How to structure trading accounts to minimise tax - Trusts, Corporations?

[arbsystrader]

Hi All,
I have been trading profitably for 4 years and am in the highest tax bracket.
I have been paying stupid levels of tax, which I am now looking to minimize as I have a family member who wants to pool assets for a trading account.
The account is reasonably high turnover, so from ATO's perspective the profits are treated as income.
I have been examining how to best structure this. Does anyone have any advice on the relative pros/cons of Trusts, Unit Trusts and Corporations in terms of taxation and costs?
Cheers

 

[willy1111]

Heya,

Considering your treated on revenue account rather than capital, ie no capital gains discount. For mine, I would look at doing the trading in a company, with the shares of the company owned by a family trust or perhaps 2 family trusts (one yours and one your other family member).

In laymans terms the major difference btw a Trust and a Company is a Trust will allow you to take advantage of Capital Gains discounts whereas a Company won't, but since you won't have CGT discounts that takes away the advantage of a Trust over a Company.

A company allows you to retain profits in the company and caps the tax rate at 30%, maybe down to 27.5% if turnover is under $10m. The ATO are planning to reduce it down to 25% over the next 10 yrs for all businesses. If you are looking to keep profits in the business and compound profits over long term this is advantageous to paying tax on profits at the top marginal rate in your personal name. However if you wish to take profits out for personal use, whatever you take out will be added to your other personal income and taxed at marginal rates. So in effect it is a tax deferral tool until you wish to take money out of the company for personal use. You can choose how much and when you take it out. This is usually done in the way of the company paying a dividend. A dividend must be paid in the ratio of who owns the shares, and you also get a tax credit for any tax the company has paid, called a franking credit. So if the shares are owned 50-50 with you (either individual or via trust) and your family member, when dividends are paid out it has to be done 50-50, if ownership is 75-25 when dividends are paid it has to be paid in same proportion.

If shares in the company are owned via a family/discretionary trust, then when the company pays a dividend to the trust, the trustee has discretion on where those funds are distributed, and can distribute them to take advantage of personal income tax rates, there is no ratio/prorata rules, one year the trustee could distribute 50-50, another year it could be 100-0, the trustee has total discretion unlike a company dividend. If you are single it probably doesn't make much difference, but if you have a spouse it will save quite a bit in tax. Assume just you receives a $180k dividend from company to trust that flows to you, tax on $180k would be approx $57,832, whereas if you were able to split it 50-50 with spouse so 90k taxable income each, tax would be approx $22,732 x 2 = $45,464 a tax saving of approx $13k.

A unit trust is owned by unit holders, somewhat similar to shares in a company, so the units can be owned 50-50, 60-40 whatever you decide with your family member. When a Unit trust makes a distribution it also has to be done in same proportion as those that own units, there is no discretion like a family/discretionary trust. As with all trusts all profits must be distributed or they get taxed at top marginal rates. One may use a Unit Trust in preference to a company if the activities of the trust may make it eligible for a CGT discount in the future, if there aren't likely to be CGT discounts in future I would say a Company would outweigh the benefits of a Unit Trust.

Shares of the company are an asset, so if a shareholder was to be sued, they are quiet likely up for grabs. So if you own the shares individually, there would be no more asset protection than doing it all in your own name. If the shares are owned by a trust it adds a layer of protection, for if you are sued personally/professionally or your family member is sued it wouldn't matter as you don't own the shares, the trust does. And nobody owns the trust so if all it does is own shares in a company that carries on a trading business then it has pretty much no chance of being sued.

A trust has to distribute all trust profits each year otherwise tax profits get taxed at highest marginal rate, whereas a company can retain profits and pay tax at company tax rate, currently 27.5 to 30%, to distribute at a future date for personal use.

As I see it they are the major advantages of the above structure you would also need to consider how you are going to get funds into the company, normally via a loan from you/family member but this should be documented with a loan agreement. Also need to consider what would happen if one of you dies or becomes incapacitated, who takes over the entity to disburse funds to your will/family members etc. Also how you calculate who is entitled to what profit, say you both put $100k in each, so you split profits 50-50 which is easy. But say 2-5 years down the track the account has grown from $200k to $400k and your family member wants to take out $50k to spend on a car/holiday/boat but you don't. Now you have a pool of $350k, 200 yours and 150 your family members as the fund grows to $500k how do you calculate your portion and there portion...it may become quite complicated.

