Developing your financial education is what the Inner Circle is all about. As a business owner, investor or employee you'll benefit from a knowledge of our taxation system and learning how it can work for you.

Why? Because following on from the introductory discussion I'll be outlining strategies you can use right now to reduce your tax bill.

With 2001 being our centenary of Federation, the message that Australia began as separate colonies is currently receiving a lot of press.

Income tax began as a tax levied by each State upon its citizens. Perhaps surprisingly, South Australia was the first Australian colony to introduce income tax in 1884, followed by New South Wales and Victoria in 1895, Queensland and Tasmania 1902 and Western Australia in 1907.

Looking at the dates above you can see that Income Tax remained a State based tax well after Federation in 1901. It was not until World War 1 in 1916 that Income Tax became levied by the Commonwealth.

It's accurate to say that Australia's first Federal Income Tax was levied to fund our involvement in WW1. It's also accurate to say that while the war ended, Federal income tax did not.

After the war, each State in its own right, together with the Commonwealth, levied and collected income tax. Although the Commonwealth income tax was consistent across all States and Territories, the State based Income Taxes were not.

With the Second World War escalating, the Commonwealth introduced a new war-time measure. This was designed to eliminate a system which was considered Federally as wasteful.

A new agreement was struck, with the central understanding that the Commonwealth would collect all income tax revenues, and then hand back a portion to each state for their own use. Despite this new arrangement, there is no Commonwealth constitutional restriction against States levying their own income tax.

After the introduction of the first Commonwealth income tax legislation in 1936, developments in income tax have been through further rewrites of the law by politicians and also interpretations of the law by independent tribunals and courts.

As someone who has studied tax law, I'm here to tell you that reading the Tax Act is a perfect cure for insomnia. It is difficult, cumbersome, and changing all the time.

Trying to set a precedent through court findings is also hard. In some cases, the ruling is different despite seemingly identical circumstances.

The result is the existence of a lack of certainty. Accountants are taught there is really no black or white in income tax, just arguments about shades of grey.

Imagine a stuffed teddy bear created in 1936.

Looking at it today, it's been restitched, repatched, handed down to many children, the colour has faded, an eye is missing and the smell is, well, suspicious at best.

So it was with our income tax system. The legislation first written in 1936 had been amended many times with new appendages, such as Capital Gains Tax, added on.

After so many rewrites, there existed many loopholes which clever taxpayers with the right financial resources could exploit. In trying to close the loopholes, new ones were exposed. Those working in the industry were united in the belief that change had to happen.

In 1993, the beginnings of change were sown when a special team was given the task of renumbering, restructuring, rewriting the original legislation. It was not going to be a process of setting new policy, just a complete overhaul of a system which had aged badly.

This good idea has become lost, as the only significant areas revamped were the income and deduction provisions. There has not been any rewrite of the original taxation laws covering companies, trusts, superannuation, partnerships or foreign taxation.

All in all, three instalments of the new legislation were enacted, the last of which generally covered the 1998/99 income tax year.

Now we have the worst of both worlds, as the old legislation needs to be read in conjunction with a partial rewrite reissued as new legislation. It's workable, but there's an understandably high turnover of tax accounting staff.

I've mentioned that the rewrite of the tax law was not meant to be a change in policy. This was done in a more dramatic way with the introduction of "Tax Reform. Not a new tax - A new tax system" in 1998. This was the new blueprint for reform, the centrepiece of which is the Goods And Services Tax (GST).

You may have heard about this in the press. The Ralph Report is the findings of a committee known as the Review Of Business Taxation, chaired by Mr. John Ralph.

Completed in July 1999, this report is driving a lot of the proposed changes to how businesses are being taxed and is very, very relevant today. Hundreds of recommendations were made; some have been introduced and others rejected. Some have been accepted and then rejected (e.g. Trust changes). All I can say is that the winds of change continue to blow.

Each State needs funding to provide the services they do. Since there is a shortfall between the amount of spending required and the amount of income tax revenue the Commonwealth distributes, additional State based taxes and duties exist.

Some of these additional taxes and duties are land tax, payroll tax, stamp duty, registration or licence fees.

Indeed, the Commonwealth Government cannot exist on income tax alone and has many other taxes and levies to fill its coffers. The most recently publicised of these is the fuel excise.

