Substantially improved property investment cash flows may be attained by using a little-known, completely legal policy within the taxation system.
For a majority of property investors, they absorb an (often sizeable) annual shortfall between rental income and investment expenses, and then wait for a tax refund after lodging their annual taxation return.
In this current climate, a no-frills, median value, detached house recently purchased with a 10 percent deposit for investment purposes is generating an annual (pre-tax) loss of between $25,000 and $50,000 in Adelaide, Brisbane, Canberra, Melbourne and Sydney.
Even though the investor may recoup (say) one third of that loss when their tax return is lodged (negative gearing), it is still a significant ongoing shortfall to cover.
A lateral-thinking strategy that property investors might appreciate being aware of is the ‘Withholding Tax Variation’ (WTV).
In a nutshell, this strategy improves the investor’s cash flow by ‘bringing forward’ an anticipated annual tax refund.
To better understand WTV’s, Jason Cook of WB Financial (advisers) provided the below comments.
What is Withholding Tax Variation (WTV)
At its core, WTV is a mechanism that legally allows taxpayers to adjust the amount of tax withheld from their income throughout the financial year.
This is in lieu of waiting for a tax refund after one’s annual taxation return has been processed.
Typically, employers deduct (withhold) tax from an employee’s salary to ensure that the government receives its share of income tax consistently. However, for certain individuals, like property investors, this may not be the most efficient way to manage tax obligations; particularly where there is a negative gearing loss to be claimed against other earned income.
Advantages of WTV’s for property investors
- Improved Cash Flow: Without a WTV, the Australian Taxation Office (ATO) will collect a predetermined amount of tax from an employee’s income throughout the year. With a WTV, the amount of tax is adjusted to better align with the actual annual liability. This means the employee could receive a bigger net income during the year, thereby having more funds to cover loan payments and other expenses.
- Better Budgeting: WTV allows property investors to plan their finances more effectively. By estimating in advance the annual tax liability, investors can avoid the stress of unexpected tax bills at the end of the financial year or, commonly, large lump sum tax refunds which could have been put to better use had the money been in their control throughout the year.
- Investment Expansion: For those considering expanding their property portfolio, WTV can be a game-changer. The extra cash flow generated from reduced withholding tax can be reinvested into acquiring additional properties or improving existing ones, ultimately accelerating your wealth-building journey.
Disadvantages of WTV’s
- Risk of Underpayment: Those who underestimate their tax liability may face penalties and interest charges from the ATO, or be refused the ability to again use a WTV in future years. Striking the right balance is crucial.
- Complexity: While the concept of WTV is straightforward, navigating the Australian tax system can be complex. Applying for a variation involves providing detailed financial information and may require the assistance of a tax professional.
How to apply for a WTV
- Gather documentation: Typical documentation required to support a WTV application includes income and expense statements, bank statements, and evidence of other related deductions used to calculate the estimated annual profit/loss.
- Seek professional advice: It is advisable to seek advice from a qualified tax professional or accountant. They can assess your financial situation and help you determine the appropriate withholding variation.
- Lodge an application: The application process can vary, so it’s essential to follow the ATO’s guidelines and deadlines.
- Annual re-assessment: WTV isn’t a one-and-done process. To ensure that your withholding aligns with your actual tax liability, you need to reassess and apply for a variation annually. Failing to do so could lead to underpayment or overpayment of taxes.
Case Study
John recently purchased an investment property for $750,000 using a 10 percent deposit. With a lease already in place, John expects to receive gross rental income next financial year of $510 per week.
After making provision for loan interest charges (at 6.5 percent) and other expenses such as insurance, council rates, repairs and property management fees, the estimated shortfall between rental income and expenses is $24,000.
Ordinarily, John would absorb the $24,000 shortfall throughout the year ($2,000 per month, excluding depreciation). After claiming the $24,000 annual loss on his tax return, he would then receive a refund of (say) $8,000.
Alternatively, if his application for a WTV was approved by the ATO, John’s employer would be authorised to deduct a prescribed reduced amount of tax from John’s salary. In this example, instead of a tax refund at the end of the year, John would progressively receive $8,000 extra net income during the course of the year.
Withholding Tax Variations can be a valuable tool for property investors, particularly those with income producing assets that are expected to produce a net loss during the coming financial year.
If considering a WTV, it is important to start by seeking expert advice and ensuring that you maintain compliance with Australian taxation laws to avoid any penalties or issues down the road.
WB Financial are advisors who tailor financial planning and advisory services that allows clients to travel the road to financial independence. Jason Cook is a non-Executive Director and Principal of WBF’s Woolloongabba office. You can contact Jason on 07 3391 7199 or email here.
Disclaimer: Taxation is a specialised field. It is important that people get specialist advice from a licensed professional. Propertyology is not a licensed taxation specialist.
