There are many aspects to providing professional advice to clients. Apart from devising strategies that enable people to enjoy the lifestyle they desire in retirement, another major part of a professional planner’s role is to educate their clients on a number of matters.

These include explaining the link between the level of risk and the expected returns from different classes of investments, and also explaining what impact income tax can have on the value of investments at retirement.

Two of the aspects of income tax most misunderstood by clients are the calculation of capital gains, and how the actual amount of tax payable depends on the interplay between tax offsets and imputation credits attached to dividends.

When it comes to capital gains, it is important that clients understand there is no separate tax imposed on profits made on the sale of investments. Instead, a process must be followed to arrive at the assessable profit made on the sale of assets.

The first part of calculating the assessable amount of capital gains, when there have been multiple sales of investments during a year, is to split the financial results into three categories:

  1. Profits made on investments held for less than 12 months.
  2. Profits made on investments held for longer than 12 months.
  3. Losses made on investments.

Once these three components have been calculated, the amount to be included as assessable income is arrived at by deducting the losses made during the year from the profits. If there are capital losses carried forward from prior years, these are then deducted from profits made.

If there are profits remaining after deducting the losses that relate to sales of investments held for longer than 12 months, the 50 per cent general discount is deducted. The remaining 50 per cent is included as assessable income if the resulting profits relate only to investments, and are not eligible for the small-business CGT concessions.

Income tax

To determine how much income tax is payable, first calculate the taxable income for an individual. This amount will include all assessable income, including assessable capital gains, and dividends (including imputation credits) relating to both direct share investments and managed investments, minus all allowable deductions.

The next step is to calculate, based on the individual marginal rates, the amount of tax payable. From this amount is deducted all relevant offsets. These can include the Low Income Tax Offset, superannuation pension tax offsets, and the Seniors and Pensioners Tax Offset.

Tax offsets cannot create a tax refund, so if the offsets are greater than the tax payable, the net amount of income tax payable is zero. To the net amount of income tax payable is added the Medicare levy, if it applies, to arrive at a total tax payable and Medicare levy amount.

The final step in the process is to deduct from this total any income tax credits that apply. These include Pay As You Go Instalments, credits for foreign income tax paid, and dividend imputation credits.

When the tax payable plus Medicare levy is exceeded by the credits – not including the credit for foreign income tax paid – a tax refund is produced.

Explaining these concepts to clients makes it easier for them to understand how strategies such as sacrificing salary into super contributions, or making deductible personal super contributions, can lead to less tax being paid over their working life and maximise their assets in retirement.

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