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

[Arq199]

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?

Perfectly valid question.

The problem is that, if a company earns money, the money belongs to the company. Eventually, you have to take the money out of the company. This will either be in the form of a loan (called a Division 7a loan - comes with interest and other regulatory requirements) or as a dividend. This means that company tax is only a placeholder tax, and eventually, everything gets taxed at a personal rate. Sure, your company tax has a slightly better return by those calculations for now, but eventually, it will be worse, because you'll have to pay top-up tax again later.

The real difference is the capital gains. Dividends are a wash, because the company pays 30% and gets the franking credits to compensate at 30%, so it works out to a nil-sum game. Companies not having access to capital gains discounts is a killer. The eventual tax you pay in your personal name is 47%, not 23.5%.

Generally, you'd want to look at trusts instead. By investing through a discretionary trust, you have the flexibility at end of year to consider who in your family should receive the distribution based on marginal tax rates. If you've got high dividend income, and want to defer the tax payment, you can also consider a company at that stage, and the trust can distribute the dividend income to the company. That way, you can still stream your capital gains to individuals, where even at the highest marginal rates, you still have access to CGT discounting.

If you want to argue that a company is fine as you can wait until you retire to draw the income at lower tax, then what you're actually arguing for is an SMSF. Pays tax at 15% (instead of 30%), can discount capital gains to 10%, while still holding off until you retire, when (depending on the laws at the time), you'll probably be able to draw it out tax free. Due to the new financial advice laws, I can not advise on the appropriateness of starting an SMSF or any specific SMSF strategy.

Again, this is general advice, and all readers are encouraged to seek their own tax advice to consider their personal objectives. I take no responsibility for anyone acting on this information.

 

[kefa]

Hi Arq199,

Thanks for the detailed reply lots of good information in there.

So with a family trust if all the members are high income earners where would dividend income on shares go? Does that go to a "bucket" company owned by the trust? Can this money in the "bucket" company be used to purchase more assets for the trust.

I have thought about family trusts before but given my children aren't anywhere near 18 years old yet I can't see how the tax savings is worth the costs of running one.

Thanks,
Kefa

 

[Arq199]

Hi Arq199,

Thanks for the detailed reply lots of good information in there.

So with a family trust if all the members are high income earners where would dividend income on shares go? Does that go to a "bucket" company owned by the trust? Can this money in the "bucket" company be used to purchase more assets for the trust.

I have thought about family trusts before but given my children aren't anywhere near 18 years old yet I can't see how the tax savings is worth the costs of running one.

Thanks,
Kefa

Hi Kefa,

Yes, you can structure your dividend income to flow to a company. No real disadvantage then. The company can then loan it back to the trust, though there are some other factors come into play there depending on circumstances.

Kids under 18 can be distributed $416 tax free each year. That's not a whole lot of savings, but it's better than nothing.

If all family members are on highest bracket, and no likelihood to change, it may not be worth it. It's usually good to budget about $1000 in trust fees per year, so if you don't stand to save that much, it may not be best for you. Would still avoid a company though. All it does is defer the problem and can cause other headaches unless you are running share trading as a business.

Don't forget to forward plan too though. You'd generally want to plan for at least 5 years in the future in terms of prospective incomes and kids ages. If there's likely to be anyone with lower income (or kids over 18) within that period, it's a good idea to keep in the back of your mind. Also look at family - I've got clients who have used their parents' taxable incomes after they've retired (being sure to take into account aged pension issues), or siblings, or nieces and nephews. Obviously you have to have a level of trust, etc, but otherwise there are potential avenues there.

This is general advice only, and no responsibility is taken for anyone acting on this information. Please consult your tax adviser to see if this information applies to you.

 

[Tano]

Hi
What if your exposed to being sued by non shareholder actions, eg if you own a rental property and/or businesses then the likelyhood of being sued by a tenant or customer tripping over etc is much higher.

Also, i plan to cash out of the trust when i retire and never before so hopefully tax will be very low. Do these 2 situations provide a good reason to use a company structure or is there something better?

. 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
...
This means that company tax is only a placeholder tax, and eventually, everything gets taxed at a personal rate. Sure, your company tax has a slightly better return by those calculations for now, but eventually, it will be worse, because you'll have to pay top-up tax again later.