Tax Tip 108: Using Bucket Companies to Save Tax

Discussion in 'Accounting & Tax' started by Terry_w, 8th Apr, 2016.

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  1. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    A 'bucket company' is a company which is set up merely to receive income from trusts. It will not trade or do business, but just accumulate income.

    Tax rates for companies (that are not small business entities) is currently 30%. This is often lower than the tax rate paid by individuals, which is the first benefit.

    Another benefit of companies over trusts is that the company can retain income. It doesn't have to be distributed each year. A trust can also retain income, if the deed permits, but the top tax rate will apply.

    Another benefit is the franking credits. A company can pay tax on income and then distribute this income to the shareholders who then get a credit for the tax paid by the company, so that the same income is not taxed twice.

    Because of these benefits a 'bucket' company can help a family save tax, especially where their marginal tax rates will decrease in future years.

    Example
    Naomi is a keen investor and has set up a discretionary trust to benefit her family. The trust has positive income of $40,000 per year from property rents. Naomi and her spouse John are both employees on the 37% tax bracket. Next year they decide they will have a year off and live in a cave, in meditation. Instead of distributing money from the trust to themselves this year they may consider whether they could set up a company and have this company be a beneficiary of the trust. The trustee could then distribute the income to the company. The company would pay tax at 30% - which is less than what they would be paying.

    Next financial year they would come out of hibernation for a day or so to cause the company to pay a franked dividend to themselves, about $20,000 each which would mean nearly no tax is payable. They would get the tax back that the company paid because of the franking credits.

    By doing this they would have saved $40,000 x 37% = $14,800 plus the Medicare levy which would have been another $800 = $15,600. They may also get a low tax offset of $343 each which would cancel out the tax they would have paid of $342 for being over the threshold.

    Also have a look at my tip in the legal section, Legal Tip 93: Bucket Companies as Beneficiaries of Trusts
     
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  2. Blacky

    Blacky Well-Known Member

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    One thing to note though Terry would be that the distribution of income is proportionate among shareholders (that is a distribution per share held).
    Therefore if you have a husband and wife, with equal shares, the dividends will be equal. If ownership is 70/30 then that is the distribution.

    If, for example, you know your wife will leave work next year you can't apportion more income to her in the lower tax bracket. Unlike in trusts which the income can be discretionary.

    But yes, being able to decide when to distribute income can be highly beneficial.

    Blacky
     
  3. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Member

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    Unless the Co shareholding is a discretionary trust AND there are human beneficiaries capable of utilising tax thresholds and marginal rates.

    Many catches to using a "bucket company". First is that the company must receive the actual distribution. Second problem is what it then does with it. Full and final tax almost always has to end with a human, a company that accumulates or with a loan that poses a concern.
     
  4. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    Good to point that out. Dividends go to shareholders in proportion to ownership. I would usually suggest a discretionary trust own the shares so the trustee can then decide which beneficiaries of the trust will end up with the dividends.
     
  5. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Member

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    If they are resident adult taxpayers. Otherwise all sorts of issues such as withholding tax, trustee distribution tax, exempt income, s99/s99A concerns etc.
     
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  6. mrdobalina

    mrdobalina Well-Known Member

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    How long can the income be retained in the bucket company, before it has to be distributed out as franked dividends?
     
  7. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    I don't believe there are any limits - but laws tend to change.
     
  8. kmrr

    kmrr Active Member

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    Terry

    How does someone actually reinvest the money sitting on a bucket company without pulling it out and paying their income tax rate balance on top and where exactly is this money? Is it just in the company on paper but could be in an offset account?
     
  9. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    The company's money is with the company. IE has been paid over. So the company could invest it in shares etc.
     
  10. Mark77

    Mark77 Active Member

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    Isn't another major difference the ability to get the 50% exemption of CGT when the beneficiaries of a trust are individuals? From what I understand this does not apply to a beneficiary that is a company. I would have thought that in most cases this would trump the tax savings of 30% vs marginal rate.
     
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  11. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    Yes. Captial gains going to a bucket company would be taxed at 30% whereas capital gains going to an individual on the top marginal tax rate would be taxed at 47% or 23.5% for assets held more than 12 months.

    The beauty of trusts is that you could divert income to the company and capital gains to an individual.

    However diverting to a company could still work out well, for example if there is a capital gain this year that goes to the company the company may pay a franked dividend next year to a child that has turned 18. The franking credits may mean the child receives back tax that the company has paid. Potentially the end tax rate could be 0%
     
  12. Mark77

    Mark77 Active Member

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    Thanks Terry, I didn't realise that was possible.

    Yes, a bit advantage to trusts occurs when you have children that are 18 or over and not earning much. Unfortunately many years off for me!
     
  13. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

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    Even without children the strategy could work - it helps divert income from one year to the next - or later.
     
  14. Ritzzz

    Ritzzz Member

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    Hi Terry,

    How about this:

    X company ATF Family Trust say Y. Inlaws currently residents not earning income as benficiaries. Read somewhere on the forum that if any trading occurs in the family trust, the assets should be kept as minimal and limited to the activities of the trust trading.

    Intention is to have income from contracting paid into family trust, then distributed to another beneficiary (to be set up as a family trust to the original family trust). Is this nuts ?
     
  15. MikeLivingTheDream

    MikeLivingTheDream BCOM MCOM MTAX CPA CTA Registered Tax Agent Business Member

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    Its possible but first question is whether the contracting income is personal services income.
     
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  16. Ritzzz

    Ritzzz Member

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    Hi Michael,

    While the income is from my labour and skills im not generating it from just the one employer.
     
  17. willy1111

    willy1111 Well-Known Member

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    Let's just hope Shorten, sorry Mr Shorten, doesn't get his way and tamper with things.
     
  18. MikeLivingTheDream

    MikeLivingTheDream BCOM MCOM MTAX CPA CTA Registered Tax Agent Business Member

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    That doesnt mean you are necessarily a PSB. That 80/20 rule is but one test. You then need to look at the unrelated clients tests, employment test and business premises test.

    Then you need to consider Part IVA. Most medical specialists meet the PSB tests but they need to consider Part IVA. ATO seems to want to see market salaries to the PSI generator before any distributions.

    Your tax adviser will be able to review your position and advise accordingly.
     
    Last edited: 10th Jan, 2018
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