When it comes to income tax, it is up to the individual to prepare and lodge his/her income tax return by the due date under a system known as self-assessment.

Reading about tax is never easy. Here's a summary of what I've written so far.

There are many taxes and levies in Australia, one of which is income tax. This tax began well before Federation, when each separate State levied its own income tax on its citizens. The Federal government did not levy a separate income tax until the First World War, when it needed money to fund Australia's war effort.

Even after the war, both the individual States and the Commonwealth levied income tax. In an attempt to make the application of income tax consistent throughout Australia, the Commonwealth Government introduced legislation in 1936. This assisted, but did not solve, the problem as each State continued to levy income tax in addition to the Commonwealth.

This continued until the Second World War when the Federal government took over responsibility for collecting all income tax and then refunded a portion of what it collected back to the states. This distribution system remains today.

Since 1936 we have seen many rewrites and add-ons to the original Income Tax Assessment Act. After nearly sixty years it was clear that significant reform was necessary as we were losing competitiveness by being bogged down in an outdated and somewhat irrelevant (by world comparisons) taxation system.

In 1993 the Federal Government began the huge task of rewriting the original taxation legislation without altering any policy. This was going to be a big project, and by 1998/1999, some improvements had been made. But then the entire process was shelved, resulting in more confusion than if nothing had ever happened in the first place.

A second attempt at reform was instigated with the politically correct name of "Tax Reform. Not a new tax - A new tax system". This time, reform coincided with a big change in policy, and despite the fancy name, we have a new Goods And Services Tax in addition to our old, stagnant, inefficient income tax system.

But it is out of the mess that opportunities arise.

The amount of income tax you paid depends on how much taxable income you have. Taxable income is calculated by subtracting your allowable deductions from your assessable income.

The income tax payable is the amount of your taxable income multiplied by the applicable tax rate. Here's an example:

Fred is the sales director for Amzco P/L. His annual salary is $65,000 and interest income of $3,200. His allowable deductions are $2,000. To calculate how much tax is due the first step is to calculate Fred's taxable income.

The amount of income tax Fred has to pay is $66,200 multiplied by his applicable tax rate

Working out who pays the income tax depends on what entity you use to structure your affairs.

The table below identifies who is liable for income tax:

Now we know who pays the tax, let's quickly look at how the government gets the information necessary to calculate how much income tax is payable.

Australia now works on a self-assessment lodgement system. This means the income tax return you lodge is processed as is and then scrutinised later. Before self-assessment, income tax returns were filed together with all supporting documentation and the taxman would process the return.

Interestingly, the introduction of self-assessment signified a change in the mindset of the Federal Government. Instead of being an administrator, they are now a watchdog. The responsibility for filling in the right form, for the right amount, is now yours.

The form used to lodge your income tax return is pre-formatted and essentially serves as a massive data input sheet.

The data must be prepared a certain way so that it can be scanned and automatically input into the Australian Taxation Office's massive databases. The old days of someone manually inputting all the information are long gone.

OK, let's look at each class of taxpayer in more detail. This is necessary if the strategies I mention later are to make sense.

Individual taxpayers make up the bulk of taxation revenue and are the hard working backbone of this country.

Most individual taxpayers are covered under as system known as 'PAYG', which is an acronym for 'Pay As You Go' (previously 'PAYE').

Under this system employers must deduct tax from an employee's pay packet and remit it to the Australian Taxation Office on their behalf. The system is very stringent and offers little flexibility.

The Australian income tax system is designed to be progressive, meaning the more you earn, the more you pay in income tax. This is reflected in the tax rates charged on a person's taxable income as you can see in the table below:

Each income bracket is known as a threshold or bracket. Let's take Fred's example again...the tax on his taxable income of $66,200 is calculated as:

Individual taxpayers must also pay the Medicare Levy, generally imposed as an additional 1.5% of taxable income.

Individuals are the most disadvantaged class of taxpayer as there is little that can be done to avoid being taxed at the top marginal rate when you earn more than $60,000. Robert Kiyosaki's book, 'Rich Dad Poor Dad', identifies this problem and encourages people to stop being employees and become either investors or business owners.

A trust relationship is where one party (called the trustee) holds income or property for the benefit of the other party (called the beneficiary). It is created with a legal document and is not a separate legal entity for legal purposes.

