The ATO is always looking at Trusts as they are the most flexible business structure, this flexibility presents a myriad of planning options but whilst most are Ok some are less so. Discretionary Trusts are required to distribute their earnings each year to a beneficiary who pays tax at their marginal tax rate.

A key difference between this type of Trust and a company is that a company is able to retain its earnings and pay a flat rate of tax (30% or 25% for a BRE)*.

But there are many differences between these 2 structures which we will not be examining today but to even up the discussion Trusts can access greater tax concessions and offer far more flexibility.

A way to allow these trusts to pay a flat company tax rate is the use of a  ‘bucket company‘ .

Here the distributions from a discretionary trust are made to a company that is a beneficiary so they can cap the tax rate on the trust’s income to the flat company rate of 30%*.

  1. Generally the trustee will first look to distribute the trust’s income to a number of individuals who are on marginal tax rates at or below  30%.
  2. When those marginal rates have been fully utilised, any residual trust income is then directed to the company, i.e. it is put in the ‘bucket’.

 

Not surprisingly, the Tax Office is not a big fan of bucket companies, so great care needs to be exercised in the use of this strategy.

If you are utilising a bucket company strategy or you are thinking of utilising one, ensure you have an effective strategy in place, seek professional advice.

There are planning opportunities and wealth creation possibilities – talk to us.

 

When using this strategy 2 scenarios emerge:

  1. If you don’t pay the money to the company you make it harder for yourself;
  • If the cash funds are left outstanding from the trust to the company – in the form of an ‘unpaid present entitlement‘
  • Then Division 7A (ITAA 36) can apply to deem the unpaid amounts to be assessable dividends.
  • These dividends are generally treated as ‘unfranked’, so the effective rate of tax on the trust income can then exceed 64%.
  • Division 7A issues can also arise if the cash is paid to another party, i.e. an associate of a shareholder in the company.

 

  1. Paying the money to the company makes things easier;
  • If the cash is actually paid to the company, then the company will need to do something with it.
  • If the company invests the cash in its own name then any investment income will also benefit from the flat company tax rate of 30%.
  • However, any capital gains that the company may make on such investments will not benefit from the 50% CGT discount. Accordingly, investing the cash through the company may not result in the best longer-term tax outcomes.
  • But don’t give up the possibilities don’t end there:
  1. The bucket company can invest in assets that provide income rather than capital gains.
  2. The bucket company can lend the cash to another entity under a complying Division 7A loan, then that other entity can invest the cash so as to qualify for a deduction on the interest paid back to the bucket company. The bucket company will then also pay a series of dividends over time to enable the other entity to fund the principal repayments on the loan. This may assist in managing short term and lumpy tax obligations of a trust however the strategy is not without its difficulties, and must be implemented extremely carefully.

All food for thought, this is a consideration when you are completing your tax planning sessions with us.

Please call if you would like to discuss this or any other matters.

* a company that is a base rate entity pays a lower tax rate i.e. 25% in FY22