31 January 2024

Albanese government change to previously legislated stage three tax cuts: Tax planning around the changes

Where do the changes hit most?

The seats with more than 10,000 taxpayers who will receive a reduced tax cut under Labors revision of the legislated new tax tables applying from 1 July this year are summarized in the table below. Nine of the ten seats having most taxpayers adversely effected by a smaller tax cut are Independent/Teal/Labor. Only one is a Liberal seat which is the sixth on the list below 5 labor Teal/independent seats. Based on 2021 census data, electorates with more than 10,000 people adversely affected by receiving a smaller tax cut than previously legislated are:

• 7 Teal/Independent held seats.

• 4 Green held seats.

• 17 Labor held seats

• 8 Liberal held seats

• Zero National party held seats.

This adds up to 28 non-Coalition seats and only 8 Coalition, (all Liberal) held seats. This gives the lie to the Coalition opposition representing the wealthy and Labor and political groupings of the left representing the low-income earners! The data suggests that the reverse is substantially the case.

Eleven of the twenty wealthiest seats most adversely effected are held by Teal, Greens or Independents! And seven by Labor. Only two are held by Liberals!

Tax planning by successful small businesses to maximum effect

This example is based around a dentist and spouse owning and building a successful practice but could also apply to a wide range of Veterinary practices, medical services, and many successful small businesses.

Lewey is a hard-working dentist, married to Louise, an allied health professional. After working in other practices for about twelve years following qualification as a dentist, Lewy purchased a modest practice in partnership with Louise in about 2001. He was aware of the capital gains trap in owning practice goodwill inside a company. As such, the practice was purchased in their joint individual names. About 8 months into the first financial year of ownership (the timing is important), through a licensing and management agreement, the practice was henceforth operated (but not owned) by a company of which Lewey and Louise were the two shareholders. Through hard work, good dentistry, good chairside communication skills and maintaining practice premises appearances they generated pleasing patient referrals and built up a successful practice.

In addition to Lewey’s personal surgery, the practice now has two other busy surgeries staffed by dental contractors (assistant dentists). They are contracted on the standard dental industry formula. When buying the practice, Lewey and Louise negotiated the right to purchase the premises within 5 years at valuation.

Louise gave up her own career as an allied health professional to raise their three children but also became the practice bookkeeper and periodically filled in as an emergency receptionist or chairside assistant, but kept a low profile in the practice. She pays the accounts, attends to the staff payroll and superannuation, maintains leave records and monitors the ordering of practice consumables and dealing with various suppliers. Much of her work is done from home.  The appointment book has been carefully managed so long-term patients with family/friendship ties to other patients are predominantly treated by Lewey. Assistant dentists’ appointments are kept tightly managed by reception so as to optimize the time of chairside dental nurses (dental assistants). Lewey has Louise and the receptionist monitor their number of repeat appointments and number of personal referrals— which are key measures of a dentist’s performance—and particularly of their chairside communication skills when treating patients. He periodically checks their clinical records but is unobtrusive while maintaining effective control. Lewey is the most experienced dentist in the practice and easily generates the highest fees. As the lead dentist he accepts the responsibility of providing dental procedures beyond the skill level of less experienced assistant dentists. Like a vast number of small business owners, Lewey is the hardest worker in the practice. Louise’s contribution is substantial but provided unobtrusively as far as possible.

Buying the premises

Due to the 2001 capital gains tax changes, Lewey and Louise were advised not to purchase their practice premises inside their superannuation fund due to its probable status as an active business asset when sold in the distant future. They also protected its access to the 50 percent concession on capital gains tax if sold personally from private ownership rather than by a company. Instead, they jointly debt financed the purchase in 2004. They arranged with their bank to accelerate the reduction in their home loan while maintaining their premises loan on an interest-only basis, initially for three years, but later extended as the equity in their home—and hence their bank’s security—improved rapidly. Initially their bank was reluctant to accede to their request, but after being informed that a competitor would take over their business banking and lending agreed. The comparative after-tax cost of the tax-deductible loan on their premises was lower than the non-deductible cost of their home loan.

