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Ensuring your business remains profitable is one of your most important responsibilities as a business owner. But do you have a plan for what to do when your business starts to generate a healthy profit? How can you avoid being blind-sided by the tax owing when the ATO comes calling?
While methods such as maximising deductions have their place in any tax planning strategy, a tax minimisation strategy that solely relies on deductions can leave you sacrificing profit in order to lower your tax when there may be other options available to you.
With you and your family relying on the profits generated by your business to fund your lifestyle, it's important you understand the most tax effective manner for distributing income and the best business structures that allow you to do so.
You may want to consider how a bucket company might fit in your overall tax planning strategy.
A bucket company (otherwise known as a corporate beneficiary) is a company that is set up as a beneficiary of a trust with the purpose of allowing any income the trust distributes to the bucket company to be payable at the company tax rate, currently 25% (only if it is a base rate entity), as opposed to the individual marginal tax rate (the top tax rate for individuals is currently 49% including Medicare levy).
They're called bucket companies because they sit below a trust like a bucket and are used to distribute income to it.
It is important to keep in mind there are rules around Family Trusts and in those structures distributing within a family group, otherwise family trust distributions tax may apply.
There are generally three elements present for a bucket company:
One of the main reasons bucket companies are used is to access the tax benefits they provide, and you should keep this in mind when you're making a decision around who holds the company's shares.
If an individual holds the shares, there is not as much flexibility in how the dividends can be distributed; they will need to be distributed exactly according to the shareholder percentage, however, if another kind of trust holds the shares the excess profits may be distributed in a way that allows for less total tax paid. For more on this see below (how to get money out of a bucket company).
The bucket company pays the corporate tax rate, which could be 25% or 30% depending on the type of company. If the company is a base rate entity a company tax rate of 25% will apply, however, if it is not the company tax rate will likely be 30%. The corporate tax rate was higher in recent years at 27.5% from the 2017–18 to 2019–20 income years and 26% in the 2020–21 income year.
The general principle is that the net income of a trust is taxed at the hands of the beneficiaries; individuals and company beneficiaries pay tax on their portion of the trust’s income at the rates that apply to them.
The highest marginal tax rate for individuals (not including the Medicare levy) at the time of writing this article is 45% for people with taxable income of $180,000 or more. There is a flat tax rate of 30% for non base rate entity companies. Due to the current discrepancy between the highest marginal tax rate for individuals and the company tax rate, there is currently at least 15% savings potential. To illustrate, on an income distribution of $100,000, a corporate beneficiary would pay at least $15,000 less tax.
It is important that you ensure that when you distribute to the bucket company for the financial year, you also distribute the same amount to the company's bank account prior to lodging the tax return.
In particular, trusts must distribute to corporate beneficiaries otherwise the Unpaid Present Entitlement (UPE) rules may be triggered.
So far in this article we have looked at how bucket companies can help individuals to save tax by paying out dividends at company tax rates. This is not the only bucket company strategy available.
A bucket company can also be used for holding long-term investments, such as shares, properties, or investments. In this regard, the bucket company becomes an investment company that can generate another source of income for the owner. However, companies do not have access to the 50% Capital Gains Tax discount, but there may be other compelling reasons to use a company structure.
As has been already established, the trust distributes the income to the bucket company, which begs the question, how do you get money out of a bucket company?
There are three ways to extract money from a bucket company:
Div 7A loans can be complicated and warrant an entire article, but for now three points are relevant to bucket companies:
If you are looking to calculate the minimum annual repayment plan, you can use the Div 7A calculator on the ATO's website, which you can find here.
In order to function as intended a bucket company must be an eligible beneficiary of a family trust. As a result, it is important that you read the trust deed of the trust to ensure the bucket company falls within the general class of beneficiaries.
Additionally, depending on the structure there may be a need to make a Family Trust Election. Consider to the Family Group may define or impact who the beneficiaries are.
While they are generally useful for investors and business owners and there is no doubt that a bucket company can be one of the most tax-effective strategies, it may not be ideal for your unique situation.
A bucket company strategy may be of benefit if you are any of the following:
Using a bucket company will not work for you if you are caught under the Personal Services Income (PSI) rules, which exist in order to prevent individuals from reducing or deferring their income tax by diverting income they receive from their personal services through companies, partnerships, or trusts.
For more information, head over to the ATO's website here.
We encourage you to seek professional advice when trying to ascertain whether or not a bucket company is right for you.
Bucket companies can work well as part of a tax savings strategy for business owners and investors alike, however, they are not for everyone. What's more, the Australian Taxation Office is actively engaged in discouraging tax avoidance and the general trend seems to be increasing crack downs as evidenced by the recent guidance from the ATO regarding Section 100A trust distributions.
A good accountant can guide you through the pitfalls and advantages of various tax savings strategies and help you work out a boutique plan that suits your unique financial situation. For the best tax advice seek expert help.
Causbrooks gives you a client manager supported by a team of knowledgeable small business experts. We’re here to take the guesswork out of running your own business.
Get in touch with us to set up a consultation or use the contact form on this page to inquire whether our services are right for you.
Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.
Contact us today to learn more about how our accounting services can benefit your business. We look forward to hearing from you and helping you achieve financial success!