Each entity would cost roughly $1,200 ish to setup varies amongt professionals. You can do online for much cheaper but if you don't know much about them that would be silly.

Ongoing tax returns/accounts anywhere between $300 and $1,500 per entity per year in accounting fees depending on professional.

One really needs to do a cost to benefit analysis, calculate the tax savings/asset protection benefits to setup/ongoing fees to determine if it is worth it.

Food for thought, no doubt you will seek advice from professionals.

 

[Mofra]

Great post Willy, very well structured and explained

 

[skc]

If shares in the company are owned via a family/discretionary trust, then when the company pays a dividend to the trust, the trustee has discretion on where those funds are distributed, and can distribute them to take advantage of personal income tax rates

This is the structure that I use for my trading. It's useful when you have members of the family who are on lower tax brackets (e.g. spouse and adult children). Just a few more points to add to Willy's detailed response.
- Remember that you don't have to pay out all company profits as dividend.... the company can retain the profits (company tax still needs to be paid for the current year). So you can take advantage of lower tax brackets in different years (e.g. holiday, having kids, or just the inevitable lean year)
- Can get a bit tricky trying to explain your income when you go for loan applications.
- Other ways to get cash out of the company are related party loans or capital return. Your tax professional should probably be consulted in each case.
- The costs can add up... accountants, recordkeeping, ASIC etc.

 

[arbsystrader]

Heya,

Considering your treated on revenue account rather than capital, ie no capital gains discount. For mine, I would look at doing the trading in a company, with the shares of the company owned by a family trust or perhaps 2 family trusts (one yours and one your other family member).

In laymans terms the major difference btw a Trust and a Company is a Trust will allow you to take advantage of Capital Gains discounts whereas a Company won't, but since you won't have CGT discounts that takes away the advantage of a Trust over a Company.

A company allows you to retain profits in the company and caps the tax rate at 30%, maybe down to 27.5% if turnover is under $10m. The ATO are planning to reduce it down to 25% over the next 10 yrs for all businesses. If you are looking to keep profits in the business and compound profits over long term this is advantageous to paying tax on profits at the top marginal rate in your personal name. However if you wish to take profits out for personal use, whatever you take out will be added to your other personal income and taxed at marginal rates. So in effect it is a tax deferral tool until you wish to take money out of the company for personal use. You can choose how much and when you take it out. This is usually done in the way of the company paying a dividend. A dividend must be paid in the ratio of who owns the shares, and you also get a tax credit for any tax the company has paid, called a franking credit. So if the shares are owned 50-50 with you (either individual or via trust) and your family member, when dividends are paid out it has to be done 50-50, if ownership is 75-25 when dividends are paid it has to be paid in same proportion.

If shares in the company are owned via a family/discretionary trust, then when the company pays a dividend to the trust, the trustee has discretion on where those funds are distributed, and can distribute them to take advantage of personal income tax rates, there is no ratio/prorata rules, one year the trustee could distribute 50-50, another year it could be 100-0, the trustee has total discretion unlike a company dividend. If you are single it probably doesn't make much difference, but if you have a spouse it will save quite a bit in tax. Assume just you receives a $180k dividend from company to trust that flows to you, tax on $180k would be approx $57,832, whereas if you were able to split it 50-50 with spouse so 90k taxable income each, tax would be approx $22,732 x 2 = $45,464 a tax saving of approx $13k.

A unit trust is owned by unit holders, somewhat similar to shares in a company, so the units can be owned 50-50, 60-40 whatever you decide with your family member. When a Unit trust makes a distribution it also has to be done in same proportion as those that own units, there is no discretion like a family/discretionary trust. As with all trusts all profits must be distributed or they get taxed at top marginal rates. One may use a Unit Trust in preference to a company if the activities of the trust may make it eligible for a CGT discount in the future, if there aren't likely to be CGT discounts in future I would say a Company would outweigh the benefits of a Unit Trust.

