Eliminate tax on investment scheme
The Australian Taxation Office (ATO) has opened the door for a new related party borrowing strategy within Self-Managed Super Funds (SMSF) that has the potential to eliminate income tax on the investment earnings of wealthy investors.
Many advisers mistakenly believe that borrowing in SMSFs is limited to the acquisition of property, and that the interest rate charged by a related party must be an arm’s length rate. This, however, is not the case. With the correct structure, SMSFs can in fact borrow to effectively acquire assets such as cash, term deposits and listed securities. Further, the funds can be lent to the SMSF without the requirement to pay interest.
“With the possibility of lending additional money to a SMSF without interest, our new borrowing strategy has the potential to completely eliminate tax payable on investment income,” says David McKellar, chartered accountant and director of Melbourne-based Allied Business Accountants.
“Take the example of someone who has $2 million worth of investments outside of super. Assuming an investment return of six per cent, this would be generating income of $120,000, with tax liabilities of up to $55,800 per annum.
“Depending on their age and circumstances, it may be possible to make non-concessional contributions of up to $150,000 per year into the fund. By bringing forward three years’ worth of contributions, you could pay $450,000 into the SMSF right now.” However, this still leaves more than $1.5 million in exposed outside investments with up to $43,245 payable in tax.
“If the remaining $1.5 million was loaned to the SMSF, it could use the loan to purchase an investment,” says McKellar. “The income from that investment would then be earned by the fund and concessionally taxed as such. If the fund is in ‘pension mode’, then the income of the fund is tax free.
“The result is no income tax or capital-gains tax being payable, and a tax savings of up to $55,800 per annum.