It's been a while since I last wrote for Firstlinks, although if you check back over the years after Graham Hand and I founded its predecessor, Cuffelinks, you can read many of my articles. I'm still an avid reader each week, and about this time each year, I ask Graham to publish a small piece to make people aware of how they can receive a tax deduction on a donation now but choose charities to support later.
A best-kept secret to an immediate tax deduction
The month of June is often a catalyst for people to establish a structured giving account with the Australian Philanthropic Services Foundation (APS Foundation), which I still regard as one of the best kept secrets around. It's an especially useful structure for people who have done well in FY22 but have not had time to decide which charities to support.
APS Foundation is part of Australian Philanthropic Services (APS), a not-for-profit organisation I founded 10 years ago and for which I have been Chair during that period. I’m honoured to have on the Board other community-minded people such as David Gonski, Gail Kelly, Michael Traill, Jan Swinhoe, Tim Fairfax, David Ward and Dan Phillips.
In essence, APS offers fulfilling ways for people to manage their charitable giving over time using tax-efficient structures called ancillary funds. The APS Foundation is a what is known as a ‘public ancillary fund’. It enables an individual, family or organisation to put aside money in a trust to support charities over the long term. They are an efficient, satisfying and tax-effective way to put a structure around your philanthropy.
Put another way, the APS Foundation is a communal philanthropic structure in which you can establish an account within 24 hours (known as a 'sub-fund' or 'giving fund'). The minimum is $50,000 to establish an account. While you think about which charities to support from your giving fund, the Foundation’s giving funds are pooled and invested by APS. Returns are tax-free and accrue to your fund monthly, offering a style of giving that allows you to both give and grow money for charity as well as gaining a tax deduction.
The APS Foundation offers two investment portfolios:
- the General Portfolio was established in 2012 and is managed by me. It is well diversified across the full investment spectrum. The performance (after fees) has been 12.0% pa since inception, and
- The Focused Portfolio opened this month and is managed by David Wright (co-founder and CEO of Zenith Partners). It will be diversified across investment funds and individually managed accounts with an explicit responsible investing/ESG objective, or in funds that generate a positive, measurable social and environmental impact alongside a financial return.
More information about the APS Foundation can be found here.
The APS Foundation is the fastest growing public ancillary fund in Australia. The Foundation comprises more than 350 giving funds, totaling almost $200 million. Last financial year, APS Foundation supported giving fund holders to make $13.7 million in gifts to charity.
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I'll also take this opportunity to remind people about how some investment structures work and the tax impact of investing in June. It can be a trap for the unwary and cause unexpected leakage in tax.
The timing of tax on distributions from a unit trust
In a unit trust, all income received (including realised capital gains) is divided among unit holders based on how many units they hold at the time of a distribution. Unit holders must then include their share of this income (which may comprise dividends, interest, capital gains and franking (imputation) credits) in their own tax return in the year it was earned.
The same distributions are paid to all unit holders according to their holding on a particular day, whether or not the investor has been in the fund one day or one year. Distributions are not pro-rated for investors who were not unitholders for the whole period. An investor may receive some of their investment back immediately as income if they invested just before a distribution.
Immediately after a distribution is declared, the unit price of the fund will usually fall by the amount of the distribution, because the distribution reduces the fund’s assets.
Don't convert capital to taxable income
An investment in June that receives a distribution in July may be converting capital to taxable income. For example, if someone invests on 25 June 2022 when the unit price is say $1.00 and then a 10 cent per unit distribution is made on 30 June, the unit price will fall to 90 cents (assuming no market movement) at the beginning of July. The 10 cents will be taxable income in the hands of the unit holder in their 2021/2022 tax return.
Obviously, the worst consequences are for individuals with high marginal tax rates where the distribution includes no franking credits. This might be the case for a global equity fund which distributes once a year with no franking credits from Australian companies.
Alternatively, an investor such as a tax-free charity or super fund in pension mode in an Australian equity fund might pay no tax and receive a franking credit, so a June investment might actually be favourable for them.
The only way to eliminate these effects would be for the fund trustee to make a daily distribution, but clearly this is not practical. The more often a fund distributes income during the year then the less of an issue this distribution inequity becomes. For example, most Australian equity funds distribute twice per year but most international funds only distribute once per year.
Other funds with particularly punitive outcomes for unit holders who invest close to a distribution date might be actively-traded funds in a rising market. They might have large capital gains on shares not held for longer than 12 months (and therefore, not subject to the 50% CGT discount factor). The distribution might contain a large taxable capital gain component.
How do we handle the problem with the Third Link Growth Fund?
Many of you know I manage a unit trust, the Third Link Growth Fund. I consider this issue of such significance that from the start of May each year, I ask our administrator to contact every new applicant and check whether they understand the tax consequences. While this might cost us some application money in the short term, hopefully it builds a better long-term investor experience.
I also provide a health warning in the PDS for Third Link Growth Fund. It says:
"Distributions are not pro-rated for investors who were not unitholders for the whole period, meaning that you may receive some of your investment back immediately as income if you invest just before a distribution."
Anyone who invests in a unit trust in June should at least ask the fund manager for an estimate of the distribution and its tax components, unless they want to share the tax burden for prior investors.
Chris Cuffe is Chairman of Australian Philanthropic Services as well as Portfolio Manager of the APS Foundation. Chris is involved with many other groups as a director, chairman and investment professional. This article is general information and does not consider the circumstances of any investors. The views expressed are his own.