How to retire early... or simply survive

[Value Collector]

Why would a company pay tax on an expense? It's getting stranger and stranger.

Let me lay it out really easy; imputation is a form of dividend tax, not company tax. It's a tax on shareholders, not a tax on company profits. They're separate taxes that are, in very limited jurisdictions, related through imputation.

Look at it from the investors perspective.

Bond holder puts $100,000 of capital into a company
Share holder puts $100,000 of capital into company

Company has $200,000 total capital and it earns $12,000 EBIT.

It pays 6% interest to Bond holder = $6000, the bond holder pays zero tax.

It then pays $1,800 in company tax,

Share holder gets $4,200 in dividends.

Both the share holder and the bond holder contributed into the enterprise, however the bond holder can take his share of the output tax free, while the share holder pays 30% unless he can get a refund

 

[Junior]

Look at it from the investors perspective.

Bond holder puts $100,000 of capital into a company
Share holder puts $100,000 of capital into company

Company has $200,000 total capital and it earns $12,000 EBIT.

It pays 6% interest to Bond holder = $6000, the bond holder pays zero tax.

It then pays $1,800 in company tax,

Share holder gets $4,200 in dividends.

Both the share holder and the bond holder contributed into the enterprise, however the bond holder can take his share of the output tax free, while the share holder pays 30% unless he can get a refund

This is true.

There are other differences too. The shareholder owns a portion of the company, the bond holder does not. Dividends are a distribution of company profits, coupon payments are not - hence different tax treatment. The shareholder may benefit from a growing stream of dividends, and capital growth in the form of share price growth. The bondholder does not.

They are very different.

 

[McLovin]

Look at it from the investors perspective.

Bond holder puts $100,000 of capital into a company
Share holder puts $100,000 of capital into company

Company has $200,000 total capital and it earns $12,000 EBIT.

It pays 6% interest to Bond holder = $6000, the bond holder pays zero tax.

It then pays $1,800 in company tax,

Share holder gets $4,200 in dividends.

Both the share holder and the bond holder contributed into the enterprise, however the bond holder can take his share of the output tax free, while the share holder pays 30% unless he can get a refund

In such a hypothetical, I would take the debt. It's a no-brainer. Security over the company's assets and the same after tax return on my marginal rate with either debt or equity. If you know a real world example where this has happened, I'd love to see it. Dare I say, the equity would be trading substantially cheaper (so would the debt) than $100k, which is the difference between hypotheticals and the real world. But that was the point right? To create a hypothetical that is so removed from what actually happens as to make the current system look like a ruse on shareholders.

Of course the big thing for the equity investor is that the bond investor has no recourse to the equity investor's family home if the company can't pay. What's that protection worth?

 

[Value Collector]

In such a hypothetical, I would take the debt. It's a no-brainer.

You are missing the point, the point is both investors (bond holders and share holders) have their capital invested in the same organisation, Both could be in exactly the same situation otherwise, except the bond holder will get to keep their interest tax free, where as the share holder will have a minimum 30% tax on the productivity of his capital if he is not allowed to get a refund of the franking credit.

I ask the same question you asked here of company profits.

why should it pay no tax because it happens to be owned by a bunch of retirees? It's a for profit enterprise that uses all the public services afforded by the state (roads, rails, ports and on and on), relies on the education system to turn out a literate workforce, benefits from the rule of law and the enforcement of contracts

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I see no difference between a bond holder and a share holder, they are basically in partnership in the enterprise and just have a contract that lays out who gets what share of the companies earnings and how its calculated, one is taking a fixed interest and senior claim, while the other just takes whats left.

I can't see a reason why one should target the shareholder to have a minimum tax.

 

[Value Collector]

This is true.

There are other differences too. The shareholder owns a portion of the company, the bond holder does not. Dividends are a distribution of company profits, coupon payments are not - hence different tax treatment. The shareholder may benefit from a growing stream of dividends, and capital growth in the form of share price growth. The bondholder does not.

They are very different.

None of that means they should be taxed differently,

The shareholder owns a portion of the company

So does the bond holder, the share holder only owns the equity, the bond holder has a senior claim on all the companies assets, the share holder just owns what is left after the bond holder has been paid all interest and recovered their principle.

