FEA Strategy - A Tax Deduction Now, No Tax Later

Written on the 1st of May 2009

The only substantial assets for most Australians are their family home and their superannuation. Maximising the benefits within a Self Managed Superannuation Fund is the main investing challenge for many Australians.

Background

This strategy relates to the tax benefits which a Self Managed Superannuation Fund (SMSF) may be able to obtain from an investment in FEA Plantations Project 2008 (Project). When someone reaches preservation age within the superannuation regime, they can commence an income stream or pension from their

SMSF without retiring. This is known as a Transition to Retirement Income Stream (TRIS).

Preservation ages are based on date of birth, and are as follows:

Why would a client want to start a TRIS?

The answer is "tax" ... or, to be more precise, "tax savings".

When a TRIS is being received, the income earned by the SMSF from the assets (and which is used to provide the TRIS) is exempt from tax. Otherwise, tax is payable within the SMSF environment at 15%.

For the individual, there are also tax benefits. Prior to age 60, an individual may be exempt from paying tax on a portion of the pension they receive from a SMSF. A tax rebate of 15% (10% on capital gains) is attributable to the balance of the pension. However, after age 60, the entire pension is tax exempt.

Assume the following about an investor:

55 years old;
Superannuation balance is $500,000;
Salary is $50,000 per annum; and
SMSF balance is expected to be $594,425 (i.e., an increase of $94,425) by the time the investor is 65 years old*.

*	This assumes the fund earns 6.5% per annum after costs and the salary grows at 3% per annum. By way of illustration, if the investor’s salary was $75,000 or $100,000, the increase in the SMSF balance, based on these assumptions, would be $141,978 or $155,230 respectively.

A person can make tax deductible contributions to their SMSF of up to $50,000 per annum if they are under the age of 50 and up to $100,000 per annum if they are between 50 to 74 years old. After 30 June 2012, the higher figure ceases. In practice, contributions are made to the SMSF each year giving a tax deduction either to the person or to their employer.

Strategy

So where does an investment in a forestry managed investment scheme fit in to the TRIS regime?

When tax deductible contributions are received by the SMSF they are subject to tax at the rate of 15%. This tax can be offset by an agribusiness investment.

One tax management strategy for an SMSF is to “deposit” money into an investment each year that does not provide income until after the TRIS has commenced – such as a long term forestry investment that provides the potential for a number of harvest incomes.

People using this strategy should consider not only the quality of the investment and the manager, but also the timeframe before income is received – such as when thinning and clearfall harvests are to occur for forestry investments.

Solution

As an example, investing in Option 4 of the Project would provide potential harvest incomes in years 9, 13, 16, 18 and 25 of the Project which are tax exempt for members of an SMSF who have started a TRIS.

This particular tax management strategy provides not only tax exempt income within the SMSF, but also assists with funding the cash to enable the TRIS pension to be paid.

A variation of this would be for the SMSF to purchase an existing investment via the secondary market. Whilst the SMSF has not received a tax deduction for the investment, because the plantation rotation is midway, there is a shorter time period before harvest proceeds are received tax exempt. Refer to page 10 for more information on a strategy that involves the purchase of an existing forestry investment on the secondary market.

Result

A forestry investment within a SMSF has the potential to:

Decrease contributions and income tax within the SMSF due to its tax-deductibility;
Provide a potential long term income stream from harvesting;
Provide a tax exempt income stream for members who have started their TRIS; and
Decrease the risk within the SMSF’s investment portfolio and increase the portfolio’s asset diversification due to the negative correlation generally associated with forestry investments compared with other asset classes.

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