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Tax Tip 85: Sale of a Rental property to Related Company

Discussion in 'Accounting & Tax' started by Terry_w, 24th Nov, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Can X sell a rental property he owns to a company of which he is a director and sole shareholder?

    Yes he can!

    Will Part VIA apply? No

    TD 95/4 Income tax: does the simple disposition of an income producing asset by a natural person to a wholly owned private company constitute the carrying out of a scheme to which Part IVA of the Income Tax Assessment Act 1936 will be applied? https://www.ato.gov.au/law/view/document?docid=TXD/TD954/NAT/ATO/00001



    See the ATO’s example
    Note that Part IVA does not apply to the transaction itself – transfer of title. But this doesn’t necessarily mean it won’t apply to the loan arrangement – the example doesn’t cover this. It doesn't say whether Anna causes the company to borrow more money than the loan she had on the property.

    So seek tax advice before trying this at home.
     
    Perthguy and Gingin like this.
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    See also TD 95/4 Income tax: does the simple disposition of an income producing asset by a natural person to a wholly owned private company constitute the carrying out of a scheme to which Part IVA of the Income Tax Assessment Act 1936 will be applied? https://www.ato.gov.au/law/view/document?docid=TXD/TD954/NAT/ATO/00001

    1. No. Of itself, the simple disposition of an income producing asset by a natural person to a wholly owned private company is not an arrangement to which the Commissioner will seek to apply Part IVA of the Income Tax Assessment Act 1936 (the Act). Examples are outlined below.

    2. It should be noted however that where there are other associated transactions, transfers or arrangements, whether antecedent or subsequent, the disposition will be examined within that broader context, and it may be concluded that Part IVA of the Act should be applied.

    ...

    Example 2: Anna holds a rental property. The initial intention was that the property would be negatively geared. However, because of an unexpected reduction in interest rates a net profit is now being returned. Anna disposes of the property to a wholly owned private company which has been newly incorporated for that purpose. The intention is that the rental earnings from the property will be retained in the company until such time as it is considered appropriate to declare and pay a dividend to Anna.
     
  3. Rob G

    Rob G Well-Known Member

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    Speculating here because we are not given surrounding facts.

    So your property is unexpectedly positively geared.

    You incur CGT (with discount) and stamp duty to transfer the property to a company. Presumably there is nobody to income split with a trust and so they choose a company to merely pay 30% income tax and defer the final distribution.

    1. Upfront CGT and stamp duty.

    2. Cost of company structure and returns.

    3, No future CGT discount when sold.

    4. Depreciation and building allowance write-offs mean a significant amount of tax sheltered profits will result in unfranked dividends when distributed. This could have been completely untaxed if held in a trust or your name.

    One question is whether the extra tax on unexpected short term profits is really worth the long term cost and complexity of restructuring.

    There are other strategies for asset protection and tax planning. For example, transfer to a trust with a bucket company beneficiary?

    We can only speculate because we don't have the full facts. However, it appears that the ATO had to issue a Part IVA ruling without being given details of the surrounding scheme and consequently the position adopted had to be broad and vague.
     
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    One potential benefit could be land tax in NSW. A potential $7,712 in savings per year compared to a trustee or an individual owning the property
     
  5. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    And of course the transfer must occur at market value in such a case as the transfer between parties who are not at arms length. CGT law requires the market value be used to ensure that the transfer is based on an arms length price. OSR generally also require a valuation where parties arent arms length to confirm the consideration is a market price.
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    @Rob G I am trying how big an effect the depreciation etc would be. Could you please give an example of how it would effect franking.

    I see it this way,
    Company A
    $10,000 in income received by a company, after expense.
    Company pays $3000 in tax
    Company credits franking account $3000
    Company pays a $7,000 dividend with $3,000 franked credits.
    Company debits $3000 from franking account.

    Company B
    $10,000 income after costs, before depreciation
    $2000 in depreciation
    $8,000 taxable income
    $2400 tax
    $2400 in franking credits
    Company pays $5,600 in franked dividends with $2400 in franking credits.
    Company pays $2,000 in unfranked dividends with no franking credits.

    So the shareholders of company B had $600 less franking credits than the shareholders of company A.
     
  7. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    The reality is a company profit is never really taxed at 30%. It gets taxed at 30% ....then in hands of the shareholders the tax can be as high as 55%+ overall. That issue alone must be clearly understood by anyone using a company for wealth building.

    For those who may use entities for development or where the company owns business land (ie factory, office) the changes that allow restructuring to be a CGT rollover (rather than a CGT trigger) after 1 July may open some opportunities for some to consider different structure arrangements (ie get a property OUT of a company and into a trust). Sure the transfer of land isnt exempt from duty (NSW) but if the duty is inevitable but there is no CGT then there could be some who can correct the errors of the past. Even the trust cloning duty concession in QLD could help.
     
  8. Rob G

    Rob G Well-Known Member

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    Or property held in a discretionary trust.

    Only $8,000 of net income to distribute. The $2,000 tax sheltered amount may be distributed tax free.

    And on eventual sale, net income is calculated with the 50% CGT discount. The other 50% may be distributed tax-free.
     
  9. datto

    datto Well-Known Member

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    Investing in IPs gets complicated and expensive as you grow the portfolio.

    Might be simpler if you just don't ever sell, draw down equity to buy more IPs and of course pay that dreaded land tax.

    Tax is going to hit you no matter what you do.

    And don't think all those fancy tax schemes and tax havens are safe either. They become unstuck sooner or later.
     
  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I am trying to work out whether it would be beneficial to owner property in a company in NSW in order to avoid paying an extra $7k or so in land tax per year.

    I have a sample depreciation report from BMT with values for Div 43 and Div 40 deductions over 40 years. On the purcahse price of $650,000 the total amount of depreciaton claimed over 40 years is $304,000.

    With the loss of franking credits on this of about 30% that would mean a potential $91k in extra tax. But if there is a saving of land tax of $7,000 per year over 40 years that would mean an extra $280,000 saved (assuming constant figures).

    So it would still appear that owning in a company in NSW can save you money in the long run.

    Add to this the ability to have the shares held by a trustee of a discretionary trusts and there are other benefits too.
     
  11. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Annual tax / accounting compliance and ASIC fees for company and trust and trustee company ?
    Estate planning costs must be impacted and risks are enhanced with time.
    The company could have other investments such as FF share divs, franked trust income etc and NOT lose franking credits too.
    Depends on shareholding
    Depends on what tax outcome you want after 20 years
    Depends on neg v positive gearing
    Asset protection issues if you depart Australia
    One of the concerns I would have is that a lender may only allow a equity release to buy more company owned property.
    Can never be owned by a SMSF. (Part or whole)
    Problems with living in a company owned property.

    Basically a long term strategy like that should not exclude a unit trust, ungeared UT, refinance principles or a SMSF either. I dont think its as easy as concluding one v's other.
     
  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes not easy that is for sure.
     
  13. Rob G

    Rob G Well-Known Member

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    Do a discounted cash flow analysis considering your dividend and asset sale strategy.

    Basically the depreciation deductions are in fact taxed at time of dividend payment - which can be deferred to a year when the shareholder is on a lower marginal tax rate.

    Similarly, the lack of CGT discount upon eventual sale means that this portion of the deferred capital gain is also taxed on a deferred basis when paid out as a dividend.

    Just remember that these extra "taxed amounts" are in fact taxed at the shareholder's marginal rate at time of dividend payment.

    A trust will distribute net income each year but may also distribute the non-assessable amounts at any time or may be permitted under the deed to reallocate to anyone's benefit.