Everyone hates paying tax. And every possible scheme, angle or method (legal and illegal) has been utilized to help people pay less tax (or evade tax altogether) for centuries. Maybe if you live in one of the Scandinavian countries where people are happy to pay high taxes in return for amazing public benefits, its different. But in most parts of the world, ‘tax’ is near enough a swear word. But the world’s changing, clever schemes are being shut down, tax information is now being shared between countries (so hiding money is becoming more difficult) and tax authorities are becoming more sophisticated in their capabilities as technology improves and information is more freely shared. So understanding tax optimisation and how to play fair and stay above the rules is becoming more important.
What isTax Optimisation?
That doesn’t mean you can’t still utilize effective tax planning strategies, but the days of tax avoidance (which used to be seen as legal and acceptable but less so now) and outright tax evasion are rapidly ending. The super wealthy will always have the ability to use clever schemes and methods to minimise their taxes (it helps being able to appoint an army of clever lawyers and accountants) – but over time and as global policy initiatives become more integrated to reduce the various tax arbitrage opportunities available from an antiquated global tax system, a more equitable system will hopefully emerge.
Kind of what the OECD is doing and the push for a minimum global tax rate of 15% to prevent companies and the wealthy from shifting profits to tax havens. Clearly in SA (despite having high tax rates) most of us feel that the tax that we pay isn’t compensated for with a level of public service we should be entitled to. But dissatisfaction with public services isn’t an unusual phenomenon and even happens in developed countries, simply that in this country it’s just on the extreme end of the spectrum (and rightly so).
Therefore tax optimisation is about using all legal and available means to reduce your tax liability – without crossing the line into tax avoidance (less acceptable than it used to be) and tax evasion (which is illegal) and can mean you end up behind bars.
Tax Planning Strategies
When working with a professional – like a Certified Financial Planner – tax planning and optimisation will always be part of any holistic financial planning strategy. But tax consequences should never lead your financial and investment decisions. Effective tax planning should simply be a consequence of structuring your affairs in a way that will help you achieve your goals. Working together with your financial planner and accountant so that they can plan your strategy together in the most effective way possible is the ultimate recipe.
Business owners and the self-employed have the greatest ability to reduce their tax liability by using all the legal deductions that are permitted to reduce taxable income and ultimately pay less tax.
If you earn a regular salary your options are typically more limited with the biggest opportunity usually being to make retirement contributions. But as more people work from home – ‘office space’ at home and all the costs incurred in running your office should be deductible, so long as you keep proper and accurate records (and know you’ll probably be subjected to a SARS audit).
As ‘side hustles’ are also becoming more popular (for young and old) it means expenses that you incur in the production of that income should also be deductible. Being self employed isn’t easy but it allows you to potentially have a much lower effective tax rate than a comparable PAYE employee.
Tax Optimisation Using Appropriate Investment Structures
Depending on your marginal tax rate, how you choose to invest and the investment vehicle you choose to use can also result in a lower tax obligation – using industry jargon, the type of ‘wrapper’ in which your actual investments sit. For discretionary investments (local or offshore) it can mean paying 12% CGT (instead of 18%) and income tax at 30% (instead of 45%)
Donations between spouses used cleverly can also reduce your tax liability, particularly on death with estate duty roll overs. Income producing assets like a money market fund that retirees might use to supplement their pension income, could benefit from being moved into the spouse’s name who has a lower marginal tax rate.
For some reason, people hate paying capital gains taxes, even though that should be a good thing because it means you’ve made a profit on your investment and realising that profit can be prudent and serve the interests of your long-term planning because those profits might be better allocated elsewhere.
Tax Planning Strategies for the Wealthy
Trusts and companies as vehicles to house wealth and own assets have forever been favoured by people with money to mitigate taxes and create inter-generational wealth transfer mechanisms. Trusts used properly still have a valuable role to play, but authorities are tightening all the loopholes that were used so setting up a new trust (or managing an existing trust) needs to be done properly so as not to fall foul of the taxman.
The HWI Unit that SARS has established to focus on taxpayers with assets over R50 million is a development to show how serious they are, where they will focus on individuals with more complex arrangements (like trust and business assets) to ensure the correct level of tax is being paid.
Used well, companies and trusts can provide excellent tax optimisation opportunities, protect assets, create legacies and provide for future generations. But there are no shortcuts so specialised advice should be obtained with the understanding that the costs to set up and run these structures aren’t cheap.
Read Next: A case study on giving wealth purpose and knowing when you have enough.
The Final Word: Tax Optimisation
Like the butterfly effect where a single decision can have a ripple effect with unintended consequences, so do all the decisions you make when planning your financial affairs. Tax planning and efficiency is always going to be a part of the conversation with regards planning your finances, managing your money and ensuring you are able to achieve what you set out to do, in the most optimum manner.
But we don’t ever think it should be the primary driver behind any financial decision you make because if you are paying taxes in the form of income tax or CGT for example, it still puts you in a privileged position relative to many people who don’t make enough money at all to pay any tax to begin with.
Charitable giving forms an important part of helping those less fortunate (with the added benefit of being a tax deduction), and at Henceforward we support the Children’s Hospital Trust because it’s a subject that is close to our hearts.
Watch the video Steven did where he explains some of the benefits of estate planning including how charitable giving and having a will (another important part of tax planning) are fundamental in a well-executed estate and financial plan.