Federal Budget Review - 2010

Courtesy of PDY


Well what a difference a year makes. Cast your mind back to last year's Budget that contained dire predictions concerning rising unemployment and low economic growth. Combined with the Government's stimulus spending measures over the GFC period it was predicted at that stage that the Budget would not return to surplus for some six years.

The 2010 Budget is set against a different backdrop. Australia has come out the other side of the GFC remarkably well, unemployment did not reach the predicted heights, economic growth has been far better than expected and the predicted sharp falls in taxation revenue have not eventuated. Australian net debt is now forecast to peak at 6.1% of GDP - in sharp contrast to major advanced economies at above 80%. We are in much better shape than most of the world – notably Europe.

This budget is a "no frills” budget – perhaps somewhat unusual for an election year. A balanced budget is now predicted to be achieved in around three years. However, there are some new tax measures in the announcements that appear to be very much dependant on the well publicised resource rent tax on the mining sector. In that sense it may not be certain that these announcements become law until after the outcome of the Federal election later this year.

At the end of the Budget Summary we have also provided you with a special report on the status and outlook of the sharemarket which in many ways is intrinsically related to some of the Budget measures – most notably the resource rent tax.

We trust that you find the summary below of some interest and as always we encourage you to contact your PDY adviser should you wish to discuss any possible impacts on you or your business.

Business Tax

The well publicised RSPT is applicable to new non renewable resource projects. This new measure is expected to raise around $12bn and is the most significant single measure in the Budget and probably the most significant income tax measure in living memory.

Company tax rates will be cut from 30% to 29% in 2013/14 and then to 28% in 2014/15. However small businesses with turnover less than $2m will get the benefit of the tax rate reductions more quickly – to 28% by 1 July 2013.

These are obviously welcome changes but we question the low turnover limit for small companies and also the non application of the reduction to businesses operating under different structures.

The $1,000 instant write-off provision for small businesses will be increased to $5,000.

Small businesses will be able to allocate all non building assets to one "pool” and depreciate the pool at 30% per annum.

The government has announced complex measures aimed at making it easier for more businesses to restructure without capital gains tax consequences.

Investors will be eligible for a 50% tax discount on up to $1,000 of interest earned from 1 July 2011 on:
• deposits with authorised deposit taking institutions, bonds, debentures and annuity products; and
• the above investments where held indirectly via trusts or managed funds.

In a simplification of the tax system, a standard deduction of $500 will apply to work-related expenses and the cost of managing tax affairs from 1 July 2012, increasing to $1,000 from 1 July 2013. Taxpayers who wish to claim a greater deduction will still be able to claim their higher expenses in lieu of the standard deduction.

The previously announced changes to the personal income tax rates and thresholds have been confirmed. These changes are highlighted below.

The increase in the maximum low income tax offset to $1,500 per year from 1 July 2010 has been confirmed. This means the amount of tax-free income low-income earners can receive each year (and the upper limit to which a partial low income tax offset can be claimed) will increase to $16,000 and $67,500 respectively.

The Government confirmed its commitment in last year's Federal Budget to reduce personal income tax. The following table outlines how these tax cuts will apply to people on various income levels:

Investors aged 60 or over will still receive an unlimited tax-free income from pension investments commenced from a taxed super fund. See below for the amount of taxable income that can be received tax free by older Australians in other circumstances.

The Government will increase the threshold above which a taxpayer may claim the net medical expenses tax offset from $1,500 to $2,000 and commence annually indexing the threshold to the Consumer Price Index. The first indexation adjustment to the threshold will take place on 1 July 2011.

In the 2008 Budget, it was proposed:
• the benchmark interest rate for capital protected borrowings be lowered to the RBA indicator rate for standard variable housing loans; and
• any cost above the benchmark rate would be taken to be the cost of ‘protection', which would not be deductible and would be added to the cost base.
This proposal was never legislated. It's now proposed, with retrospective effect, that the benchmark interest rate will be the indicator rate plus 100 basis points.

The annual Child Care Rebate will be capped at $7,500 per child (reduced from the current cap of $7,778), and indexation will be paused for four years from 1 July 2010. Out of pocket expenses will continue to be rebated at 50% of the annual cap.

Henry Review Announcements confirmed:
• the super guarantee (SG) rate will increase gradually from 9% to 12% from 1 July 2013;
• the SG contribution age limit will increase from 70 to 75 from 1 July 2013;
• a Government super contribution of up to $500 pa will be made for people earning up to $37,000 pa from 1 July 2012 to effectively refund contributions tax; and
• the concessional cap for contributions to super will be reinstated to $50,000 pa from 1 July 2012 for people age 50 or over with super balances below $500,000.

The Government will permanently retain:

• the matching rate for the super co-contribution at 100%; and
• the maximum co-contribution payable on after-tax super contributions at $1,000.

This overrides the measure announced in last year's Federal Budget to reduce the matching rate and maximum co-contribution temporarily (as per the following table).
The Government also indicated the income thresholds for eligibility won't be indexed for 2010/11 and 2011/12.
The overall effect though is that the maximum co – contribution is now capped at $1,000:

 

Special Report - Recent Sharemarket Developments and Outlook

We would like to provide you with an update on some recent developments in global sharemarkets. There has been increased sharemarket volatility over the last few weeks but it is also important to be aware that the Australian sharemarket, as measured by the S&P/ASX 200 index, reached an intra-day high point on 15 April 2010 relative to its low point in March 2009. Following the recent market high point, the Australian sharemarket has retraced some of these gains and this has been driven by global and domestic events, primarily by issues in Europe as well as proposed Australian regulatory changes.