Rebuilding and expanding their practice business

As the practice grew with hard work, Lewey and Louise sacrificed part of the practice income in keeping the premises in good order and appearance deducting the maintenance costs. They quickly became sufficiently profitable to top up their superannuation on a regular basis taking care to keep their balances approximately equal with both deductible (concessional) contributions and steadily increasing non-deductible (non-concessional) contributions. The practice had had two original surgeries and sufficient space for a third but had been run down under the previous aging owner. Only sufficient patients for one dentist remained. Under their control and effective relationship with patients the practice was refreshed and expanded into the second surgery which had urgently needed refurbishment and re-equipping for an employed/contracted dentist. They re-equipped it using corporate hire purchase financing. They then added and equipped a third surgery which requiring internal building alterations. It gradually filled a day of patients at a time. Several years of building patient relationships and referrals meant that they built up to a busy three surgery practice business. A three-surgery practice is optimum size for a single dentist to control while maintaining a busy personal clinical schedule. Thereafter they kept the appearance of the practice attractive to patients and staff doing their last substantial refurbishment three years before its eventual sale. It had the appearance of a practice in which potential purchasers would feel comfortable working in.  

Drawing income and tax planning 

Lewey drew income from the practice steadily rising to $200,000, mainly via grossed up franked dividends augmented by a small management fee. Louise drew a slightly smaller amount and both had maximum deductible superannuation paid by their company. Their older children in turn cleaned the practice after school and were paid modest amounts. Lewey and Louise were careful to plan the combination of their net personal taxable income and concessional superannuation contributions so as not to trigger the superannuation surcharge. (refer to ATO guidance). Overall, they paid substantial income tax but kept their tax exposure within reasonable limits.

Sale of practice and premises

By 2023 Lewey had reached the point of wanting to slow down as dentistry is a physically and mentally demanding occupation. He and Louise were approaching age 60. Lewy was still doing four busy clinical days per week made up of three full days and two half days per week but knew that if he reduced his practice sessions further the professional wisdom was that profitability was likely to diminish sharply and with it practice sale value. They decided to sell with Lewey prepared to work for the new owners for a short time on a part time basis. Louise would continue her background bookkeeping role only for sufficient time to hand-over to somebody else or until Lewey left the practice, whichever occurred first.

Sale value 

The practice goodwill which was generating nearly $2 million of fees profitably, including fees generated in the name of dental contractors who paid the practice a facilities and services fee, was sold for $1,150,000. Virtually all this sale price was classified as goodwill since equipment had been depreciated to near zero. The premises which had a capital gains tax base of $450,000 were sold for $1,700,000. Both practice goodwill and the premises were classified as active business assets. The practice was by now owned outright as was their home worth $2 million. They had a small residual debt on their premises. They had a combined $5 million in their superannuation fund roughly $2.5 million each.

Their company had retained some earnings year by year to constrain their personal taxable income from having a significant amount taxed at the highest rate as well as avoiding the high-income earners surcharge on their concessional superannuation contributions. Normally their company drawings during a financial year were extinguished by a franked dividend approved on 1 July and credited on 2 July in order not to create loan account tax complications. Any amount left over was carried forward inside their company.

Dentists should read the above in conjunction with my book “Financial Success as a Dentist” which provides greater detail.

Retaining some cash inside company until their taxable income fell 

At sale their accountant advised them to retain surplus income carried forward in their company and pay it out in years following their sale of practice financial year and post-retirement when their personal taxable income would be below the company rate.

Dealing with capital gains and small business capital gains tax concessions 

Lewey and Louise have net $2,400,000 of capital gain on the sale of their practice and their premises which attracted a 50 percent discount because of being owned for much more than the required 12 months and owned personally, not through a company. Their otherwise net taxable capital gain was now $1,200,000 before applying other concessions applicable to the sale of small business active assets.

There are further options to consider such as how they each claim their portion of the small business capital gains tax concessions and whether they roll over a portion of their gain into their superannuation accounts. Note: depending on personal circumstances these concessions are generous but tricky and no individual decisions should be made without input from an accountant experienced in applying the rules. This may require referral from their tax agent to a specialist in that area. But suffice to say that since their home value and their superannuation fund are both exempted from being counted in the assets test, applying to the use of the sale of small business concessions, they will pay a very small amount of capital gains tax on the sale of their practice and their premises. Refer to Australian Tax office site and a specialist accountant for more information.

Dependent on circumstances it can be advantageous to roll a substantial amount of sale of business proceeds into superannuation, then commence superannuation assuming business sellers meet the conditions of release of having passed their 60th birthdays. 

Their post-retirement tax planning

Lewey and Louise are each permitted to have $3 million in superannuation as at 30 June 2025 which will be measured at the conclusion of the 2026 financial year before the higher tax assessment on assets beyond $3 million commences. This includes taxing unrealized capital gains on assets above $3 million in each individual’s account. If they have elected to make a substantial rollover of business sale proceeds into superannuation it is likely that they will each broach the $3 million amount prior to 30 June 2026 the point at which assets above $3 million per superannuant is assessed for higher tax including tax on unrealized capital gains.