 

[McLovin]

You are missing the point, the point is both investors (bond holders and share holders) have their capital invested in the same organisation, Both could be in exactly the same situation otherwise, except the bond holder will get to keep their interest tax free, where as the share holder will have a minimum 30% tax on the productivity of his capital if he is not allowed to get a refund of the franking credit.

I ask the same question you asked here of company profits.


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I see no difference between a bond holder and a share holder, they are basically in partnership in the enterprise and just have a contract that lays out who gets what share of the companies earnings and how its calculated, one is taking a fixed interest and senior claim, while the other just takes whats left.

I can't see a reason why one should target the shareholder to have a minimum tax.

Both investors are paying 0% tax. The company's profit available to shareholders after it pays tax is $4,200. It is not paying tax on behalf of shareholders.

 

[Value Collector]

Both investors are paying 0% tax. The company's profit available to shareholders after it pays tax is $4,200. It is not paying tax on behalf of shareholders.

Thats just semantics,

The fact is the government taxes the earnings of the shareholders equity both at the company level, then again at the shareholders level.

If it doesn't allow franking credits to be used, the tax burden on people taking a capital position in a company via a shareholding is going to be unfairly higher than those taking a capital position via a bond holding.

 

[McLovin]

Thats just semantics,

I think it's more that you just don't like it because it doesn't fit into your world view.

The fact is the government taxes the earnings of the shareholders equity both at the company level, then again at the shareholders level.

What were you saying about semantics?

Companies are taxed, shareholders are taxed. Australia is the only country in the world that hands cash back at the shareholder level that was paid by a company. So every other country has the incorrect interpretation of the relationship between companies and their owners it would seem.

If it doesn't allow franking credits to be used, the tax burden on people taking a capital position in a company via a shareholding is going to be unfairly higher than those taking a capital position via a bond holding.

I won't hold my breath waiting for the stampede out of equities and into fixed interest if this change gets up. Was there a big rush into equities in 2000 from fixed interest when the change was implemented? I seem to remember it being a pretty bad year...

 

[bellenuit]

So remove dividend franking for foreigners.

Imputation Credits on franked dividends are only available to Australian tax payers.

 

[PZ99]

It's also worth pointing out that in the same year 2000 the 45 day rule was implemented where franking credits were forfeited if the shares were sold in that time frame.

I'll ask Bill Shorten to roll that one back

 

[Value Collector]

Companies are taxed, shareholders are taxed.

Yes, thats the problem. without a tax system that has some allowance for it, the same profits will be taxed twice.

once when the company earns the profits, and then again when it hands those profits to the company owners.

Australia is the only country in the world that hands cash back at the shareholder level that was paid by a company.

The other countries have lower rates of taxes for dividends.

USA for example only charges 15% tax on dividends regardless if they are a high income earner or not.

So that caps the tax on company profits to a little under 37%,

However, Australia has a higher company tax rate, and puts dividends onto the Marginal tax rate, which would means the company profits that hit a high income earners tax return ends up paying more than 60% tax.

I think a system that taxes the company profits at 45% on a high income earners tax return, while allowing the lower income earners to claim lower tax returns (perhaps even a refund) is fair.


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Any way I will leave the conversation here, as I have explained I see nothing wrong with allowing company profits that are paid out to flow through to the individual investors tax return and be taxed at whatever rate that is.

even if it means a low earner gets a refund.

 

[McLovin]

Yes, thats the problem. without a tax system that has some allowance for it, the same profits will be taxed twice.

once when the company earns the profits, and then again when it hands those profits to the company owners.

Double taxation does not happen under the current system, nor will it happen under the proposed reform.

However, Australia has a higher company tax rate, and puts dividends onto the Marginal tax rate, which would means the company profits that hit a high income earners tax return ends up paying more than 60% tax.

?

The other countries have lower rates of taxes for dividends.

So does Australia. The effective rate of tax is between 0%-~24% depending on the shareholder's marginal tax rate.

 

[Value Collector]

Double taxation does not happen under the current system, nor will it happen under the proposed reform.

Without franking credits it would though, thats my point.

So does Australia. The effective rate of tax is between 0%-~24% depending on the shareholder's marginal tax rate.

If it wasn't for franking credits, an Australian tax payer could pay up to 45% on their dividends, on top of the 30% company tax.

Meaning the a Company profit of $100 triggers a $30 Tax at the company level.

