LOUISE FAIRSAVE: Investing and tax shelters
Taxes are as certain as life and death.
Government authorities in Barbados have introduced the VAT system. They have been reducing the level of direct income tax. To some extent, the expectation is that with less income tax and the resulting greater net income to employees, there will be an increase in spending leading to increased collection of VAT.
With an indirect tax system, everyone who purchases goods or services subject to VAT shares in the tax burden – employees, self-employed persons and investors. As the VAT system takes firm root, relief can be offered to those who are taxed directly through PAYE deductions by reducing the personal income tax rates.
So where the employee is assessed under the PAYE system, any tax payable is deducted there and then on pay days. The indirect tax system through the VAT will provide some means of balancing out possible inequities that may arise with respect to the self-employed.
There are opportunities to recover/earn extra net income using tax shelters. The Government typically provides tax abeyance incentives for taxpayers who spend or invest their earnings in specific ways.
For example, given the concerns about pension earnings for the baby boomers, Government has established a fiscal policy which encourages personal saving and investing towards retirement. In addition, tax abeyance incentives are also provided for investing in and/or the upkeep of one’s residence or for installing certain alternate energy facilities.
A taxpayer may thus decide to shelter part of his income from taxes by saving or investing in accordance with Government tax incentives. For example, a taxpayer may shelter the lower of 15 per cent of the assessable income or $10 000 from income tax if this amount is invested in a Registered Deferred Annuity (RDA), and/or a Registered Retirement Savings Plan (RRSP).
Say, this taxpayer incremental tax bracket is 35 per cent and that $10 000 is less than 15 per cent of his income and the full $10 000 had been invested. Then by investing this sum in an RDA, the taxpayer would be saving the 35 per cent of $10 000 or saving $3 500. The taxpayer would have earned an extra $3 500 for that income year.
The taxpayer may also elect to have deductions, which are consistent with applicable income tax incentives, made through payroll before income tax is assessed. The taxpayer would so pay less income tax than if the deductions had been included in the amount assessed for income tax. Net income to the taxpayer will be more although the actual cash received would be less.
Typically, it takes careful tax and cash flow planning in order to leverage the various tax incentives wisely. Advice from a trained tax planner is desirable. Particularly for persons who would otherwise have had a significant personal income tax liability, tax planning and income tax avoidance can provide another stream of income that would otherwise have gone into the Consolidated Fund.
In addition, the taxpayer would be expanding his annual retirement contribution by the tax saved, and so increase his invested funds and reduce the reliance on the state when retirement actually does come. Annual tax savings should be maximized within reason and within the scope of the overall financial objectives of the taxpayer.
Such tax savings provide extra earnings which can be saved or invested, earning compounded interest and generating capital growth.
• Louise Fairsave is a personal financial management advisor, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.