As we head towards the end of another financial year we move closer to entering tax season, where some will be rewarded with a refund while others will be disappointed with a “tax to pay” notice.
As an investor there is a lot you can do to make sure you fall into the more attractive category.
In terms of doing your personal tax return, keep in mind what you do and what the ATO may already know: over the years the ATO has built impressive technological capabilities to extend its tentacles into the deep and dark corners of your financial life.
Brendan Balasekeran of accountants BDO in Brisbane says: “The ATO collects data from a wide range of sources and continues to refine a sophisticated set of tools to identify and investigate tax risk.”
At present, the ATO has specific data about:
● Wages you earn;
● Interest and dividends you receive;
● Private health insurance details;
● Distributions from investments; and
● An idea of potential capital gains tax events.
What’s more, many people don’t realise the ATO also collects data about cars, horses, artwork, houses, boats, overseas transfers and receipts and other private assets you own.
ATO personnel feed this data into their risk matrix to understand if the incomes reported by taxpayers support the accumulation of the wealth required to own these assets and use this analysis as one tool in determining taxpayers to be reviewed.
So, let’s be clear, the idea is to do your tax smartly and efficiently and to engage with the system as expertly as you can manage — nobody wants an ATO audit, which will be expensive, time-consuming and potentially damaging to your reputation.
Sydney accountant Timothy Ricardo of Ricardo Accounting says: “Check your occupation code. If certain occupations wouldn’t have expenses that are being claimed at the extent that you’re claiming them … they are more likely to be audited if you mistakenly use the wrong occupation code.”
Also, when claiming any tax deduction, be aware of the golden rules of deductions.
First, have receipts (substantiation), make sure you have incurred the expense and it hasn’t been reimbursed and, second, make sure the deduction has a link with an income-earning activity … that’s what the ATO looks at when they’re auditing you.
No doubt you are already familiar with the basics of a good tax return, but I might add a few other items to your initial checklist.
• Claim everything you are entitled to — don’t forget any legitimate receipt or expense you have collected through the year;
• Don’t bother testing the ATO patience on items that we know are rejected in almost every situation. This would include clothing expenses for work (very rarely allowed) or travelling expenses related to investment property (this one-time allowance has been gone for nearly two years); and
• Keep the accounts for personal income and your self managed super fund entirely separate.
In terms of when is best to lodge your tax return, taxpayers must lodge their return by October 31 each year unless they are represented by a tax agent.
They then generally have until May 15 in the following year to complete their return.
However, lodgement before February will mean any tax is due for payment by March 21 whereas lodgement in April or May will mean a June 5 payment date. Balasekeran says: “We recommend lodging early only where tax refunds are owed to you or where the total tax payable is lower than previous years.”
For any diversified investor it might be sensible to take a look across your share portfolio to determine if there are stocks that no longer suit you.
With two weeks to go, there is still enough time to make some last-minute adjustments.
Balasekeran at BDO says: “As June 30 comes up, a common tax planning concept is to consider any stocks that are currently trading below cost and sell these to crystallise losses, which may then be used to offset other gains generated in the year.”
The key thing to watch here is that such a sale does not constitute a “wash” sale, which refers to where investors sell a share trading at a loss and then buy it again shortly into the new financial year — this can be done to minimise capital gains but, beware, the ATO is cracking down on this and it can determine that the tax loss created by the manoeuvre be denied.
Balasekeran adds: “If an investment is sold in June it needs to be demonstrated that there has been a search across all investments for a suitable replacement given the investor’s goals, risk tolerance and assessment of market opportunities. If after that search the stock that was sold in June appears to be the best opportunity to buy, you are more likely to avoid ‘wash sale’ problems with the ATO.”
If you have an investment property of any description there are always opportunities to grab by the end of the financial year.
The recent federal election outcome was a useful development since the ALP had a long menu of tax changes that were planned for property.
However, there has still been a gradual windback in recent years of property-related deductions.
The ATO has shown a keen interest in making sure property owners are only claiming legitimate expenses against rental properties in their tax returns. A recent audit showed nine out of 10 taxpayers misunderstood the rules and made mistakes when claiming property-related tax deductions.
Balasekeran says: “Historically, we understand some of these errors are from taxpayers looking to push the boundaries of what is acceptable. The ATO is looking to cut down on inflated or fraudulent claims and this will be a key focus area by the ATO. Holiday homes that are not genuinely available for rent are in the spotlight. The ATO has seen many examples of properties that are advertised at above-market rates, with taxpayers claiming the home was advertised for rent but no one rented it, and claiming costs of ownership as a result. Also, the ATO are more likely to look at taxpayers where there is no apportionment for private use of the holiday home.”
And, for all rental properties, the ATO takes a dim view on deductions claimed during periods the property is being renovated and not available for rent. For new investment property owners, be aware of claiming on initial repairs. If you buy a rental property and spend money restoring or renovating the property, those larger non-maintenance costs may be considered capital and add to the cost base. They are not allowed to be deducted against any rent derived in the year.”
Another area that escaped a bullet this year with the failure of the ALP to get its ambitious agenda across the line is trusts.
Nonetheless, trust structures are another area of interest for the ATO this coming tax season. The ATO is currently undertaking test cases of an old but underused anti-avoidance provision in relation to trust distributions.
Put simply, the risk arises where a trust declares a distribution to an individual but the cash representing the distribution is not actually distributed to the individual — simply, where low-income adult children or other non-working beneficiaries are declared trust distributions on paper, but never receive the money.
To mitigate the potential risk, you might consider implementing one or more of the following to evidence that a relevant beneficiary has true entitlement to their trust distribution in cash:
1: Transfer the cash distribution to the individual’s bank account for their use;
2: Pay the individual’s expenses directly from the trust’s bank account; and
3: Pay the individual’s expenses from another beneficiary’s bank account and keep a clear record of such expenditure.
If you fall foul of the trust rule and the Australian Taxation Office applies the anti-avoidance provision, the distribution may be taxed at the highest marginal tax rate instead of the marginal tax rate of the beneficiary to whom the distribution was made.
One last thing: almost every financial adviser has one big headache this year and it is in relation to life insurance — specifically, life insurance that investors rely upon inside a large super fund such as a retail fund or industry fund.
There has been a major effort to clean up this area and a genuine attempt to halt fees on inactive accounts through what is called the “protecting your super’’ program. There is a risk that investors lose their life insurance.
The problem centres on inactive accounts — defined as a super account that has not had a contribution for 16 consecutive months and has less than $6000 in funds inside the account.
To stop pension fund managers clipping fees on these accounts, there is a push by the government to close down inactive accounts — the plan is to send inactive accounts over to the ATO to manage from July 1. The issue is if you have an inactive account and you use it for life insurance, you absolutely must review your situation — either reactivate that account by putting in a contribution of any amount, or close the account down and sign up to a new provider for your life insurance.
All the major super funds are sending out correspondence on this issue, but there are always those who have changed address or changed email or simply do not read this sort of correspondence.
For any investor who might be exposed here, if your inactive account is to be closed, make a move.
Either make a contribution or log into your account and tell the fund you want to “keep my insurance’’ cover. Do it before July 1 … you have been warned.
James Gerrard is the principal and director of Sydney financial planning
By James Gerrard
The Australian Business Review
15 June 2019