Legal Tip 288: Structuring the Ownership of Shares in a Company

Discussion in 'Legal Issues' started by Terry_w, 19th May, 2020.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    Generally, companies are not considered to be good vehicles with which to hold shares because they do not receive the 50% CGT discount like individuals and trusts do. The company will be taxed on the capital gains at 30% whereas the individual would be taxed anywhere from 0% to 24.5%.


    But companies have an advantage because they can pay the tax and reinvest the proceeds without the complex scenarios that play out with trusts, bucket companies, division 7A, family trust elections and interposed entity elections.

    Furthermore where the shareholder of the company is a discretionary trust the income of the company could be paid out to a wide range of beneficiaries who could then claim franking credits to get a credit for the tax the company has paid – the income could potentially come out tax free to a degree – not only tax free but the tax the company has paid could be received back by the recipient of the dividends.


    Example

    Homer decides to use a company to invest in dividend paying shares with expectation that the shares will grow in value too.

    He lends the company $100,000 and it buys $100,000 worth of shares.

    The shares pay $5,000 worth of dividends and they are fully franked. So, the company receives income of $5,000 with no further tax to pay.

    The company later sells the shares, after 12 months, for $150,000

    The company has made $50,000 in capital gains and will pay 30% of this in tax - $15,000.

    The company still has $35,000 left after paying this tax. So, after repaying Homer his $100,000 – which is tax free as it was a loan, the company will have retained earnings of $40,000.

    Luckily, Homer had set the company up with the shares of the company held by the Trustee of the Simpson Family Discretionary Trust – which is Homer himself. Homer then causes the company to pay a dividend which is received by the trust. The trustee then makes Homer’s 3 adult children entitled to the income.

    In equal shares they receive $13,333 each plus franking credits.

    Each of their grossed up income is $19,047 – which is the $13,333 plus $5,714 in franking credits. If they have no other taxable income they will receive back the tax that the company has paid previously - $5,714 each in this case.

    Use this calculator to check Franking Credits Calculator | Pearler

    Since they are adults and assuming they are not working and have no income other than these dividends they will pay no tax.

    Use this calculator to check TaxCalc - Calculate your tax. 2019-2020 financial year



    So, this means that this structure enabled tax free investing to happen.


    The main benefit though is the administrative ease.

    The company can retain income. Trusts need to distribute their income every day.

    No need to pay a bucket company and borrow back under a complex division 7A loan agreement with mandated repayments of principal.

    Companies can use a dividend reinvestment plan. Trusts can too but due to the need to distribute income this becomes difficult to manage.

    The shares of the company can be set up in such a way that upon the death of an individual family member the shares can be passed to the trustee of a Testamentary Discretionary Trust so that dividends can then come out to minor children at adult tax rates. With a discretionary trust holding the shares the trust would not be able to be passed to the TDT.

    Income can be diverted to future tax years by controlling when dividends are paid, but this can only be done with a trust by using a bucket company.

    Companies are generally easier to understand than trusts.


    See also:
    Legal Tip 151: Structuring the Ownership of Shares Legal Tip 151: Structuring the Ownership of Shares
     
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  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Sometimes a trust can assist with streaming a category of income to retain its charecter where a company cannot do this.

    eg Trust produces CGT income in place of the example above. The $50,000 of CGT profit in the trust is discounted right ? Well not if the beneficciary is a non-resident streamed that specific income. A indirect element of non-property CGT income can be streamed to a non-resdient (eg a kiwi). No CGT in NZ. Australia doesnt impose tax on non-resdient CGT events either except property (direct or indirect) or when a persons owns 10%+ of a listed company. It is exempt income and the net trust income is reduced. Basically disregarded on both sides of the dutch. eh bro.

    Strreaming interest and dividends could also only be subject to withholding tax for a non-resident beneficicary where if it were company dividends this could be either subject to withholding tax or "forfeiture" of the 30% franking credits. Ouch.

    The company comes out worse at 30% each time vs 0%, 10% or 15%

    eg CGT Gains. Distribute to beneficiary with CGT or income tax losses. 0% tax payable.

    eg Franked income. Distribute to one of more beneficiaries who may even get franking refunds. A company with its fixed dividend policy (ie all ordinary shares) may be unable to pay a dividend in such a manner.
     
    Last edited: 19th May, 2020
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    Yes that is true. Someone with a capital loss couldn't have that loss offset a capital gain on the shares.But for someone on a high income starting out investing in shares, and they have no capital losses carried forward, the company can provide a simple tax effective solution with the side benefits of asset protection and estate planning with potentially no tax payable.
     
  4. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Always comes down to.personal advice and specifics. Tax advice involves more than one dimension.
     
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  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    Not to mention the legal side and the lending side as well.
     
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  6. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    I read posts everyday which scream...I need to pay for advice
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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