Our tax system encourages debt
AS COCKAMAMIE as it might be, our tax system encourages debt.
If you want to put your hard-earned in a bank account, fixed deposit, debentures or bonds, then your interest gets absolutely no relief from our relentless tax system.
If you are the average tax-payer paying 30% tax on your investment income and are fortunate enough to be getting 5% interest, you'll lose 1.5% to the taxman and 2.5-3.0% to inflation.
At best, you'll be getting a net return of just 1%!
If, however, you get yourself a negatively geared investment property, you'll pay no tax on its earnings at all and should you on-sell it, you'll pay capital gains tax on only half of the gain.
In saner climes than Gladstone, the rental income you can expect on a residential property is about 5%.
If you borrow, you'll be facing a cash shortfall for sure (added to by rates and the other pleasures of property ownership) but you'll be able to deduct that shortfall and non-cash expenses such as depreciation and the building allowance from other income, reducing your tax bill.
Inflation? In most times, not a concern as inflation usually pushes housing prices and values rise over time.
So there are potential benefits to be had in borrowing to invest in property if you are a taxpayer.
In the right market, at the right time, of course, like everything.
The same goes for shares. If you borrow to invest in shares you obviously get hold of a much bigger portfolio than you can pay cash upfront for.
The interest on the borrowings is tax-deductible, if the shares are blue-chip their dividends carry a 30% tax credit - tax-free if you are an average taxpayer - and half of any capital gain you make on on-sale is free from capital gains tax.
Your share selection done carefully, the deductible interest on the loan will lower your tax on other income.
There we have it. The tax system encourages you to borrow to buy capital assets like property and shares and goes soft on those who sell them at a profit.
So why are the youngsters coming to me to get their tax done coming in buying into high-risk superannuation "to reduce their tax".
It's madness to lock up your dough in an investment so exposed to risk of legislative change!