Shares of the company are an asset, so if a shareholder was to be sued, they are quiet likely up for grabs. So if you own the shares individually, there would be no more asset protection than doing it all in your own name. If the shares are owned by a trust it adds a layer of protection, for if you are sued personally/professionally or your family member is sued it wouldn't matter as you don't own the shares, the trust does. And nobody owns the trust so if all it does is own shares in a company that carries on a trading business then it has pretty much no chance of being sued.

A trust has to distribute all trust profits each year otherwise tax profits get taxed at highest marginal rate, whereas a company can retain profits and pay tax at company tax rate, currently 27.5 to 30%, to distribute at a future date for personal use.

As I see it they are the major advantages of the above structure you would also need to consider how you are going to get funds into the company, normally via a loan from you/family member but this should be documented with a loan agreement. Also need to consider what would happen if one of you dies or becomes incapacitated, who takes over the entity to disburse funds to your will/family members etc. Also how you calculate who is entitled to what profit, say you both put $100k in each, so you split profits 50-50 which is easy. But say 2-5 years down the track the account has grown from $200k to $400k and your family member wants to take out $50k to spend on a car/holiday/boat but you don't. Now you have a pool of $350k, 200 yours and 150 your family members as the fund grows to $500k how do you calculate your portion and there portion...it may become quite complicated.

Each entity would cost roughly $1,200 ish to setup varies amongt professionals. You can do online for much cheaper but if you don't know much about them that would be silly.

Ongoing tax returns/accounts anywhere between $300 and $1,500 per entity per year in accounting fees depending on professional.

One really needs to do a cost to benefit analysis, calculate the tax savings/asset protection benefits to setup/ongoing fees to determine if it is worth it.

Food for thought, no doubt you will seek advice from professionals.

Thank you for your thorough explanation! At this stage creating a corporation with my trust as the shareholder seems to be the most beneficial way of doing this. Thank you!

 

[arbsystrader]

Heya,

Considering your treated on revenue account rather than capital, ie no capital gains discount. For mine, I would look at doing the trading in a company, with the shares of the company owned by a family trust or perhaps 2 family trusts (one yours and one your other family member).

In laymans terms the major difference btw a Trust and a Company is a Trust will allow you to take advantage of Capital Gains discounts whereas a Company won't, but since you won't have CGT discounts that takes away the advantage of a Trust over a Company.

A company allows you to retain profits in the company and caps the tax rate at 30%, maybe down to 27.5% if turnover is under $10m. The ATO are planning to reduce it down to 25% over the next 10 yrs for all businesses. If you are looking to keep profits in the business and compound profits over long term this is advantageous to paying tax on profits at the top marginal rate in your personal name. However if you wish to take profits out for personal use, whatever you take out will be added to your other personal income and taxed at marginal rates. So in effect it is a tax deferral tool until you wish to take money out of the company for personal use. You can choose how much and when you take it out. This is usually done in the way of the company paying a dividend. A dividend must be paid in the ratio of who owns the shares, and you also get a tax credit for any tax the company has paid, called a franking credit. So if the shares are owned 50-50 with you (either individual or via trust) and your family member, when dividends are paid out it has to be done 50-50, if ownership is 75-25 when dividends are paid it has to be paid in same proportion.

If shares in the company are owned via a family/discretionary trust, then when the company pays a dividend to the trust, the trustee has discretion on where those funds are distributed, and can distribute them to take advantage of personal income tax rates, there is no ratio/prorata rules, one year the trustee could distribute 50-50, another year it could be 100-0, the trustee has total discretion unlike a company dividend. If you are single it probably doesn't make much difference, but if you have a spouse it will save quite a bit in tax. Assume just you receives a $180k dividend from company to trust that flows to you, tax on $180k would be approx $57,832, whereas if you were able to split it 50-50 with spouse so 90k taxable income each, tax would be approx $22,732 x 2 = $45,464 a tax saving of approx $13k.