The trustee has a unique fiduciary duty to act in the best interests of each beneficiary in the trust.

There are many different types of trusts. For the purposes of this newsletter I'm just going to outline a discretionary trust.

A discretionary trust is where the Trustee decides in his/her/its discretion as to how the income and assets of the trust are to be distributed.

With this discretion comes flexibility to distribute income to beneficiaries and take advantage of lower marginal tax rates.

The Government knows about this practice and tried to close the loophole, but recently abandoned plans to tax trusts as companies fearing a voter backlash at the next election. Legislators seem to think anyone using a trust structure is a tax avoider.

The net income of a trust is usually distributed to the beneficiaries of that trust. There is little benefit in retaining any income in the trust, since it is taxed at the highest marginal bracket (47%).

Practically, the net income of the trust is distributed to the beneficiaries (at the discretion of the Trustee), who are then taxed on that distribution on their own income tax return, not the trusts.

Trusts are an excellent tool for protecting assets as you do not own the asset, yet it is held in trust for your use. Should you be sued then the asset cannot be touched.

While the taxation of trusts is a complex area, there are still benefits available now the government has taken reform in this area off its immediate agenda.

Companies are treated as a separate legal entity and as such they can do pretty much anything a normal human can do except vote.

Unlike Trusts, where the net income is usually distributed to the beneficiaries who pay tax on that distribution, companies pay tax in their own right. Any money distributed from a company comes from reserves 'below the line' rather than a distribution of pre-tax income.

Company distributions (normally called dividends), are taxed in the hands of the recipient and a credit is allowed for any tax which had previously been paid by the company.

If individuals are the backbone of the working class, companies are the domain of the entrepreneur. Entrepreneurs create jobs and fund election campaigns and despite what the Government might like to say publicly, reducing the benefits associated with companies would have a dramatic impact on employment and investment in this country.

As a separate legal entity, a company pays tax in the same way an individual does with generally two exceptions. The first is the company tax rate is a flat 34% for the 2000/2001 income year and falls again to 30% in 2001/2002.

The second exception is a company does not pay any Medicare Levy.

For individuals, the highest after Medicare tax rate is 48.5%; companies pay just 34%.

Playing around with numbers, once an individual has more than, say, $75,000 in taxable income it is more advantageous tax wise to use a company.

But don't be quick to think you can just transfer from being a high paid employee to a company director...the government closed that loophole a long time ago!

Usually, when I mention the word 'partnership', people think of two or more individuals in some sort of business relationship. In reality a partnership can be between any sort of entity - you can even have a partnership of a partnership.

Partnerships are not separate legal entities, and any taxable income is divided between the partners and recorded on their own income tax return.

Three years ago I realised being an employee was a poor option. I was being taxed at the highest marginal rate, taxation laws stopped me from calling myself a contractor, I could only ever spend in after tax dollars, my wages were eroded with compulsory superannuation and I hated ironing shirts every Sunday night.

Being an individual means you are probably "taxationally challenged". In making the transition to where I am now, I needed to start working within the parameters the taxation system allowed, rather than fighting tooth and nail against it.

Today I don't earn a salary, yet nearly everything I require is funded from either my company or personal trust. I legally minimise my taxation to almost zero - and any tax I do pay is only on cashflow profits, so I don't mind. As I write this I still haven't legally lodged my 30 June 2000 return, yet the normal deadline for individuals was the end of October 2000.

I don't have to pay any compulsory superannuation since I have no salary, yet my automatic investment plan has magically accumulated $15,000. I have my overseas trip fully tax deductable - in fact, I'm even paid a living away from home allowance while I'm away.

Each month someone in the office wins an 'employee of the month' and receives a lunch or dinner paid for by the Company. At Christmas we can send ourselves a Christmas gift fringe benefit tax free.

I've spent a lot of time telling you about how the tax system is set up, and I've talked about the different classes of entity and how they're taxed. You now know the system is disadvantageous for most, but not me. It's now time to reveal how I'm able to play within the rules.

Earlier I mentioned that if you have a trust then the net income of that trust is usually distributed to the beneficiaries each year.

The taxman allows you to distribute up to $643 per annum to a child with no other income, tax free. Now depending on what your trust deed says, you may be able to distribute to your nieces and nephews too.

