Tax Mitigation Strategies oh Tax Mitigation Strategies

1st time I heard about this 4D. Not the MAGNUM 4D. 

By Richard Oon / Aug 26, 2013
Minimising the tax exposure on your property investment will go a long way towards maximizing the hard-earned yield on your property investments. To develop a game-plan on how you can minimise your tax exposure, you must first have an understanding of what the law allows you to do legally. Practically all tax strategies involve structuring a transaction to obtain the lowest exposure to tax by using one or more of the following overlapping strategies, which I’d like to call the 4 D’s: • DUCK • DEDUCT • DEFER • DIVIDE The 4 D’s are elaborated as follows: Duck – No, I don’t mean a water bird with a broad flat bill and webbed feet, neither do I mean ducking away from declaring your income! ‘Duck’ in this context, refers to avoiding unnecessary penalties by understanding your responsibilities as a taxpayer under the SAS. Filing your tax returns incorrectly or making your tax payments late will result in penalties. Ducking penalties therefore will save you a lot of your hard-earned money. Deduct – Maximise your claims for tax deductions and reliefs which are due to you. Many are unaware of what expenses that they can legally claim to reduce their taxable income. The types of expenses that you can claim for income tax and real property gains tax purposes are explained further in have been explained in my earlier articles. In addition, do not overlook or under-estimate the power of your personal reliefs. Many may have maxed out on their claims for personal reliefs such as life insurance, medical and education insurance, but you still have an opportunity to take advantage of newer personal reliefs such as contributions to the deferred annuity and private retirement scheme of RM3,000 and the increase in contribution to the Skim Simpanan Pendidikan Nasional of RM3,000 to RM6,000 which took effect in recent years. Remember, besides the product benefits, your investment in those products can potentially give you a first-year return of up to 26% of the amount invested, which is reflected in the reduction of your annual tax bill! Been putting off buying a new computer for yourself because you can’t bear to part with your money? Then look at this way; you are entitled to a relief of up to RM3,000 for purchase of a computer every 3 years, Depending on your personal income tax bracket, the government is effectively subsidising your purchase possibly as high as 26% of the cost of your new computer! Defer – There are certain situations that you can defer payment of taxes. A tax-deferral strategy means putting off the taxes you need to pay now to a later year. Tax-deferral would have the following advantages: 1. Using the financial concept of ‘time value of money’, it is better to pay a ringgit of tax tomorrow than it is to pay it today. This is because the money saved on taxes today would have an opportunity to earn interest and due to inflation, the same amount of money would worth less tomorrow. 2. As Malaysia moves toward becoming a developed country and in order to remain competitive with other countries in the region, the general opinion of many is that the tax rates in Malaysia will reduce gradually in the upcoming years and hence, one would end up paying less tax in future years as compared to now, on the same amount of income. There are several ways where tax can be delayed to future years. The basic principles behind this strategy are to postpone the recognition of income to future years or to bring forward expenses which qualify for tax deduction to an earlier year. For example, if you have been meaning to carry out repairs works on a property which you have rented out, carrying out the repairs in December of one year means you’ll enjoy a tax deduction on that expense for that year, as opposed to carrying out the repair works in January of the following year where you’ll only get a deduction for this expense in the next year. In the case of real property gains tax, the deferment of the sale of a property (if possible) can save a substantial amount of taxes. The tax rates gradually decrease from 15% for sale of property within 2 years from the date of its purchase to 0% for sale after 5 years of ownership of the property. In most cases, by merely paying attention to the date on the Sale and Purchase Agreement, a property owner by postponing the sale of his property by a matter of weeks may be able to lengthen his period of ownership from say, 2 years to 3 years which will mean a reduction of a 5% tax rate from 15% to 10%. Divide – This strategy involves ‘income-splitting’ ie. where situation permits, dividing income among several parties in order to reduce the overall tax incidence. This is best illustrated by looking at a graph of the income tax rates of individuals, below: Graph 1: Income tax rates of an individual taxpayers As you can see, tax rates at lower bands of chargeable income are lower and progressively increase as the bands of chargeable income increase. For example, if a person is paying tax on a net rental income of RM70,000, he will be subject to a tax rate of 19% (Line 1, Graph 2). However, if there were 2 persons (eg. husband and wife) paying tax on RM35,000 income each, each person would be subject to a tax rate of only 6% (Line 2, Graph 2)! Naturally, anyone would prefer the second scenario. Graph 2: Comparison of effective tax rates ‘Income-splitting’ may also be achieved by using a special purpose vehicle such as a private limited company (company) or a limited liability partnership (LLP). These vehicles, being separate legal entities, will be taxed on their own right, distinct from the income of that of the owners. A company with a paid-up capital (or in the case of a LLP, capital contribution) of not exceeding RM2.5 million at the beginning of a basis period for a year of assessment will be subject to an income tax rate of 20% on the first RM500,000of its chargeable income while the balance taxed at 25%. It is interesting to note that an individual will already be subject to income tax at a rate of 24% or 26% on his chargeable income exceeding RM70,000, which is higher than that of a company or a LLP (Graph 3). Graph 3: Comparison between the income tax rates of an individual and a company/LLP Now, with proper advance planning, if the same individual, say together with his spouse incorporate a company or a LLP (both business vehicles require a minimum of 2 persons to incorporate) and has the ability to ‘split’ part his income effectively into the said vehicle, then the income received under that vehicle will be taxed at a rate of 20% on the first RM500,000 of its chargeable income (Graph 4). This means that the individual would save a maximum of 6% in taxes (individual’s highest tax bracket of 26% - 20%), which can be quite substantial in tax savings. In the scenario of a property investor, acquiring new properties through the company/LLP and deriving rental income therefrom can achieve this tax savings. Graph 4: Most efficient tax scenario will be where the individual has a chargeable income of RM70,000 while the balance of income ‘split’ into a company/LLP, as illustrated by the vertical line above. However, there are annual running costs involved in the case of a company/LLP such as audit fees, secretarial fees, etc. so therefore you must consider these incremental costs involved so you need to achieve a positive cash position (tax–savings deduct annual running costs) before this scenario becomes viable.

Graph 1

Graph 2

Graph 3
Graph 4

Ways to Save Tax:


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