However, it is very important at times like this to remain focussed on the long term and to understand that volatility is a natural characteristic of the sharemarket. History shows us two key learnings - the sharemarket does recover after experiencing declines and it is important to "ride out” the volatility. These learnings have continued to apply over the more recent past.
As an example, from the March 2009 lows, the Australian sharemarket (as measured by the S&P/ASX200 Index) has rebounded around 45% as at the market close on 6 May 2010. Clearly this is a significant rise in a very short period.

Times like this also remind us of the importance of having a diversified portfolio with exposure to all the main asset classes. Diversification and a focus on the long term will continue to remain vital ingredients in the achievement of long term wealth creation.
Update on Recent Economic and Market Developments

Below are some key events that have occurred over the last few weeks. While there were some indications that markets have started to stabilise, global economic issues especially around the Greek debt problems have continued to emerge.

Over the last few weeks the main concern for investors has been the possible European debt contagion which has continued to drive markets down. While the Greek Government passed a set of severe spending cuts amid further violent protests, fears of the stability of the banking systems in several European nations including Italy, Spain, Ireland, Portugal and Britain continue to concern investors as the banking system could be impacted by further sovereign debt woes sparking what could be a new "credit crunch”.

At the European Central Bank (ECB) Meeting (6 May 2010), the ECB kept its main re-financing rate on hold at 1%.

As at the close of markets on 6 May 2010, some key European markets have declined in the last few weeks in the vicinity of 10% (the UK sharemarket) to 13% (France).
On 6 May 2010 the US Dow Jones index at one stage fell nearly 1,000 points, but recovered to close down 347.8 points (down 3.2%) for the day. The large fall was partly blamed on a technical glitch or mistake trade on the stock Proctor & Gamble which caused the stock to fall 37%.
However, daily sharemarket fluctuations in the range of -3% to +3% have been a common occurrence over the past 2-3 years relative to the longer term and such volatility is likely to continue in the future.

A very important point to be aware of is that despite recent volatility, sharemarkets around the world have rebounded strongly from the previous lows set in March 2009. Using the US Dow Jones index as an example, this sharemarket index is still up 0.9% for the calendar year to date (as at 6 May 2010) and up just over 60% from the March 2009 lows.

Despite further headwinds facing the global economy, fundamental corporate earnings growth appears to remain intact for calendar year 2010 and 2011. US corporate earnings for the first quarter of 2010 look pleasing and Australian second half 2010 forecasts are still improving with overall global equity markets remaining at attractive valuations.

In terms of the Australian dollar it remains extremely volatile, trading in a broad range between 0.87 and 0.93 USD.

Market Outlook

In summary, despite the current short term correction in global sharemarkets, overall equity market valuations continue to look reasonably valued on current earnings estimates. This is despite global structural risk issues related to the aftermath of the global financial crisis, specifically high Government debt and global unemployment, in addition to currency readjustments. These are issues that are anticipated to be a consistent theme for an extended period.

Global economic data has continued to improve over recent months with US calendar year 2010 quarterly reporting numbers continuing to pick up since the earnings lows of the fourth quarter of 2008. The weak US dollar combined with substantially improved productivity increases has provided the basis for a strong earnings lift for a significant component of companies within the US S&P500 index.

A key for US growth is the unemployment data which has continued to improve in recent months. Helping stimulate the US economy, the US Federal Reserve (Fed) continues to keep the accommodative monetary policy in place, and this is likely to continue for most of the rest of the year.

Corporate Australia's balance sheets remain strong with gearing levels for the ASX200 at the lowest levels for many years at around 27% for the Industrials component of the market.However, risks remain for the Australian sharemarket, notably a rising interest rate environment (official cash rates are now at 4.5% and possibly rising), an inflation rate of 2.9% (close to the Reserve Bank of Australia's (RBA) upper end range) and increasing regulatory risks, for example the proposed "Super Profit Resources Tax” on resource companies. The impact of proposed regulatory changes has been a detractor from the Australian sharemarket causing share prices to fall on "blue chip” stocks such as BHP and RIO Tinto. While the outlook for the Australian sharemarket and markets globally may remain challenging in the short term, it is important to remember that the Australian sharemarket has generated returns for investors over the 15 years ending March 2010 of 10.8% p.a. This is as measured by the S&P/ASX 300 Accumulation index which includes both share price movements (capital growth) as well as dividends (income).

Expected returns over the next five years for the Australian sharemarket are around 8-9% p.a. However, this does not mean that each year investors will receive 8-9% as there will be volatility and negative returns from time to time over this period. The 8-9% p.a. forecast is the expected average annualised return.

While the short term outlook for Australian and global sharemarkets may be uncertain and volatile, they have historically been solid investments, delivering strong long term returns. It is important for investors to focus on the long term and "ride out” any market volatility and look to possibility take advantage of oversold markets affected by short term "noise”.
Remain Focused on the Long Term

We understand investors' concerns in times of heightened market volatility. Whilst the risks and volatility inherent in investing may seem to prevail at times, losing track of long term objectives by focusing on the short term poses a far greater risk to achieving longer term goals than any past or present economic event.

While times like these may cause investors to question their investment strategies and consider increasing investments in cash and short term money-market products, this course of action may result in being worse off in the long run than staying with a well diversified plan and riding out the volatility. History has demonstrated that a large proportion of investors invest near market peaks and sell near market lows. While investing at market peaks is not the most favourable entry point, as markets grow over the long term, timing becomes less relevant.

As always it is really important that you notify us of any material changes to your situation, needs or objectives so we can ensure that our advice continues to remain appropriate.

If you would like to discuss your investment options further, please contact Rod.Dickinson@pdy.com.au or your PDY adviser.

 

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