Tax optimization (Courrier des investisseurs #4)

Sabaidi light! Whatever you do, do it well. "The saints who are in the land, The godly men are the object of all my affection." (Psalms 16:3, LSG) "In his right hand is long life; In his left, riches and glory." (Proverbs 3:16, LSG)

"Render to every man his due: tax to whom you owe tax, duty to whom you owe duty, respect to whom you owe respect, honor to whom you owe honor." (Romans 13:7, Segond 21)

"Go to the ant, you sloth! Observe his behavior and become wise: he has no boss, no inspector, no superior; in summer he prepares his own food, during the harvest he gathers enough to eat. Lazy man, how long will you stay in bed? When will you rise from your slumber? You want to doze a little, rest some more, just fold your hands and sleep? Poverty will surprise you like a prowler, and misery like an armed man" (Proverbs 6:6-11, Segond 21).

1. Tax optimization or tax exemption

2. Tax optimization does not guarantee profitability

Very often, when it comes to investment, taxation is the last thing on everyone's mind, if at all. Admittedly, not all countries are in the same boat. For some, taxation is like an (unstable) rollercoaster. For others, it's like Kilimanjaro. You literally feel like you're being ruined by the state. Fortunately, there are those for whom it works, even very well. It's clear, easy to understand and, above all, not exorbitant.

Taxation is necessary. Tax revenues regulate economic activities, finance investment and public spending. Taxation encompasses all the rules, laws and practices governing the collection of taxes. Taxes are compulsory financial contributions imposed on legal entities and individuals according to their income, activities (social and professional categories), transactions, property and dwelling locations, and possibly their age. Taxes are applied to specific products or services. They are the monetary counterpart of a public service (e.g. household waste collection).

In many countries, low-income earners don't pay taxes. This is one of the reasons why many countries have chronic public deficits. I believe that everyone should pay a minimum tax, because everyone benefits from a minimum public service.

 1. Tax optimization or tax exemption

In investing, knowledge can provide gains and avoid losses. The aim is not to know everything, but to understand what you need to know. Tax exemption, also known as tax optimization, is a set of measures used by governments to encourage investment, direct investment (where it is needed), regulate competition or give a competitive advantage.

Tax exemption solutions can be real estate, professional or financial. Tax relief gives the right to a tax reduction, credit or deduction in exchange for an investment.

• A tax deduction is a reduction in taxable income or the tax base, i.e. the income subject to taxation.

• A tax reduction is a reduction in the amount of tax due.  If the amount of the tax reduction exceeds the amount of the tax, it is refunded or carried forward to future tax years.

• A tax credit is a payment of a sum by the State for an investment or for employing certain people (e.g. home workers).

Here are a few examples (check to see if they apply in your country):

• The amount calculated for your income tax is €1,000. You make a donation of €200 to a charitable organization, which entitles you to a tax reduction of 65%. Your tax reduction is €130 (200*65%).

  
  

• You buy a studio or apartment under certain conditions, which entitle you to a tax reduction. The reduction is calculated according to the age of the property (new or very old), the location of the property, the amount invested, the use made of the property and the minimum commitment period.

  
  

• Professional expenses are tax-deductible in your country.  This year, these expenses amount to €3,000. Your taxable income before deductions is €50,000. Your tax bill will be calculated on €47,000.

  
  

• You set up a business in an innovative, craft or educational sector, or locate your company's headquarters in a special economic zone. Your company will benefit from a tax reduction over one or more years.

• You invest part of your salary or savings in the Plan Épargne Entreprise (PEE) or Plan Épargne Retraire (PER) of the association or company that employs you. The sums invested are not subject to income tax. You benefit from a tax deduction.

• You invest part of your savings in startups and social enterprises. You benefit or will benefit from a tax deduction or reduction on your income, the dividends you receive or any capital gains you make if you sell your shares after a few years.

  
  

• You pass on a business, land or property to your descendants, a charity or a public body (town hall, schools, hospitals, university) free of charge. You benefit from a tax deduction or reduction.

 2. Tax optimization does not guarantee profitability

Tax exemption is important, but it's not an end in itself. Getting a tax break is no guarantee of profitability. It's very important to understand this. Paying less tax means reducing your expenses, not making money.

Example1

• It's better to invest at a 5% yield with 35% taxation than to invest at a 2% yield with no taxation. The first investment will yield 3.15% (5% - 35% of 5%). Compared to the 2% of the second investment, it is obviously more profitable.

  
  

Example 2

• Let's say you're buying a house for €200,000. To top up your €50,000 down payment (your savings), you've taken out a €150,000 loan repayable over 15 years at a fixed rate of 4% (including borrower's insurance) in fixed monthly instalments. This works out at a monthly payment of €1,110. Let's assume that you rent out this house and that it generates an average additional income of €1,300 per month.

  
  

• Let's estimate that the average, the sum of property tax, insurance costs, maintenance charges, and possibly management fees, is €200 per month.  The net income generated by this apartment is therefore €1,100 (€1,300 - €200). After deducting the loan repayment, your return on investment is a monthly loss of -10€ (1,100€ - 1,110€), or 1,800€ over 15 years.

• From the outset, is this investment profitable? 🙂 In what year will this investment pay for itself?
  

• The decision to invest will depend on your personal goals and current priorities. If you can afford a monthly loss of €10 for 15 years, you'll invest. If not, you won't. If your priority right now is to supplement your income to finance another project or cover expenses, this investment is not what you need. 

  
  

• Let's assume that at the end of 15 years, the value of this house is €180,000. The opposite is possible, but let's be optimistic.

  
  

• In the sixteenth year, you decide to sell the house. Let's say that, after deduction of taxes and notary fees (which vary from country to country), you receive €160,000.

  
  

• Remember, you've already paid off your loan in full 🙂 In the end, was the investment worth it or not?

  
  

Let's assume that the purchase of this house will entitle you to a tax reduction of €5,040. You could use this tax saving to gradually build up your savings for a future project. What do you think?

Tax deductions and reductions are conditional and time-dependent. It is strongly recommended to define an objective (priorities) beforehand, and then weigh up the short and long term before making a decision.  What is a short-term disadvantage may be a long-term advantage, and vice versa. Remember the difference between valuation and yield. There's no need to rush or procrastinate. Take action gradually.

We speak of appreciation if the object of the investment has increased in value over time. The capital gain is the difference between the sale price and the purchase price.   Return on investment (ROI) means that the investment generates regular income (e.g. rent) or regular payments (e.g. from customers). Return on investment (ROI) is an indicator for measuring and comparing the return on an investment. The general formula is: [(gains or returns - investment costs) / investment costs]. The payback time is the time required to recover the initial cost of the investment (i.e., return on investment equal to zero).

🙂 Choosing GOD will always be the best choice. His will is the best. His method is the best. His time is the best. There are not only beautiful stories. There are also long nightmares.  Copying and pasting without wisdom and without the inner witness of the HOLY SPIRIT could lead you to ruin.

** Sabaidi = Good morning in Lao (Laos)