A unit trust is owned by unit holders, somewhat similar to shares in a company, so the units can be owned 50-50, 60-40 whatever you decide with your family member. When a Unit trust makes a distribution it also has to be done in same proportion as those that own units, there is no discretion like a family/discretionary trust. As with all trusts all profits must be distributed or they get taxed at top marginal rates. One may use a Unit Trust in preference to a company if the activities of the trust may make it eligible for a CGT discount in the future, if there aren't likely to be CGT discounts in future I would say a Company would outweigh the benefits of a Unit Trust.

Shares of the company are an asset, so if a shareholder was to be sued, they are quiet likely up for grabs. So if you own the shares individually, there would be no more asset protection than doing it all in your own name. If the shares are owned by a trust it adds a layer of protection, for if you are sued personally/professionally or your family member is sued it wouldn't matter as you don't own the shares, the trust does. And nobody owns the trust so if all it does is own shares in a company that carries on a trading business then it has pretty much no chance of being sued.

A trust has to distribute all trust profits each year otherwise tax profits get taxed at highest marginal rate, whereas a company can retain profits and pay tax at company tax rate, currently 27.5 to 30%, to distribute at a future date for personal use.

As I see it they are the major advantages of the above structure you would also need to consider how you are going to get funds into the company, normally via a loan from you/family member but this should be documented with a loan agreement. Also need to consider what would happen if one of you dies or becomes incapacitated, who takes over the entity to disburse funds to your will/family members etc. Also how you calculate who is entitled to what profit, say you both put $100k in each, so you split profits 50-50 which is easy. But say 2-5 years down the track the account has grown from $200k to $400k and your family member wants to take out $50k to spend on a car/holiday/boat but you don't. Now you have a pool of $350k, 200 yours and 150 your family members as the fund grows to $500k how do you calculate your portion and there portion...it may become quite complicated.

Each entity would cost roughly $1,200 ish to setup varies amongt professionals. You can do online for much cheaper but if you don't know much about them that would be silly.

Ongoing tax returns/accounts anywhere between $300 and $1,500 per entity per year in accounting fees depending on professional.

One really needs to do a cost to benefit analysis, calculate the tax savings/asset protection benefits to setup/ongoing fees to determine if it is worth it.

Food for thought, no doubt you will seek advice from professionals.

One concern I have is that I am just pooling family money (and one friend has expressed interest), but a colleague told me I would need an AFSL licence to do this. Is this correct? It seems exorbitant and prohibitively restrictive when one is simply trying to help out family members and potentially a friend. Does anyone have any thoughts here? How do others do it?

 

[skc]

One concern I have is that I am just pooling family money (and one friend has expressed interest), but a colleague told me I would need an AFSL licence to do this. Is this correct? It seems exorbitant and prohibitively restrictive when one is simply trying to help out family members and potentially a friend. Does anyone have any thoughts here? How do others do it?

It will be something along the lines of "small scale offering". But definitely seek professional advise.
http://rostroncarlyle.com/article/raising-capital-disclosure/

When it comes to mixing money with family and friends, the best solution is avoid. The second best solution is have everything signed off on paper. I am sure things will work well when you are making money, but it can turn sour when everything ain't sunshine and lollypop. Think very hard about it imo.

 

[galumay]

but a colleague told me I would need an AFSL licence to do this. Is this correct?

Not as far as I know, a friend of mine runs a small fund and thats for more than just family and friends and he doesnt need an AFSL to operate. I think there is a significant threshold.

 

[Klogg]

One concern I have is that I am just pooling family money (and one friend has expressed interest), but a colleague told me I would need an AFSL licence to do this. Is this correct? It seems exorbitant and prohibitively restrictive when one is simply trying to help out family members and potentially a friend. Does anyone have any thoughts here? How do others do it?

Ask the relevant advisor about a rule that allows a company to take on <$2m or <20 investors in any one year without an AFSL.

 

[galumay]

Thats what i meant! Thanks klogg.

 

[barney]

Hi All,
I have been trading profitably for 4 years and am in the highest tax bracket.

Hi arbsystrader, Just noticed this thread. Firstly well on your achievement. Curious as to what instruments you mainly trade. Cheers.

 

[goponcho]

Thanks willy very useful and succinct information!

 

[Arq199]

I'd note that realistically, the only reason you'd consider yourself a business is because you have to. The difference between capital account (investment) vs revenue account (business) is primarily for tax, and there is minimal protection provided for passive investors.

