Distribution to Bucket Companies MIGHT attract SBE rate

been doing some research and reading through TR 2017/D7.

Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?

Question being asked by accountants and clients is if I have a trading trust and I distribute to a bucket company will i be taxed at the small business entity (27.5% for 2018 if the company's aggregated turnover is less than $25m) rates or the maximum corporate tax rate (30%).

Its not as simple as one thinks. Reading through the TD it gives an example

Example 5 - Family company

56. FamCo is a company incorporated in Australia. FamCo is a discretionary object of the Pail Family Trust. It otherwise has no income or assets. The Pail Family Trust carries on a profitable trading business. The trustee of the Pail Family Trust exercises its discretion and makes FamCo presently entitled to $50,000 of the trust income, but does not pay this amount to FamCo. It remains as an unpaid present entitlement (UPE) of FamCo.

Possibility A - FamCo does not reinvest its UPE

57. FamCo's income consists only of the trust entitlement. FamCo's only asset is the UPE from the Pail Family Trust. FamCo has no entitlement to receive interest on the UPE. The company does nothing to demand receipt of its UPE, nor does it enter into any arrangement that would give it an entitlement to any type of profit. FamCo has not invested its assets in any activity that has a purpose or prospect of profit. It only has a mere hope of receiving future appointments of income from the Pail Family Trust, of which it is an object. FamCo does not carry on a business.

Possibility B - FamCo reinvests its UPE

58. After being made presently entitled to the $50,000 of trust income, FamCo enters a written loan agreement on commercial terms with the trustee of the Pail Family Trust. Under this agreement, FamCo loans the money back to the trust in return for a commercial rate of interest secured against the assets of the trust. The interest income received is then either distributed to FamCo's shareholders by way of annual dividends, or reinvested back in the trust by way of further loans made on the same terms under written loan agreements. FamCo's activities consist of investing its assets in a business like way with both a purpose and prospect of profit. FamCo carries on a business.

Possibility C - FamCo receives trust distributions in cash

59. FamCo's income consists only of trust distributions from the Pail Family Trust which it receives in cash. FamCo distributes part of these distributions to its shareholders and retains the balance. Its only assets are the part of the trust distributions it retains and holds in a bank account, pending distribution to its shareholders. This account does not bear interest.

60. FamCo has not applied its assets in any activity that has a purpose or prospect of profit. It only has a mere hope of receiving future appointments of income from the Pail Family Trust, of which it is an object. FamCo does not carry on a business.

Under Example 5 Possibility C the first impression is oh ill be subject to 30% maximum corporate tax BUT read it carefully. it says "This account does not bear interest."

So if the corporate beneficiary got the cash and invested in dividend yielding shares or interest bearing deposits it changes the nature of it. In my view it is a business as it has a profit making purpose. SBE rate of 27.5% applies if the other conditions are met.

However if you merely use the corporate beneficiary as a "wash". i.e. distribute trust profits and immediately pay out dividends I think you have an issue and it isn't a business and 30% rate applies.

Company lending back to the trust with a complying Division 7a loan agreement seems to also indicate it will be a business.

If you lodged your 2017 returns already you may want to amend them if you applied the 30% tax rate and instead now believe your entity is in fact eligible for the lower 27.5% rate.

For 2018 if the legislation is passed the business test wont need to be applied for the bucket companies which will remove some of the confusion. The Bill proposes to remove the requirement that a BRE ‘carry on a business’, and replace it with a requirement that no more than 80% of its assessable income is passive income.

 

This would be good news for investors as less tax payable would mean more capital compounding.