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The New Business Tax System
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Impact on tax incentives for philanthropy The Treasurer announced a new tax system for business, including changes to capital gains tax on 21st September 1999. While the impact of these changes on philanthropy was not discussed, they have significant ramifications for the tax incentives for giving. Also, the adoption of the entity tax regime will impact on the use of trusts as vehicles to make charitable donations. Reduced Capital Gains Tax - a new tax incentive for giving Taxpayers who donate an asset that is subject to Capital Gains Tax (or use the proceeds of an asset they have sold to make a donation) remain liable for capital gains tax. However, they are eligible for a tax deduction on a donation of cash or for the value of an asset which exceeds $5,000. A different treatment applies for cultural gifts over $5,000 which are not subject to CGT. Also bequests of assets are not subject to CGT. In most cases, a taxpayer uses the tax benefit of the deduction to offset the CGT liability, both of which occurred at the taxpayer’s marginal tax rate. From October 1 this will change with only 50% of capital gains to be assessed at the taxpayer’s marginal tax rate. Example
Compare the after tax cost/benefit of donating the asset to a tax-deductible entity.
This represents a reduction in the cost of the donation of 17%. The ‘out of pocket’ cost of the donation has fallen from 85% to 71% of the value of the asset. If the asset was a cultural gift to a public museum, library or art gallery then the cost of a Post Oct 99 gift reduces further to $2,575 ($5,000 less $2,425) because no CGT is payable on eligible cultural gifts. If the asset were donated from an estate then the cost of a Post Oct 99 bequest would be $4,030 ($5,000 less $970 in CGT relief) as a bequest is not a tax deduction to the estate. Overall, the new CGT regime will provide further incentive for gifts of taxable assets, or their proceeds. However, this means of giving remains less attractive than gifts of cash or cultural gifts. Donations from Family Trusts It is common for family trusts to make donations to tax-exempt entities that are nominated as a beneficiary of the trust. The tax benefit from this strategy is that pre-tax income is distributed an income tax exempt beneficiary, hence no tax is payable on the distributed income. This strategy also allows tax-free donations to churches, sporting organisations etc which did not have tax deductibility status. The strategy survived the family trust election provisions as trusts with tax exempt beneficiaries could still elect to become a family trust. The introduction of the entity tax regime on 1 July 2001 will mean that a trustee of a family trust will pay the corporate rate of tax on its taxable income and beneficiaries of the trust will be able to claim an imputation credit of the tax paid on their distribution. The Treasurer also announced that “Excess imputation credits will be refunded … to registered charities where imputation credits are attached to donations by way of trust distributions.” This means a charity will be able to claim back the tax paid by a trustee of a family trust before it distributes a donation. No doubt the trustee will take this benefit into account before deciding how much to donate. The attractiveness of this strategy will now depend on the entity tax rate compared to the marginal tax rate of the trust beneficiaries. Beneficiaries on the top marginal tax rate of 48.5% would be better off making the donation themselves if the trustees tax rate were 30%. It appears that the tax effectiveness of using a family trust to pay church (and other non-tax deductible entity) donations will virtually close from 1 July 2001. However, a small tax benefit will arise if the beneficiaries who might otherwise make the donation are on a higher marginal tax rate than the entity rate. Implications for Charities and Charitable Trusts It appears that charities and charitable trusts will not be able to claim imputation credits on dividends received from their investment in shares. However, it may be possible for a charitable trust to pass on imputation credits on its investment in shares to a charity beneficiary, which in turn claims a refund because it attaches to “donations by way of trust distributions”. In conclusion, business tax reform will support the charitable sector in Australia by providing further tax incentives to reduce the cost of giving. However, the entity tax regime will close an existing loophole enabling untaxed donations to flow to tax-exempt entities which are not eligible to receive tax deductible donations. Michael Walsh Executive Director, Givewell October, 1999 |
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