While we live in world seemingly full of unrelenting change, there are some things that will never change in the financial world.  For a very long time, I have maintained a set of ‘Golden Rules’ that are always relevant and good for investors to keep handy when contemplating making investments.

So let’s get started with a Golden Rule that deals with tax benefits.

1.    Tax should never be the primary reason for making an investment.

Why? (people always ask)  It’s quite simple really – taxation law is subject to change so the overriding question you should ask yourself – before investing – is:

If the government were to cancel the tax benefits associated with this investment, would I still be happy to put my money into it?

If the response is ‘No’ then that – in isolation – should be sufficient to deter you from putting your money into the investment.

 

The Australian investment landscape is littered with the carcasses of investments that were marketed to investors on the basis of tax benefits which were, at times, questionable to say the least. As I write, the collapses of more than twenty years of professional practice come flooding back.  Over the years I’ve witnessed, from the sidelines, collapses of investment schemes which involved:

  • Pine trees
  • Jojoba beans
  • Cray fish farms
  • Wild flower plantations
  • Tea tree plantations
  • Ostrich breeding
  • Oak trees
  • Cattle breeding
  • Film production

Rest assured there are more failures than recorded above.  All the schemes above were variations of a theme – investors borrowed all or part of their investment and hoped for that the forecast capital and income returns came true. In many cases it was little more than the proverbial ‘wing and a prayer’ due to the fundamental flaws in the investment structures.  Some such schemes claimed that for every $1 invested a tax deduction of $5 could be claimed.

Consider this excerpt from a 2006 report by the Australian Taxation Office:

The Senate Economics References Committee found support for the view that “the growth of a highly competitive entrepreneurial promoter market … has been the most significant driver of the growth in aggressive tax planning.”

This finding built on the Committee’s previous reports. In its Interim Report it concluded:
“ it is the view of the Committee that a large number of these schemes appeared to be designed specifically to defraud the tax system and to use ordinary taxpayers in that process. Not only have they left many taxpayers with large tax bills, but many of these schemes have ceased to exist. The Committee is of the view that few schemes represented ‘a good investment’ in the ordinary meaning of the term, and that without the ‘tax deductibility’ factor, very few would have got off the ground.”

I recall explaining to students in an adult learning program which I taught that: “If the tax office ever disallows the tax deductions (on these exotic investment schemes) people will march in the street!”  And so I was not surprised to see that in Sydney, Melbourne, Perth and Canberra, so-called ‘tax effective’ scheme investors marched in protest at the Australian Taxation Office’s early 2000s decision to disallow tax deductions on such schemes[1].

To make matters worse (for such investors), the decision was made with retrospective effect to 1992.

What appealed to such investors was, in effect, a view of getting something for nothing; the so-called ‘free-ride’ that investors sometimes believe they receive when tax deductions are on offer. Of course there is no such thing as a ‘free lunch’ and many such investors were subsequently hit by the dual impact of a failed investment followed by a retrospective disallowance of tax deductions from many years previous.  For many investors, the losses amounted to hundred of thousands of dollars.

‘Tax effective schemes’ are by no means the only area where investors focused on tax deductions can be at risk. For example while I’m a great supporter of superannuation as an investment vehicle to accumulate retirement savings, it concerns me when investors have all their investment capital in superannuation. This is because – no matter how many super funds you have – superannuation is subject to constant legislative change and such change isn’t always beneficial for investors.  While it’s a very tax efficient system through which most Australians can save for retirement, there is substantial legislation risk with it.  It is sound planning to accumulate wealth in superannuation and outside of superannuation.

So the ‘Golden Rule’ is:

1.    Tax should never be the primary reason for making an investment.

Tax should only ever be a secondary consideration.  Remember: Tax laws change.

 

 



[1] The Australian Taxation Office has previously referred to the schemes as ‘abusive tax schemes’.

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