that “it is not the Institute’s business to act as spokesman or apologist for a
political party”.
I thank
Member 372 for their comments. However, with all due respect to the
member, to suggest that by examining these measures, I am acting as an
apologist for the Labor party is no more accurate than to suggest that when
the Institute published
figures to show that the Coalition’s planned reductions in marginal tax rates
would give rise to progressive overall effective rates made me a Coalition
apologist.
Member 372 for their comments. However, with all due respect to the
member, to suggest that by examining these measures, I am acting as an
apologist for the Labor party is no more accurate than to suggest that when
the Institute published
figures to show that the Coalition’s planned reductions in marginal tax rates
would give rise to progressive overall effective rates made me a Coalition
apologist.
This week, I want
to examine some practical examples of how Labor’s restrictions on negative
gearing might operate if they were to be successful at the next Federal
election. In doing so, I make no political statement, either on my own behalf,
or on behalf of The Tax Institute.
to examine some practical examples of how Labor’s restrictions on negative
gearing might operate if they were to be successful at the next Federal
election. In doing so, I make no political statement, either on my own behalf,
or on behalf of The Tax Institute.
Labor’s proposed
measures
measures
So, to the
proposals themselves – after some interrogation of the Labor party, I have been
able to confirm that Labor’s restrictions on negative gearing will apply (after
a yet-to-be announced commencement date) to all investments and it will apply
on a global basis to every taxpayer. In other words, it will apply to property
and shares alike (and any other relevant asset classes) and it will apply by
looking at a taxpayer and assessing their overall investment income as measured
against their overall investment interest expenses.
proposals themselves – after some interrogation of the Labor party, I have been
able to confirm that Labor’s restrictions on negative gearing will apply (after
a yet-to-be announced commencement date) to all investments and it will apply
on a global basis to every taxpayer. In other words, it will apply to property
and shares alike (and any other relevant asset classes) and it will apply by
looking at a taxpayer and assessing their overall investment income as measured
against their overall investment interest expenses.
Both these points
are critical to an understanding of what is proposed, and while Labor has
previously hinted at both outcomes, I can now confirm that the policy design
will be precisely along these lines.
are critical to an understanding of what is proposed, and while Labor has
previously hinted at both outcomes, I can now confirm that the policy design
will be precisely along these lines.
What does this mean
for investors in a practical sense?
for investors in a practical sense?
Let me illustrate
what this means for investors with three examples.
what this means for investors with three examples.
Example 1 - Harry
After the proposed
commencement date, Harry, an Australian resident, borrows $500,000 from a bank
and uses the borrowed funds to buy an investment property in suburban
Melbourne. The interest rate is 5% per year and the net return (after all deductions
other than interest) will be 3.5% net per year. Harry is employed deriving PAYG
income of $200,000 per year but has no other investments, geared or
otherwise.
commencement date, Harry, an Australian resident, borrows $500,000 from a bank
and uses the borrowed funds to buy an investment property in suburban
Melbourne. The interest rate is 5% per year and the net return (after all deductions
other than interest) will be 3.5% net per year. Harry is employed deriving PAYG
income of $200,000 per year but has no other investments, geared or
otherwise.
Example 2 - Raylene
After the proposed
commencement date, Raylene, an Australian resident, borrows $500,000 under a
margin loan arrangement and uses the borrowed funds to buy shares in an
Australian listed public company. The interest rate is 8% per year and the net
return (after all deductions other than interest) will be 2% per year (being
the grossed up dividend yield). Raylene is employed deriving PAYG income of
$300,000 per year but has no other investments, geared or otherwise.
commencement date, Raylene, an Australian resident, borrows $500,000 under a
margin loan arrangement and uses the borrowed funds to buy shares in an
Australian listed public company. The interest rate is 8% per year and the net
return (after all deductions other than interest) will be 2% per year (being
the grossed up dividend yield). Raylene is employed deriving PAYG income of
$300,000 per year but has no other investments, geared or otherwise.
Example 3 - Suellen
After the proposed
commencement date, Suellen, an Australian resident, borrows $1,000,000 from a
bank at a 5% per year interest rate and uses the borrowed funds to:
commencement date, Suellen, an Australian resident, borrows $1,000,000 from a
bank at a 5% per year interest rate and uses the borrowed funds to:
·
buy a property for $500,000 which will return a net rent (before
interest) of 3%; and
buy a property for $500,000 which will return a net rent (before
interest) of 3%; and
·
buy shares in an Australian listed public company which will pay a
grossed-up dividend yield of 5%.
buy shares in an Australian listed public company which will pay a
grossed-up dividend yield of 5%.