Then when the owner gets paid the remaining $70, it would trigger another tax of 45%.

Meaning that $100 of company earnings would have an effective tax rate 61.5% for the high income earner.

While the low income owner would have an effective rate of 30%, if he were no allowed to claim back his refund.

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either way I am not really interested in the discussion any more I have said my piece, I know you seem to think company profits are different, and should be separated from the taxes of the owners, but I just don't see it like that.

To me a company is just a conduit, I don't think the guy that mows my lawn under a company structure should pay more tax than the guy who mows my lawn as a sole trader, just because one chose to use the company structure.

I am fine with distributed profits flowing to peoples personal tax returns and being taxed there, even if that means a refund of some company tax to the low income earners.

 

[McLovin]

If it wasn't for franking credits, an Australian tax payer could pay up to 45% on their dividends, on top of the 30% company tax.

More hypotheticals. I don't see anyone on here suggesting franking be scrapped.

 

[sptrawler]

Oh Bill, but when you run out of capital then you can get the aged pension

Its a scary proposition eating into the capital, its like giving up part of your security blanket especially with the unguaranteed returns shares offer...but they suggest the capital is meant to be consumed during retirement, not passed on as part of ones estate.

You really think the pension will be in the form it is now, when everyone is on it?
That is very unlikely, as has happend to the qualification age for seniors cards, the whole pension handout will be reviewed.

 

[willy1111]

You really think the pension will be in the form it is now, when everyone is on it?
That is very unlikely, as has happend to the qualification age for seniors cards, the whole pension handout will be reviewed.

It was tongue in cheek, hence the smiley face afterwards.

I have no idea what the future rules will be with regard to the age pension. At a guess I would say the country couldn't afford it as it is now at some point in the future, as you say it will be reviewed and further means tested or the qualifying age most likely pushed out further, or they will need to raise more taxes and will probably go after the tax free Super pensions after age 60 for self funded retirees.

I can almost hear Shorten now, these self funded retirees with all this money in Superannuation are receiving a tax free income for the rest of their lives, this could be another 10-40 years of not paying income tax. This loop hole being rorted by the rich (Shortens term for anyone with assets of more than a $100k) needs to be stopped now. That will be Shortens next tax grab. I really hope he doesn't get into power.

 

[Wysiwyg]

The Super fund numbers will add up quickly for people nowadays forward with higher average wages and the minimum contribution goes higher to 12%. The inflation bogey inescapable. Ultimately aiming for as many self funded retirees as possible.

 

[tech/a]

When inflation does come along
How would people here invest to avoid the erosion
of purchasing power if held in cash?

 

[Value Collector]

How would people here invest to avoid the erosion
of purchasing power if held in cash?

Owning Assets that generate income that increases with inflation.

Over time rents and house prices increase along with inflation, so good real estate provides inflation hedged income, same with companies that produce many other goods, services and commodities, eg the price of coke will increase with inflation, so will the reported profit of the coca cola company and their dividends.

Think about it, the thing that worries people about inflation is increasing prices, But this means that the companies and assets whose prices are increasing (which is nearly all of them), will probably be maintaining profit margins.

High inflation over a short period can make things wobbly, but the long term holder will be fine. eg no one is sitting there upset because their rental property is stuck earning 1977 based rent, but term deposit holders have lost alot of spending power if they have had term deposits since 1977.

When inflation does come along

It's always present.

 

[Value Collector]

If some one wishes to maintain spending power while still investing is fixed dollar investments, they must choose cash based investments that will produce an after tax return higher than the prevailing inflation rate and then reinvest a portion of these after tax profits equal to the decline caused by inflation.

eg. if the tax rate is 30% and inflation is 3% and you have $100 to invest, you have to be earning a rate of 4.29% to breakeven against the inflation and tax.

The $100 will earn $4.29 interest, but the government will take $1.29 tax (30%) and you have to reinvest $3 back to maintain the spending power, because it now costs $103 to purchase what you could have purchased for $100 12 months earlier.

The only way around this is to invest your cash where it will earn a rate above 4.29%, every 1% you earn above 4.29%, will create 0.70% real spending power for you and 0.30% additional taxes.

Offcourse you need to risk adjust though, as you move higher in interest rate your risk increases, So moving to say 7.29% interest while taking on a 3% risk of loss, is really still just a break even investment.