Legal Tip 93: Bucket Companies as Beneficiaries of Trusts

Sometimes a trust may distribute income to a company, rather than an individual. Often this is done because the individual(s) controlling the trust are paying tax on their personal income which is more than 30%. Tax on companies is a flat 30% so tax can be saved this way. These companies are often referred to as 'bucket companies'.

Income can accumulate in companies. But trusts must distribute income or the trustee will pay tax at the top marginal tax rate. Companies can pay the tax on the income and can then hold onto the distributions from trusts. This money can then be taken out at a later date by the shareholders at a time which benefits them the most. The company may also further invest the money to compound returns.

Care must be taken when setting up companies as ‘bucket companies’ because they could end up holding large sums of money. To reduce risk the shares of the company should not be owned by an individual as if the individual were to become bankrupt their shares would fall into the hands of creditors. The company should also not trade so as to avoid potential litigation.

Advice should be sought before setting up a bucket company to make sure it will fall into the definition of beneficiary. Further advice should be sought before taking money from a company - whether by loan, payment into superannuation, wage, dividend or director fees.

 

The days of dumping profits from the trading entity trust to the bucket company and paying flat 30% are done.

Division 7A rules have put an end to that.
If your accountant is still doing this and does not have a strategy in place to deal with the Div7A time bomb each year, I would be changing accountant SUPER fast!!

IMO majority of firms do not understand div 7a rules and the implications.. Money for jam for the ATO to audit these.
Deemed dividends, no loan docs in place, incorrect interest calculations, debit loans being tainted, the list of potential issues goes on..

If you are running a semi profitable business it may pay to inquire to your accountant how they are addressing theses issues (if they are relevant)..

 

Div 7A only applies to taking the money out as loans. This doesn't necessarily need to happen.

 

If funds on paper have been directed to the bucket company, but beneficiaries of the trading entity (trust) have overdrawn their accounts (debit loans) in the trust then there is division 7a issues, which is usually the case.

Hardly ever see funds distributed to the bucket co follow to the bank acc of the co and then dividends flowing accordingly with cash to shareholders..

In times of old bucket companies were used to mop up profits and only pay 30%.

Now with Div 7a rules there are not as many benefits of doing so.
Instead 180k is the new 80k for trust distributions to individuals before bucket is used. In saying so, there is no real advantage of cash flowing to bucket, then holding it there.. Not efficient to the business, so dividends need to be paid, and if the dividends ultimately come to the individuals then there is no benefit as they are already maxed at 180k.
Timing difference is big advantage.

I have delved into basic tax strategies but policy should be to avoid bucket company use if possible.

 

This is one strategy, but another strategy is to distribute the money from the trust to the company, the company pays the tax and then holds retains the money. The company can then further invest and receive further distributions from the trust.

At some future point when the opportunity arises the company can make a dividend payment to its shareholder which would be another trust. The trust could distribute that money to a person who then could get franking credits.

It may work well for a small family on a high income one year, but expecting much lower incomes in future years.

 

how does "franking credits" work?

you pay company tax 30% on profit then then pay personal tax on the money again? :s

 

Good posts. Yes it makes sense as a compounding vehicle where franked dividends from operating business are genuinely transferred to buckets account, then bucket buys stock / bonds / cash to compound at company tax rate until it can be distributed at other benefiaries, ie. Stop working, kids come of age etc. Long term, 10 years + this method will create a much larger pool then distributing to top bracket beneficiaries each year. Obviously no free lunch, so need enough $ to make it work and forgo CGT discount so the bucket is for holding income assets not intended for sale IMHO

 

No a franking credit is precisely that. You don't double pay, just the additional above 30% depending on beneficiaries tax position

 

Exactly. Taking advantage using time.
Problem is when you have a husband and wife business making 1.2m net profit each year, no geared investments and no debt..,

 

Its similar to super in these respects. Putting money aside in a 'tax haven' until needed - but not locked down like super.

 

First world problems

They'd probably struggle with the additional small business operator cgt concessions at time of exit given net wealth over 6m..the poor *******s!

 

this might be off topic.. if i bought a couple of properties through a discretionary trust with a corporate trustee (i think this is correct, correct me if i'm wrong) if i distribute the profit i would get taxed company tax and then the shareholder etc would be me as a person so i'd get the franking credit?

so if i wanted to keep purchasing properties it would be best to keep the money in the company structure (this is where i'm confused with my above scenario) or like terry has said i'd actually need a bucket company to hold the money so i'd have 2 companies?

 

No. This is a trust, and trusts are not taxed. Income is distributed to beneficiaries and beneficaries are the ones that are tax.

The company here is merely acting as trustee.

 

@Terry_w & @Greyghost

Hey guys,

Heard this podcast the other day http://www.3aw.com.au/radio/investor-laurence-freedman-explains-tax-havens-20151019-gkd1e9

Basically they sent up an offshore company in Jersey the Channel Islands... investor funds were held in the company and then invested around the world including Australia - the beauty is that the money can be left in the company to compound away at 0% tax. Obviously when the money is taken out it gets taxed in the hands of the investor and the individuals tax rate in his/her country of residence.

Say you had a sum of money like $100K+ you just wanted to invest in the share market (maybe here, maybe in the US) and allow it to compound away for 10 years without the earnings being taxed, just keep reinvesting and not taking any money out of the company.

Can set up a company in Oz to do the same thing, problem is that the ATO wants 30% of the earnings every year which puts a serious dent into the effects of compounding.

From my searches - it only costs circa 600 pounds to set one up.

Is this a possibility for the average Joe?

 

It is possible to set up a structure in a tax haven but if you control it then it will generally be taxed in Australia. It is possible to avoid this by giving away control, but by doing this you really will be at risk of losing your money.

 

So who owns the shares in the company then? Another trust? And if so who is the shareholder in that trusts corporate trustee?

 

It would vary depending on how people set it up. I suggest another trustee of a discretionary trust should own the shares of a bucket company. If this trust had a corporate trustee an existing trust could own its shares.

 

Thanks Terry.

 

If the company tax rate went down in the interim, could future dividends still be franked at the old rate, or would those extra franking credits above the current rate at the time be locked in the company?

GP

 

off topic.

"If are buying in a Company name then the loan is considered non coded so there is less requirement for the lender to ask for the traditional income evidence however there is still something known as “responsible lending”."

i saw the above statement posted a while ago. is this correct? is there any benefit from purchasing with a company name if your income stream is from investments and not so payg?