The ATO determine business vs investment on a basis of practicality. If you do this as a full time job at 40 hours a week, you would have no option but to be a business. The ATO look at character, repetition, research, expenditure, business-like traits (employees, offices, websites, hours invested, etc) when considering whether a series of investments is instead a business.

Companies are not a great structure for investment. In terms of tax rates, yes, the company tax rate is 30% (27.5%, soon 25%) flat tax rate, which can be advantageous, however if you take money out of a company, you must pay either the tax on it (less relevant franking credits) or interest at Division 7A interest rates (generally Fy16 - 5.45%) plus mandatory annual repayments to complete the loan within 7 years. Investing as an individual you would pay normal marginal tax rates, however with the potential for discounts, which would pull down your maximum tax rate below that of a company.

Investing through a company would provide protection only through very limited circumstances. As shareholders, we are not liable for a companies debts, except for any amount unpaid on our shares (eg. If you were in a Telstra float tranche, and you had an amount still unpaid, you would've had to pay it if Telstra went bust). Obviously, this doesn't apply to us, so most of us have no exposure to being sued for our shareholdings. Likewise, even if your day job is running a business, the protection is limited, because if you get sued personally, the company would be an asset of yours, meaning that any creditors of yours personally would have potential access to your shareholding company.

Generally, a trust is still the best way to go. Discretionary trusts provide you with the tax advantages of an individual, but with the added flexibility of being able to elect where your distributions go in any particular year. This means that you can distribute to children, parents, siblings, spouses, etc - using their lower rates where available in order to minimise your tax effectively.

In all honesty, I can think of very few circumstances where a company would be more beneficial than a trust for shareholdings. This remains true even if the ATO judge you to be a business instead of an investor.

Please be aware that this constitutes general advice only, and does not take into account anyone's individual circumstances. While I am a licensed tax accountant, I am not engaged as accountant for anyone on this site (to my knowledge), and as such have not considered any personal factors.

 

[skc]

Please be aware that this constitutes general advice only, and does not take into account anyone's individual circumstances. While I am a licensed tax accountant, I am not engaged as accountant for anyone on this site (to my knowledge), and as such have not considered any personal factors.

Thanks for the detailed post.

 

[aussiefx]

Some excellent content here, thanks guys.

Does anyone have recommendations for a good tax professional in the SE Queensland area? I tried KPMG and was less than impressed with their service and more so with their fees.

 

[traderxxx]

as far as yourself and your family member you
could also set up a smsf and pay 15% tax.

 

[Arq199]

Some excellent content here, thanks guys.

Does anyone have recommendations for a good tax professional in the SE Queensland area? I tried KPMG and was less than impressed with their service and more so with their fees.

I'm a tax accountant, and I know 2 or 3 good ones in Brisbane. Depends on the size/scale of what you're doing, and what sort of info you're looking at. Send me through what you're looking for and I can recommend one if you like.

Big 4 are excellent if you're a medium-large business (that is, having 100+ employees) or have highly complex tax scenarios (eg. significant international business dealings). For most investors though, it'd be a huge waste of money. I've seen fees 3-4 times what I charge for clients picked up from the Big 4.

 

[ducati916]

I'd note that realistically, the only reason you'd consider yourself a business is because you have to. The difference between capital account (investment) vs revenue account (business) is primarily for tax, and there is minimal protection provided for passive investors.

The ATO determine business vs investment on a basis of practicality. If you do this as a full time job at 40 hours a week, you would have no option but to be a business. The ATO look at character, repetition, research, expenditure, business-like traits (employees, offices, websites, hours invested, etc) when considering whether a series of investments is instead a business.

Companies are not a great structure for investment. In terms of tax rates, yes, the company tax rate is 30% (27.5%, soon 25%) flat tax rate, which can be advantageous, however if you take money out of a company, you must pay either the tax on it (less relevant franking credits) or interest at Division 7A interest rates (generally Fy16 - 5.45%) plus mandatory annual repayments to complete the loan within 7 years. Investing as an individual you would pay normal marginal tax rates, however with the potential for discounts, which would pull down your maximum tax rate below that of a company.