In addition,
Suellen uses $500,000 of her own funds to purchase 5-year treasury bonds,
paying her an interest rate of 2% per year. (I assume treasury bonds will also
be an investment asset class covered by the negative gearing
restrictions?)
Suellen uses $500,000 of her own funds to purchase 5-year treasury bonds,
paying her an interest rate of 2% per year. (I assume treasury bonds will also
be an investment asset class covered by the negative gearing
restrictions?)
As everything takes
place post the commencement date, the restrictions on negative gearing will
need to be carefully monitored by all three of these individuals.
place post the commencement date, the restrictions on negative gearing will
need to be carefully monitored by all three of these individuals.
Harry and Raylene
will both fall foul of the proposed negative gearing restrictions as their interest
expense exceeds the net rent – in Harry’s case by $7,500 and Raylene’s case by
$30,000.
will both fall foul of the proposed negative gearing restrictions as their interest
expense exceeds the net rent – in Harry’s case by $7,500 and Raylene’s case by
$30,000.
Under current
rules, that excess could have been used to offset other income earned by Harry
and Raylene giving rise to tax savings of $3,375 for Harry and $13,500 for
Raylene. Under Labor’s proposals, the excess cannot be so utilised but must be
carried forward for offset in future years against future investment income or
capital gains from the disposal of the investment assets.
rules, that excess could have been used to offset other income earned by Harry
and Raylene giving rise to tax savings of $3,375 for Harry and $13,500 for
Raylene. Under Labor’s proposals, the excess cannot be so utilised but must be
carried forward for offset in future years against future investment income or
capital gains from the disposal of the investment assets.
Their position will
need to be looked at afresh every year as their circumstances may change. If,
for example, the interest rate falls and the rent rises, the previously
negatively geared property may become positively geared (or just less
negatively geared). In addition, they may buy new assets with better gearing
ratios, in which case the problem may again be reduced or even completely
eliminated.
need to be looked at afresh every year as their circumstances may change. If,
for example, the interest rate falls and the rent rises, the previously
negatively geared property may become positively geared (or just less
negatively geared). In addition, they may buy new assets with better gearing
ratios, in which case the problem may again be reduced or even completely
eliminated.
Suellen on the
other hand owns property bought with borrowed funds, shares bought with
borrowed funds, and bonds bought with her own funds. She will not have a
negative gearing problem. Her total interest expense is $50,000 but her total
investment income from the three sources is $50,000. She will be able to fully
utilise the losses which she makes through the negative gearing of her property
and share portfolio essentially through the positive gearing of the bond
portfolio.
other hand owns property bought with borrowed funds, shares bought with
borrowed funds, and bonds bought with her own funds. She will not have a
negative gearing problem. Her total interest expense is $50,000 but her total
investment income from the three sources is $50,000. She will be able to fully
utilise the losses which she makes through the negative gearing of her property
and share portfolio essentially through the positive gearing of the bond
portfolio.
To me, this is the
key to dealing with the proposed fallout from Labor’s restrictions on negative
gearing – management of portfolios in order to have regard to the restrictions
on negative gearing, will become crucial.
key to dealing with the proposed fallout from Labor’s restrictions on negative
gearing – management of portfolios in order to have regard to the restrictions
on negative gearing, will become crucial.
In addition,
purchasing properties in the name of the family member best able to manage any
negative gearing restrictions will also be vital.
purchasing properties in the name of the family member best able to manage any
negative gearing restrictions will also be vital.
In the next few
months, I will similarly analyse other Labor party proposals. If Labor is
successful, our members will then be well placed to deal with the new
environment that will apply under a Labor administration.
months, I will similarly analyse other Labor party proposals. If Labor is
successful, our members will then be well placed to deal with the new
environment that will apply under a Labor administration.
Finally, I should
add, that all this, while I believe it to be conceptually consistent with what Labor
has said, will depend very much on the detail of the legislation. Sometimes the
detail can surprise and can be inconsistent with the conceptual foundations
originally announced.
add, that all this, while I believe it to be conceptually consistent with what Labor
has said, will depend very much on the detail of the legislation. Sometimes the
detail can surprise and can be inconsistent with the conceptual foundations
originally announced.
