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Tax credit system plagued by deficiencies

Prudential tax manager Andrew Schmidt outlines some concerns about the proposed Tax Credit System.

Monday, May 11th 1998, 12:00AM

by Philip Macalister

The government as introduced legislation allowing taxpayers to have the income on their savings taxed at their personal tax rates rather than the pooled tax rate applicable on investments in the life and superannuation regimes. It is called the tax credit system (TCS).
The TCS regime should be cause for celebration for those on low marginal tax rates. However, the delivery of the regime is unlikely to meet this expectation.
While the regime may be theoretically correct, it is plagued by technical deficiencies and has a compliance cost that will outweigh the investor benefits for many investment products.

The proposed legislation addresses the growing tax differential between the pooled tax rate and individual tax rate that has resulted from the reduction in personal income tax rates.
The tax differential was 5 per cent (33 per cent – 28 per cent) and is now 9 per cent, and from July 1 1998, it will be 12 per cent (33 per cent – 21 per cent). The proposed legislation will be backdated to April 1, 1998.
It is an optional scheme, life insurance companies and superannuation scheme administrators/trustees will be able to decide whether they will provide TCS for their policyholders/members.
If the regime is offered then investors will have to make a positive act to elect into the regime. Once they do so they will receive a certificate showing the income attributed to them and the tax credits attached at 21 per cent. The investor will have to include this in their individual tax return. The certificate will receive similar treatment to a dividend statement with the tax credits being treated as imputation style credits.
The income tax resulting from the different tax rates will be claimed back by the fund and applied to the investor’s withdrawal/surrender value.
Before electing individual investors will need to take into account any family support tax credits, guaranteed minimum family income tax credits, income tested benefits, child support contributions or any impact on student allowance payments to ensure they receive their expected benefits.
The government has touted this regime as the final solution to the problem of over-taxation in pooled funds.
However, there are significant difficulties with the new regime that will make it almost impossible for the scheme to be applied to some products. It is predicted that 56 per cent of the assets in products covered by the main industry players will not be able to utilise the new regime.
There is particularly difficulty in applying the regime to insurance bonds, whole of life and endowment policies.
As the legislation currently stands life insurers are at a disadvantage from superannuation schemes in that they can only use their policyholder base income tax liability rather than the tax paid by the fund.
Submissions on the bill are expected to address this point.
For many products the regime will not match the actual income as tax credits may not be available to impute the full income earned by the investor. This is likely to cause considerable confusion amongst electing members of the fund.
In addition the cost of setting up the systems to deal with the new regime for all products has been speculated to be as high as $180 million. Treasury have reduced its tax forecasts by $30 million to take into account the new regime, which is only a small percentage of the total tax take from the funds management industry.
For many other products the cost of providing the opportunity for investors to access the regime may be more than the benefit.
Fund managers will have to ensure that the non-electing savers do not suffer any extra system charges when implementing the new regime.
Existing annuity holders should receive an increase in their annuity payments, as they will be re-calculated on a 21 per cent tax basis. New annuities will also use the 21 per cent if the investor elects to receive tax credits.
Another feature of the new regime is the ability for employees to elect to have their employer contribution to their superannuation fund treated as salary and subject to PAYE. At present such payments are liable to Specified Superannuation Contributing Withholding Tax (SSCWT) and are taxed at 33 per cent of the gross contribution leaving 67 per cent to be paid into the fund. The 21 per cent tax rate will result in 79 per cent of contributions being paid into the individual’s account.
Andrew Schmidt is a tax manager at Prudential
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