Game of Tax by Ed Chan in Business Blueprint Elite Conference

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Watch this video of Ed Chan at the Business Blueprint Elite Conference in Sydney, where he talks about how you can maximise your profit by planning your tax and structures well.

Youtube: Game of Tax by Ed Chan

Transcript:

Dale: Let’s us put our hands together and welcome Ed Chan.

Ed:

Today I’m going to talk about running a business. You need three skills: You need a grinding, a minding, and a finding skill. The grinding skill is to do the work that your business produces and sells to the customer. And of course you need a finding skill to bring your sales in because without sales, you know you don’t exist. And you also need a minding skill because it’s about managing your staff because it can cost you a lot of money if you don’t manage them properly. And most of us, our business evolves from a grinding point of view. We’re not trained to manage people so we end up mismanaging them and it costs us a lot of money.

Also, you’re going to manage your clients or your customers’ expectations. You’re not going to let them manage you. To minimize the leakage, you also got to minimize the risks. The risks are the taxes. Taxes are a big part of your business and you can easily pay too much tax. We’re not trying to avoid any tax because we live in the best country in the world and we need hospitals and schools and law and order and so forth and that requires a certain amount of revenue to fund all that. But you don’t want to pay any more than you have to. And of course, litigations. So, you don’t want to get sued and lose everything through mistakes you’ve made or even if not from the mistakes you’ve made but through mistakes somebody else made and dragged you into it. I’ve seen that happen over and over again.

Disclaimer

Okay, tax. I’ve talked about leakage, so tax and asset protection. Tax is a pretty big factor and if I can demonstrate how big a factor… If I had $2, and I invested it and I got a 100% return. My $2 increased to $4. Then the $4 then increased to $8. And $8 increased to $16. And I left it there for 20 years. How much do you think I would end up with?

Can I have a show of hands who thinks I’ll have more than $500,000? Who thinks I’ll have more than a million dollars? So okay you’re right. Let’s have a look at the compounding effect or the effect of compounding your money. So, down at the bottom you can see one thousand and, was it $48,000?

Now what about tax? What if I took tax off? So, my $2 doubled to $4, so I made a $2 profit. But if I pay half of the $2 in tax, so I’m left with a $1.50. So, $1.50 plus $2 leaves me $3.50 instead of $4. And it doubles again and I lose half in tax again and so on and so forth. So, let’s have a look at what we are left with.

Remember the first lot which was a million and 48 thousand. Can I have a show of hands who thinks you’ll end up with less than $500,000? Less than $500,000? Can you keep your hands up? Who thinks of less than $200,000? Less than a $100,000? Okay you’re right, you’re actually left with $5,356.

Tax is really an important component of your business and it’s very easy to pay more than you have to. So, we should pay a bit of attention into it. I call it a game of tax with four stages. So down here – if you’re dealing with cash and aggressive tax planning and so forth, we call you a fool. And you’ll end up in jail. All right, or if you’re playing this game here with sole traders and partnership and you end up paying that 48% tax, we call you a pawn.

And if you’re playing right up here, then you got to have really deep pockets to fight the tax man on. Because the tax man loses 50% of the cases he takes to court. So, 50% of the time, he’s wrong. And that’s only the ones that go to court. So, you should know they are not the law. That the government makes the law. And the tax man polices the law, they interpret the law and according to how they interpret it, it’s obviously in their favour.

And then you know the community including the tax lawyers interpret it their way until it goes to court and the judge gets something and says, “no, this is how I interpret it.” It’s any man’s game and unless you’ve got deep pockets, you won’t be able to fight the ATO. So, the game that we’re playing is in this area here. The tax rate that you pay there is between 0% like a superannuation fund in pension stage up to a maximum of about 30%. So, you don’t pay any more than that.

The wrong way to do it is as a sole trader. The reason why the sole trader’s a wrong way to do it is because you could pay 48% in tax or you can get sued. So, if the business is holding your name and someone sued you because of something you did in the business then your home, anything that is in your name is exposed. So, you could lose your home, just because a business went under and had nothing to do with your home. So, we don’t have that, we don’t hold it in the sole trader.

The other one is the partnership. If I was in partnership with somebody else and the business got sued and the liability is $800,000… If he had a house with a million dollars and I had nothing, then because we’re joint and severally liable, he will lose his house and I won’t lose anything because I’ve got nothing. So, you’re caught and jointly and severally liable with somebody else. Of course, you end up paying more tax because you know that you’re 2 sole traders sticking together. So, we don’t do that either.

