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Getting in Early and Out Tax Free

In 1895 a small mining company was established in western New South Wales. At the time no-one could have known that this company would go on to become the Broken Hill Proprietary Company (BHP) and be worth over $40 billion in today’s money.

There are hundreds of other instances where a small investment when a company was just starting-up would now be worth significant amounts of money.

Of course, the problem is identifying the BHPs of tomorrow is almost impossible and even if you could accessing these opportunities is difficult, as minimum subscription amounts are generally beyond the average investor’s financial reach. As a result large institutions and a few high net worth individuals have dominated this market.

However recent changes have now made it possible for small investors to access these investments in a very tax effective manner.

A pooled solution with tax benefits
Pooled Development Funds (PDFs) were established through the Pooled Development Funds Act (1992) with the aim of encourage investing in Australian small to medium sized companies.

A PDF typically provides investors with access to a range of companies across a range of industries thus reducing the risk of just investing in one company and increasing the chance of investing in a giant of tomorrow. Some PDFs are also listed on ASX making it easier for investors to trade in and out of the particular fund.

Since PDFs are designed to promote investment in growing companies they also offer some very attractive tax incentives. In particular PDFs offer investors an exemption from income and capital gains taxes on any income or capital growth arising from the PDF.This means any dividends received or capital gains made are tax-free. So:

  • Any unfranked dividends paid by the PDF are tax-exempt.
  • Any franked dividends paid by the PDF can be treated either as being exempt from income tax or assessable with the franking credits. Franking credits are calculated at the 30% corporate tax rate, despite the PDF only having to pay 15%, creating additional credits for investors.
  • Capital gains are similarly exempt however; any capital losses on the sale of holdings in a PDF cannot be claimed as a tax loss.

A range of PDF opportunities
Examples of ASX-Listed PDFs with solid performances for the 12 months to 30 April 2004 include:

· Authorised Investments, 119.46%

· Biotech Capital, 78.72%

· Strategic Pooled Development, 34.28%

Most PDFs will usually trade at a discount to the underlying value of their assets (or Net Tangible Assets), which may offer potential for value-seeking investors. Current examples of funds trading in this manner include Biotech Capital, First Wine Fund, JAM Development Capital and Strategic Pooled Development.

PDFs tend to be volatile in the short-term and so may allow traders to benefit from short-term changes in price, however investors should view PDFs as a moderate to high risk investment that requires a 5-year time horizon order to ride out the short-term volatilities and benefit from the long-term growth potential of the PDFs’ investments.

Another issue to watch out for is the liquidity of the PDF. It can be difficult to trade out of a position if the liquidity is low but having the PDF listed on ASX makes it easier to monitor turnover and liquidity.

Further information on PDFs can be found on the ASX website www.asx.com.au or please email ASX.

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