Investing through a company would provide protection only through very limited circumstances. As shareholders, we are not liable for a companies debts, except for any amount unpaid on our shares (eg. If you were in a Telstra float tranche, and you had an amount still unpaid, you would've had to pay it if Telstra went bust). Obviously, this doesn't apply to us, so most of us have no exposure to being sued for our shareholdings. Likewise, even if your day job is running a business, the protection is limited, because if you get sued personally, the company would be an asset of yours, meaning that any creditors of yours personally would have potential access to your shareholding company.

Generally, a trust is still the best way to go. Discretionary trusts provide you with the tax advantages of an individual, but with the added flexibility of being able to elect where your distributions go in any particular year. This means that you can distribute to children, parents, siblings, spouses, etc - using their lower rates where available in order to minimise your tax effectively.

In all honesty, I can think of very few circumstances where a company would be more beneficial than a trust for shareholdings. This remains true even if the ATO judge you to be a business instead of an investor.

Please be aware that this constitutes general advice only, and does not take into account anyone's individual circumstances. While I am a licensed tax accountant, I am not engaged as accountant for anyone on this site (to my knowledge), and as such have not considered any personal factors.

My question to you is:

If you had a [small] group of companies, say 3 and of those 3:

(a) was the trading/investing Co which is profitable; and
(b) was a property rental Co, which is profitable; and
(c) was an 'Art' company [as an example] that had nothing but losses currently.

Is the tax situation such that the tax losses incurred by Co (c) could generate tax loss carry forwards, that could be attributed to Co (a) thereby reducing the amount of tax paid.

Assuming Co (c) was a legitimate Co that incurred costs etc and was part of the small group of companies, and set -up as such, that this is a legitimate way to reduce the tax payable?

jog on
duc

 

[Arq199]

My question to you is:

If you had a [small] group of companies, say 3 and of those 3:

(a) was the trading/investing Co which is profitable; and
(b) was a property rental Co, which is profitable; and
(c) was an 'Art' company [as an example] that had nothing but losses currently.

Is the tax situation such that the tax losses incurred by Co (c) could generate tax loss carry forwards, that could be attributed to Co (a) thereby reducing the amount of tax paid.

Assuming Co (c) was a legitimate Co that incurred costs etc and was part of the small group of companies, and set -up as such, that this is a legitimate way to reduce the tax payable?

jog on
duc

Generally, no, you can't do that.

For starters, it's very difficult to transfer money from one company to another, unless the shares in A or B are owned by C (in which case, maybe, as you can look at dividends and tax consolidated groups, but it's very messy). Apart from that, you have to transfer money on an arms length basis - that is, C must perform a service for A or B that it can charge them for.

This is further complicated by the same business test, which prevents C from changing its business from doing Art things to doing something else more useful for A or B, and then still being able to use its tax losses.

Provided C's ownership doesn't change and it continues the same business, C's tax losses would carry forward indefinitely, so if it ever DOES make a profit on art, it can utilise them then.

All of this is, of course, general information, and does not take into account any person's specific situation. I take no responsibility for anyone acting on this information, and recommend you consult your own tax advisers to discuss whether this information applies to you. Mind you, if your tax adviser told you to set up that structure, I'd be questioning whether they have any clue what they're doing, unless all three operations qualify as businesses. You just don't put passive investments into companies. It's a great way to donate lots of money to the Australian Government.

 

[kefa]

You just don't put passive investments into companies. It's a great way to donate lots of money to the Australian Government.

Hi,

Can you clarify this comment? Lets say I am in the top personal tax bracket and want to own some passive investments like ETFs. In a company structure I would pay less tax on my dividends than if I held them in my own name. Total returns of aussie shares over the long term is roughly half capital gains and half dividends. So just throwing using some "typical" numbers:

Dividends 4% annual return:
Company tax at 30% = 2.8% after tax
Personal tax at 47% = 2.12% after tax

Capital gains 4% annual return:
Company tax at 30% = 2.8% after tax
Personal tax at 47% (with CGT discount is 23.5%) = 3.06% after tax

Total return:
Company = 5.6%
Personal = 5.18%

Did I miss something?