It is sometimes said that “the rich get richer and the poor get poorer”. While this article won’t address that particular ethical dilemma, it is often worth looking at your financial and personal affairs from a tax planning perspective to ensure that you are taking advantage of all passive wealth creation opportunities – including those that may The way you structure your business and / or investments is inherent in the way you structure your business and / or investments.
Below is an overview of the role of the corporate beneficiary or “bucket company” in investment structures.
Income splitting is a thing of the past.
The wealth accumulation structure of choice for “everyday” individuals and families used to be almost exclusively the family foundation. However, what is commonly known as “income splitting” (i.e. the practice of taking the income generated by a person with a high marginal tax rate and assigning all or part of that income to a single beneficiary with a lower marginal tax rate) is due to anti-tax avoidance measures no longer a valid tax planning strategy, including:
(a) the introduction of penalty tax rates (currently 45%) on “undeserved / non-exempt income” of minors (under 18 years of age) above a certain amount (currently USD 417);
(b) regulations relating to personal service income; and
(c) the general anti-circumvention provisions in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
Using a corporate beneficiary to receive distributions from a family trust is not to be confused with income-sharing – the two problems differ conceptually in key ways from a tax avoidance perspective. However, there are “pressure points” that need to be considered before using a corporate beneficiary as part of a comprehensive tax planning strategy.
Whether the beneficiary is part of a long-term family investment structure or a larger privately owned group of companies, the difference between the Australian corporate tax rate (currently 30% for passive investment companies) and the highest individual marginal tax rate (currently 45%) remains the same (around 15% or 15,000 $ 100,000 trust payout). This difference offers the possibility of postponing the tax date for the relevant natural person (s) who are to benefit broadly from the trust until the date when the beneficiary generally receives a future dividend explained.
Individuals can also access the funds distributed to the corporate beneficiary by entering into a loan with the trust that conforms to Division 7A of ITAA 1936 (e.g., meets minimum interest rate, minimum interest and principal repayments, and loan term requirements).
Use of loss carryforwards
Subject to compliance with the rules governing the availability of loss carryforwards (e.g., ownership continuity review), it may be possible for a trust to distribute income to a beneficiary and for that beneficiary to use retained losses, resulting in offsetting and no tax liability at company level.
The following points should be considered before implementing a corporate beneficiary:
- the tax rate differential generally applies only to the distribution of ordinary income by the trust (transferring capital gains to a corporate beneficiary may not be advisable as the CGT discount of 50% is applied and corporations are not available);
- the rules governing income from personal services may apply to distributions from a business trust that generates income from the personal skills and efforts of an individual who is a trust beneficiary;
- all financial arrangements made by the beneficiary of the company to an associate (including a fiduciary beneficiary) must be subject to a Division 7A loan agreement;
- unpaid current claims owed by a trust to a corporate beneficiary may trigger Division 7A of ITAA 1936; and
- the corporate beneficiary must be a “beneficiary” under the terms of the trust deed (this is not automatic and a change to the trust deed may be required).
A corporate beneficiary is an entry-level tax planning strategy that is within reach for many “everyday” investors. A thorough understanding of the framework that governs the nature and scope of a corporate beneficiary’s activities will help determine what they can (or cannot) offer you as a tax planning strategy.