Let's imagine you have three minors who are beneficiaries of your family trust. That means you can distribute to them $1,929 per annum tax free. Is that the limit of your saving? No! The $1,929 is, for those on the top marginal rate, an equivalent of $3,977 of salary income.

Would you like an instant pay increase of $3,977 per annum on behalf of the taxman?

Your child who sits around all day long eating you out of house and home may actually be a huge tax saving. Each adult is allowed to earn up to $6,000 before any tax is levied. Adding the low income rebate, this figure increases to $6,882 per annum.

As outlined in the first point, if your child does not have any other taxable income, your family trust can distribute up to $6,882 to them and that money will be tax free.

For those on the top marginal bracket, this is the equivalent of an extra $14,189 per annum, per child above 18 years old without any other taxable income.

This strategy is ideal for people with children entering University and require the support of their parents to fund them through it.

Do you have a spare room cluttered with junk? Why not make it a dedicated office where you could carry on a business? Doing this unlocks a whole range of tax benefits. It can't just be an office or study where you do some work which can't normally be done at work.

Generally the following conditions must be met to qualify:

a) The area must be clearly identifiable as a place of business (perhaps a plaque by the front door saying the business name).

b) The area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally (the unwritten rule is to not have a bed in the room. Perhaps a dedicated phone line is a good idea).

c) Whether the area is used almost exclusively for business purposes (it can't just be a convenience...it must be a dedicated business area. Remember, no beds).

d) Whether the area is used regularly for visits by clients and customers (this is of decreased importance if you run a web based or network marketing business).

If you have your home as a place of business what can you claim? Here's a list as a guide:

• A portion of the interest on your home loan or rent, council and water rates.
• A reasonable estimate for the cost of heating and lighting the area.
• Depreciation, insurance and repairs to fixture and fittings within the room.
• An allowance for cleaning, toilet paper and amenities (tea, coffee, biscuits, toilet paper etc.)
• Maintenance and decorating and perhaps a portion of repairs.

Is it worthwhile? I wasn't sure until I added up all the costs. For example, the area in my home is about 20% of the available space. We pay $210 per week or $10,920 in rent per annum. My allowed deduction is $2,184 for rent alone. Trust me, it adds up!

The strategy is to change the nature of as many expenses in your house as possible away from private and domestic (which isn't deductible), to business related (which is deductible).

There are limits to what you can do, but remember, the system allows some flexibility for those who work within its boundaries.

You may have heard that the Government is changing the way they tax trusts. Some changes have been legislated, while others have been put on hold.

What is known, is that for the 2002/2003 year the maximum tax rate applicable on trust income will be 30%.

Some commentators are saying tax reform is the worst thing to ever happen. But to a minority of others who look for opportunities that change inevitably brings, the new trust laws will just mean that the maximum amount of tax anyone ever needs to pay is just 30%.

How? Well, the way the law is at the moment, a trust's net income is taxed at 48.5%, but once the changes come in and trusts are taxed as companies, the rate will fall to 30%.

Previously, complex tax structures existed which corporate beneficiaries used to cap tax rates at the company rate (i.e. once the individual's beneficiaries tax rates went above the company tax rate any surplus income was just distributed to the company).

Now, this is no longer necessary as, if the individual beneficiaries tax rate goes above 30%, you can simply retain the money in the trust and pay tax. Trust money can be distributed in future years with a credit for the tax already paid, similar to the current system for companies and franked dividends.

The first thing I'd like to say here is that you are allowed to claim the expense of seeing your accountant as a tax deduction. Now, if you're in Sydney and your accountant is in Melbourne, then the cost of a trip to Melbourne is generally deductible (subject to a few provisos).

So long as the predominate reason for the trip is to see your accountant, then the cost is deductible. If you add on an extra for sightseeing, then, generally, that's ok.

Let's imagine you work for BHP. It's conceivable that they would send their company director's off on corporate retreats. If you're a director of your company, why not do the same?

Sure, you'll need to actually have a meeting and take minutes, set resolutions and goals and generally be productive...but these retreats are also about bonding as a team.

Just because you have a private company and BHP is a public company does not mean you cannot claim a deduction. So long as there is a link between the expense and business income, then it should be reasonable.

