Company vs Trust - Is it that simple ?

I discussed whether Bob should hold an investment property in a company or a trust. Trust, trust, trust yells all the accountants. Companies don't get the discount you fool.

Agreed. And sometimes that decision is the right one.

But sometimes it is worth challenging the default position and asking "I wonder what would happen if events changed"

In this discussion Bob and Wendy have used a company to hold the asset and paid tax on the capital gain. "see mike they are almost $40k worth off"

ahhh , but are they ?

have a look at the scenario and maybe over 10 years Bob and Wendy are actually better off having thought outside of the norm.

check it out

Michael A. posted on LinkedIn

 

• Travel expenses are deductible
• Costs while developing a new build
• Buying an existing residential and claiming past Div 40
• Can still neg gear if there is a second source of income and it doesnt need to be within the same company (trust or a dividend from another company)
• Franking
• Small Business CGT concessions can be easier than a trust. (if applicable)
• Shareholders are not vastly different to trust beneficiaries in that they cant demand income
• Asset protection v a disc trust is potentially enhanced
• Land tax threshold (NSW) saved $11k a year

Poor tax advisers yell trust.
Good tax advisers start to explain the +plusses and -negatives of each option and merely educate the client on the choices. A poor adviser tells the client what to do. Often because they didnt explain it. Ithen allow them to consider the options and seek additional eg legal advice.

This often comes up with SMSF loans. Often (not always) there are other options. I usually compare three or four broad choices. Yes choices.

 

shares of the company can be transferred without duty - in some situations.
Interest while constructing deductible.
easier to retain income
easier to maintain residency when going overseas
shares could end up in a Testamentary Discretionary Trust - which is not possible with discretionary trusts.

 

Isn't it apples to oranges to compare distributing to one person with some income, v distributing to two retire people with no other income?

 

trainee...yes that is the whole point...to open a discussion as to what a person's circumstances may be. the scenario would be totally different if both Bob and Wendy were earning $200k each and antiicpated doing so until death.

It's about a discussion. Not about what is the best structure as no such thing actually exists.

 

Trainee. Imagine if that income was franked income for the retired couple. Refundable franking credits can be more than a pension x 2. A pre retirement strategy can include trust to company restructure. Part IVA is hard to apply when the Govt passes laws specifically to encourage this.

Spot on Mike. The accountant that adds value is never a compliance chaser.

 

On this topic, I've tried to model a comparison where there is a active business run in a trust which can distribute either to a trust (or a person) or to a corporate beneficary. Does this look like a reasonable model? Any significant adjustments I can do to make it more realistic?

My assumptions:
- $100k of profit in an active investment coming in for 10 years.
- Lowest marginal tax rate of any beneficiary of the business trust is 39% for the 10 years.
- Tax rate on the company would be 27.5% for the 10 years

If my model is accurate it reflects a significant advantage (in these circumstances) for using the company.

Thanks,

Jason

 

Is the company a base rate entity? usually 30% tax
Companies dont get the 50% CGT discount
Who owns the shares?
What about franking credits when the shares come out - beneficiary might get a refund
depreciation effects, depending on what it invests in - reduces franking
The trust could distribute to a company and get the best of both worlds - 50% CGT discount plus ability to retain earnings so it comes out a another tax year.

 

How does a 50% CGT discount apply to a company ? The vague issue with a trust tax return is that the NET CGT amount is shown as distributed to a corporate beneficiary however the same income when included in the company return is grossed up ie doubled. Images in file. But if the company has losses available these can be used but the loss would be reduced by the full value of the gain. Only individuals and suprannuation entities get a discount. The reason why a gain is grossed up is to ensure that the entity rate of discount (if applicable) is correctly reflected. Otherwise it would be an avoidance heaven.

 

The trust would distribute the capital gains to the individual and the dividends to the company. Getting the best of both worlds.

 

Streaming franked income , foreign income etc may better suit a resident individual but when distributed to another trust its ultimate beneficciary must also be considered.
Certain income may be exempt streamed to a non-resident individual eg Franked elements, CGT on non-property interests etc
Property v non-property investment ? (ie land tax)
Can the trust stream?
Validity of distribution resolutions ? Otherwise the trustee may (also) be assessed
Losses may impact ?
Family Trust Election ?
Interposed entity election ?
Deductibility of interest and borrowing isssues ? Can be affected by the trustee (eg an individual) but typically doesnt hamper a company

Why limit the issue to a trust OR company. Both can work

 

Tax considerations aside, you also need to consider the finance implications. Simply buying a property through a company (rather than a trust) isn't a big deal for most lenders, but there are some caveats as I recently discovered.

If you're purchasing vacant land with the intention to build, most lenders will be okay if there's a trust involved, but not when it's just a straight up company ownership. They tend to look at it as a commercial deal and will want to fund it that way. Then their commercial department will say it's a single property and too small for a commercial development.

There's a couple of exceptions, it is possible to get funding in this scenario, but it is limited. You need to also consider the restrictions with finance when making decisions about how you'll own the property.

 

Or even vice versa.

Low income individuals = refundable franking credits.
Company with losses or CGT losses
Those screen shorts are literally that example....

I guess terry and I are saying the same thing. Flexibility and customisation to specific family needs can occur with a trust to company structure. But a company to trust can assist with deferral since the company can pay 30% and defer away but charecteristics of income can be lost in that structure eg No CGT amounts and discounts etc.

 

Also with trusts or companies servicing might be reduced as no negative gearing add backs like with an individiual, but there could be other servicing advantages

Legal Tip 91: Structuring a Trust to Maximise Borrowing Capacity Legal Tip 91: Structuring a Trust to Maximise Borrowing Capacity

 

I just posted this as you were writing:
Tax Tip 287: How Capital Gains Through a Company can be Tax Free

 

another benefit as the company would be entitled to a deduction of the interest costs on the vacant land during the construction phase as it is a corporate entity

trusts and individuals no longer get that deduction.

 

Some will say that the company has no other income (if that applies) ...so what the point ?..... Ah maybe but the interest deduction is still allowed hence creating a tax loss where the individual and trust etc can only defer the cost into the cost of the property. I had a recent client where the company dev had a 2 year lead time and the interest created a loss which carried forward. When the first (of 4) properties sold that one was tax free in 2019. In 2020 the other three sold....This helped with tax deferral. That and the GST credits helped cashflow. All rolled into the next build. Tax paid at 27.5%....Had it been a trust a whole different outcome. And NSW land tax of $28K more.

 

this should be the same result as the interest deduction provisions for vacant land dont apply where you are carrying on a business of property development. the trust would still have a carried forward loss to offset against the future development profits. what made it different ?

 

Good point. But isolated profit making can be on the edge. This entity started that way and has progressed towards a business.

 

are you saying you cannot claim interest on loans whilst the construction phase is happening? surely i've misunderstood :S