They therefore plan on

1.     Commencing superannuation pensions immediately after their 60th birthdays, having met a condition of release by sale of their business.

2.     They then may have more than $3 million each in their superannuation fund with $1,900,000 being inside their pension accounts which become tax free once they commence pensions. Their superannuation pensions are also tax free in their hands. They will be permitted to each have up to a further $1,100,000 of their fund retained in accumulation accounts taxed at only 15 percent of earnings and 10 percent on realized gains on assets held for twelve months. But they face a heavier tax of 30 percent including capital gains tax on unrealized gains on the surplus per member above $3 million.

3.     If small business sale proceeds rollover creates balances of superannuation above $3 million per individual, it should be withdrawn from their respective accumulation accounts leaving their pension paying accounts untouched except for their required tax-free pension withdrawals.

4.     They intend drawing the minimum tax-free superannuation pension amounts required by superannuation rules. Should they require more it will be drawn from their superannuation accumulation accounts.

Personal tax rates from 1 July 2024 following Labor’s stage three changes

Assuming legislation passes these are:

·       $0 - $18,200 nil

·       $18,200 - $45,000 16 cents per dollar.

·       $45,000 - $135,000 30 cents per dollar.

·       $135,000 - $190,000 37 cents per dollar

·       $190,000 upwards 45 cents per dollar.

Note Medicare levy of 2 cents per dollar also applies if joint taxable income exceeds the threshold for the time being.

Low marginal tax rate following retirement 

With careful investment of the surplus of amounts above $3 million each removed from their super fund and jointly invested with a view to a proportion in growth rather than income assets in retirement, Lewey and Louise will likely be able to keep each of their personal taxable incomes below their respective $45,000 income tax thresholds and contain their marginal tax rates to 16 cents per dollar.

Helping children and reducing tax 

A further consideration is that Lewey and Louise may assist their children’s purchase of homes and in doing so reduce capital invested personally outside of their superannuation accounts and in doing so keep their respective personal taxable incomes below $18,200 each at which nil tax applies. They have ample tax-free superannuation payments to fund their lifestyle post-retirement. They may also assist by paying some of their grand children’s education expenses.

The key lessons are the importance of: 

1.     Sharing business ownership and business income between spouses.

2.     Planning for superannuation deductions and building equal superannuation accounts. Note that the value of the family home and superannuation are exempt from the qualifying asset test for gaining the small business capital gains tax concessions. For many this provides extra incentive for placing more contributions into superannuation and for investing personal capital in upgrading their home.

3.     Adopting the most efficient business structures to gain long term tax benefits including the small business capital gains tax concessions.

4.     Assisting children at critical times with tertiary education and assisting in first home purchases.

Conclusion 

Small businesses of all kinds are critical to providing much of Australia’s employment and economic growth. Their success invariably comes from sustained hard work, good management and leadership. Successful ones reinvest a portion of their income in business improvement including updating equipment and business expansion. They undergo considerable stress and their owners are unable to shirk responsibility. They need to plan their capital decisions carefully and take a long-term view of structuring to enable maximum capital retention and resale value of their practices and businesses. Their superannuation investments and those of millions of others indirectly provide capital for business development and for banks to lend to homebuyers and property investors. A significant proportion of Australia’s superannuation is invested internationally and indirectly offsets Australia’s foreign debt.

Graham Middleton advice to dentists and veterinarians 

Graham provides limited advice to dentists and veterinary practitioners on the basis that recipients make an appropriate donation to the charity he supports, the Delany Foundation a charity set up by the Patrician Brothers who provide him with a bursary for his secondary schooling. The Delany Foundation assists worthy causes particularly schools set up by the Patricians in Papua New Guinea, Kenya and Ghana.

Graham Middleton

graham.george.middleton@gmail.com

Financial Success for Dentists 

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:

·       Understand key practice valuation criteria.

·       Learn how some dentists inadvertently reduce the value of their practice by $500,000

·       Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school. 

—Merv Saultry, Founder Dental Innovations Network

To Obtain a Copy:

·       Go to the Delany Foundation website at http://www.delanyfoundation.org.au

·       Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

·       Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address

·       A copy of the book will be mailed directly to you

All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome. 

The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.

Please Pass On 

If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com 

Independence And Disclosure

I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.

A great deal of business information, particularly applicable to dental and dental specialist practice owners is available at grahammiddleton.com See particularly reproduced articles from Australasian Dental Practice Magazine.