Let’s quickly look at the company. A company is a separate legal entity. And the difference, the major difference between a company and the individual is that the company has a fixed tax rate of 30%. The company structure as you know, there’s a director and there’s a shareholder. The way people set this up incorrectly is that while it gives you some asset protection because the business is held in the company and if someone sues the business, they sue the company, not you. But the laws have changed quite a bit over the years and made the directors personally liable.

So, the situation is if you go to your accountant many many years ago when you first started your business and he set you up a company, the business at that time wasn’t worth anything. So, over the last 10-15 years it’s now worth (I’m making this up) 5 million dollars. And they issued two shares one is for the husband, one for the wife and he appointed the husband and the wife as directors. Now that share that used to be worth $2 or $2 share is now worth 5 million dollars. Two and a half million dollars per share because your shares is reflective of the value of your business. And because you are a director of your company, you can get sued so you can get sued for insolvent trading.

If you couldn’t pay your debts and you continue to trade, you can be personally liable for that and if you don’t pay your PAYG installments and superannuation, then you’re personally liable. Obviously that’s the wrong way to set it up. Now, can I have a show of hands who’s set up that way? Who’s got directors. Okay so I’ll show a way how to fix it.

So, the other benefit of a company, whilst there is a 30% tax rate, once you pay that 30% tax, it’s not gone, it’s not lost it’s actually sitting there in an account called a franking account. Whereas if you pay tax in your own name, it’s gone, you might never see it back. So, if you’re paying tax in a company, and somewhere down the track, you’ve retired, your tax right is lower than 30% you take money out of the company as a form of a dividend.

Tax in that dividend has been paid 30%, so if your personal tax right is 20%, you get a 10% refund from the ATO. And it could be 30 years into the future. Or if your tax right is 35%, you only have to pay the top up of tax 5%, so it’s fantastic. You don’t lose your tax, you keep that credit, you build it up, you use it as a retirement fund, where you can then start taking the money out tax-free.

Now there are some disadvantages, the directors as I said are personally liable for the debts. And things like negative gearing is quarantined in the company. There’s a lot more but I don’t have enough time to go through every detail so I’ll just skip through this very quickly.

The other thing about asset protection is that the theory is that you should own nothing but you control everything. So, you could be worth 10 million dollars, but you don’t own any of it. But you control every single bit of it. And that’s what asset protection and the strategy that we run with. And we use things like trusts. The concept of a trust is just a separation of control and ownership.

I’ll just quickly explain these two types of ownership. There’s legal ownership and there’s beneficial ownership. In most instances, if you own your own house, you have both the legal ownership and the beneficial ownership. In instances like a trust, there’s a separation between a legal ownership and a beneficial ownership. So, if something’s in my name it does not mean that I actually own it beneficially so I might be the legal owner of it. The title of the property holder company or a share is in my name but I don’t actually own it. I’m holding it on behalf of someone else. And now it’s a bit of hard to understand. So, if I didn’t want the property in my name, I can ask Johnny Smith to have it in his name. it’s registered in the land tax office as Johnny Smith’s but there’s a document that I have with Johnny Smith that he’s holding it on my behalf.

Now among these different types of trust, the most common trust is the discretionary trust. And the discretionary trust allows you to drive the income to lowest tax file. And it gives the trustee the power to do that so you could change that from year to year.

So there’s also different types of trusts. I want go through each one of them just to say they’re all used for different things like a superannuation is also a trust and is used for retirement but the most common is the discretionary trust. There are certain things that you don’t use in a discretionary trust. For example you’re buying property in a discretionary trust because if it’s negatively geared and then the gear is quarantined inside the trust, you can’t offset that negative gearing as losses against your wages.

So, in that case you’d use property investors trust. We developed this and it got an ATO product ruling so we went to ATO and got them to sign off on it. And it allows you to claim the negative gearing against your wages. You get a refund from the tax man but also safeguard it in your trust so when someone sues you, you don’t have any asset in your name.

Okay so I’ll just use some examples. Let’s have that example of you having the share in your company in your own name and your business is now worth 2 or 3 million dollars. The shares is now worth 2-3 million dollars. You’re a director of your company, you can get sued for whatever insolvent trading or risk of it. So that asset if you like, that shares is an asset that’s in your name just like perhaps you bought your house in your own name. You shouldn’t have your house in your own name if you’re in business because if you get sued your house could be lost.