So far I've been able to highlight tax advantages if you have a trust or company. Here's one for employees. Normally if you receive a benefit from your employer then it is subject to Fringe Benefits Tax (FBT).

An employer will usually 'package the benefit', that means they deduct the cost and FBT from your overall salary. For example, if you're provided with a car then the employer usually deducts the cost of providing the car and the FBT associated with it from your package.

Where once salary packaging was a great tax planning tool, the Government has today made salary packaging far less attractive.

But there is still some opportunity within the system. There are some items which are FBT exempt which you can package, meaning you pay for them out of pre-tax dollars. Here's a short list to highlight the sort of items that may be eligible:

• Mobile phone (provided the primary use is for business)
• Calculator or tool of the trade
• Electronic diary
• Portable computer (one per year per employee)
• Membership fees and subscriptions to a trade or professional journal
• Newspapers and periodicals (used for business purposes)

Here's how it works. Let's say you want to buy a laptop computer. You get a quote at $5,000. Normally that $5,000 would be paid for with your after tax salary. If you earn $70,000 per annum (plus superannuation) then here's an analysis of the figures.

But what if the computer was packaged? Here's how the figures change:

You end up saving $2,420.50 after tax dollars by just taking advantage of what the system allows.

Paying taxes is not the dreadful thing some people think it is, provided you pay the lowest amount legally permissible, and also control when you pay.

The date for paying company tax is set and there is little flexibility that can be offered for paying company tax. But individuals and trusts can take advantage of the tax agent lodgement system to legally delay the payment of tax.

This is like having the government provide you with an interest free loan for the amount of your tax bill for up to five months!

And all you have to do is use a tax agent to lodge your return, which is what the Government wants anyway to cut down on their administration.

Normally, individuals and trusts have to lodge their returns by the end of October each year, but the tax agent lodgement system allows agents to maintain a progressive pattern of lodgements. A tax agent must comply with the Australian Taxation Office lodgement program, but often payment can be legally delayed for up to five additional months.

I know I'm happier with the money in my account than in the Governments, even if only temporarily!

I've now highlighted seven strategies which allow you to legally minimise your tax bill as a business, investor and employee. I now have to give you a warning...it is illegal to avoid paying tax or go into a scheme or arrangement designed to avoid tax.

When the anti-avoidance provisions were first introduced, the then Treasurer announced such provisions were designed to operate against "blatant, artificial, or contrived arrangements, but not necessarily cast unnecessary inhibitions on normal commercial transactions by which taxpayers legitimately take advantage of opportunities available for the arrangement of their affairs."

Practically speaking the anti-avoidance provisions operate where there is a scheme whose sole or dominant purpose was to provide a tax benefit, and a tax benefit was derived from its use.

The tax laws are complex. It is enough to say that in introducing any of the ideas above you must be genuine in your attempt to seek a commercial or business benefit, rather than simply trying to avoid tax.

There are so many legal ways to minimise your tax - there is no need to do anything dodgy.

As someone seeking to increase your wealth you must have a basic level of understanding about taxation and how it applies to you. You now know how taxation law has evolved in this country and you also know seven very practical strategies designed to save you income tax immediately.

Being able to use just one of the strategies above should return to you an instant tax saving which makes the cost of Inner Circle membership look abysmally small. I can point you in the right direction but you need to take action.

I encourage you not to sit on this. The time for tax planning is well before year end, acting in retrospect dramatically reduces the options available to you. As Dave Bradley says, the time to solve June 2001's tax issue is not in December 2001...it's before June 2001.

I know that Tim and Dave are planning our tax obligations and strategies right now for the 2001 year...what are you doing?

My aims for writing this newsletter is to educate you more about Australia's taxation laws and identify areas where you can immediately save tax.

The strategies identified above work. I know because I'm using most of them myself. The task for you is to think about how you can apply them too.

If you have any general questions or queries I invite you to post them on the Inner Circle forum board.

All material is provided as an information service only and should not be relied upon as a substitute for commercial or other professional advice. Inner Circle members are strongly advised to use the services of a competent tax accountant to help them understand more about Taxation laws and how to minimise their income tax liability.

3. I recommend you surf the Internet under accountants and sign on for a few free newsletters and see what sort of information you can access at no cost.