So, let’s say that share is or the house is in your name, this is how we could fix it. We could set up a trust. We’ll call it an equity bank trust. We give the asset across to the trust and then lend the money back to the individual and secure a mortgage over that asset. So, when someone sues you and they’re after money, there’s a huge mortgage in that asset then generally people don’t bother because they’re not going to spend money to litigate against you and then at the end get nothing out of it. So that’s one way to fix it and we’ve done quite a few of these.

And then the very last thing that I want to share with you is just the application of the use of the trust not just what they are but how to use them. So, here’s an example. Let’s say the situation is Tony and Sue. Tony and Sue own this house. They paid the mortgage off and is worth $500,000. Actually, must be in Tasmania somewhere cause it’s worth $500,000. But just for the purpose of the presentation.

So, they own that property, they’ve paid them off, they own it outright. They’re thinking of or they want to upgrade to a bigger house. The bigger house is worth $800,000. So, they have to borrow $800,000 to buy the second property. And then they want to then rent out the first property. And with the rent they want to be able to then pay their mortgage and so forth. So now they got a loan of $800,000. Now they’re going to use the first property as security. So they go to the bank and say “take my first property as security” and the money is provided to them where in fact you’re going to put both property up for security but the first one is rented out. So, the interest in the loan of $800,000, is that now tax deductible? Can I have a show of hands? Yes or no? Yes? No?

Okay, the answer is actually no because then the ATO doesn’t care what property you put up in the security because that’s the requirement by the bank. And as you know, the bank and the ATO are two different institutions. And the ATO, they only look at one thing, they look at the purpose of the loan. Where did the money go to, to determine the deductibility of the interest. And in this example here, the money went to where? To the second house, okay? So, and they’re going to live in the second house, the interest is not deductible cause it’s private in nature. So how can we switch this around so we could make it tax deductible? So again, the majority of that loan is the tax deduction.

Okay so let’s just run through the clever way of using trust. So, let’s say, this is the last slide. So, let’s say Tony is the higher bread winner, he earns most of the money so we borrow. We lend $500,000 to Tony. Tony then buys $500,000 worth of units in this trust. It’s a bit like borrowing 500 grand and buying shares or something like that. And then the property trust uses $500,000 in cash and buys the property of Tony and Sue.

So now Tony and Sue have $500,000 in cash. Tony goes and borrows another $300,000 but the original $500,000 they got for the sale in the property, that’s in cash. They put that towards their new home. So, they’ve reduced their non-deductible debt by $500,000. He still got a $300,000 non-deductible debt but now we’ve swapped at least $500,000 from a non-deductible debt into a deductible debt. Now, the savings on that I’d say 4% interest rate is about $20,000 a year. So, he now claimed $20,000 a year against his taxes for as long as the loan exists. Is that cool?

So last thing I want to say now to hand it back to Dale… The thing is you’re gonna do it not for tax purposes but for other things like in this instance, Tony might be in a business and he restructures to protect his assets. So, he didn’t do it to avoid tax, he did it to protect his assets because now it’s already in a trust and that the ATO is cool with that.

But if you did it to avoid tax, there’s a thing called PartIVA where the ATO can come in and unwind the structure and penalize you for it. So, you got to be very careful with how you set it up and if you set it up correctly and get your paper work correct then there’s no problem. Okay, I just ran out of time so I better hand you over. So, thanks a lot.

 

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Disclaimer

4 responses to “Game of Tax by Ed Chan in Business Blueprint Elite Conference”

  1. Stiven Denkovski says:

    Can you please advise me when Ed will holding a seminar on tax planning and minimisation in Sydney nsw this year 2018

    • Chan & Naylor says:

      Hi Steve, we don’t have the dates for the succeeding seminars yet but we recommend that you sign up for our monthly newsletter as Ed regularly writes on similar tax topics and updates that are truly informative and educational. We also announce seminar dates on our newsletter.

  2. Ken Stratton says:

    Could you mention the (NSW) Stamp Duty and Land Tax implications in transferring property to a unit trust, and property being owned by a discretionary trust please?

    • Chan & Naylor says:

      Dear Ken
      Thank you for your question. When you transfer property it means a “sale” and with that means Stamp Duty and Capital gains tax.
      A Unit Trust May also not have a land tax threshold so you could potentially pay more land tax.

      Also holding a property in a Discretionary Trust means if it was negatively geared the losses will be trapped in that Trust and you are unable to offset the losses against your wages.

      To properly determine how it’s should be held you will need to sit down with someone from Chan & Naylor to go through the 4 taxes that applies to property including your personal tax rate and what other structures you currently have.
      Hope that helps.

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