Do you have a Discretionary or Family Trust that generates profits? If yes, then this strategy may apply to you.
When business owners start making a healthy profit, one of the most unexpected things is the tax they owe to the ATO. In most cases, business owners will try to minimize tax by maximizing deductions. Yes, deductions will help you save money on taxes however you must ask yourself, do you really want to give up profit just to save on taxes?
A solution to this is the use of a Bucket company. By distributing profits to a Bucket company, you are able to reduce the amount of tax your business pays without sacrificing profits.
There are several benefits to using a bucket company, and it is essential to work with an accountant who understands this type of structure. In this blog post, we will discuss the benefits of using a bucket company and why you should consider incorporating one into your tax plan.
What is a Bucket Company:
A bucket company is simply a company that has been established as a beneficiary of a trust. The term “bucket” comes from the fact that the business sits beneath your trust and is used to channel money into it in order to reduce taxes. This allows you to limit your tax obligation at a corporate tax rate.
Reduces overall tax payable on profit distributed from the trust.
Allows you to control how and when income is distributed to shareholders/ beneficiaries.
Provides asset protection for the company’s assets.
Can act as a holding company for investments.
Who is the “Bucket Company” Strategy for:
The Bucket Company strategy is most beneficial for businesses or families that have a discretionary trust and make profits. If you are looking for ways to reduce the amount of tax your business pays, then this may be a good option for you.
It is important to note that the Bucket Company strategy is not a way to avoid paying taxes. The goal is to simply reduce the amount of tax your business pays. This can be a helpful strategy for businesses that are looking to reinvest profits back into the business.
When you work with an accountant to establish a Bucket Company, they will help you determine if this is the right solution for your business. They will also help you set up the company and ensure that it is compliant with all tax laws.
Why would you use a Bucket Company?
A bucket company allows you to cap the tax on the profits distributed to it by a trust to just the company tax rate of 30% or even maybe the lower small business company tax rate of 25%. This is much less than the individual top marginal tax rate of 45% plus Medicare.
Put it into action:
Assume a trust earns $250,000 in profits from business.
Option 1: Distribute profits 50 / 50 to Individuals 1 and 2. Total tax (inc. Medicare Levy) payable = $66,734 (26.7%)
Option 2: Distribute $90,000 each to Individuals 1 & 2 and distribute balance of $70,000 to a “bucket” company at a 25% tax rate. Total tax payable = $57,534 (23%).
(Note: This strategy assumes that the $70,000 in cash is available to be distributed to a bucket company, otherwise what is known as a Div 7A Loan Agreement will need to be entered into and loan repayments made over a 7-year period.)
Accessing money in the Bucket Company:
Once the Bucket Company has been set up and is operational, there are a few ways to access the money that has been “bucketed” away.
The cash in a bucket company can be used to invest in shares, property, or to lend to other entities at a specific interest rate.
Alternatively you can have the Bucket Company make a distribution to the shareholders (which would be you and/or your family members). This can be done either as a dividend or as a loan. If it is done as a dividend, you don’t have to pay any tax on it (depending on your personal marginal tax rate). The company would frank the dividend and pass on the franking credit to you. This means that you would get a refund of the tax that was paid by the company on your behalf. If the distribution is made as a loan, you would have to pay tax on the interest that you charge on the loan.
Another way to access the money is to have the Bucket Company make an investment in another company. For example, if you have a rental property business, you could have the Bucket Company invest in one of your properties.
Risks of using a Bucket Company:
The main risk of using a Bucket Company is that it can be perceived as tax avoidance. If the ATO believes that you are using a Bucket Company solely for the purpose of avoiding taxes, they can deem the company to be a sham and take action against you.
Another risk to consider is that if the Bucket Company makes investments that are not profitable, this could result in losses that would be passed on to the shareholders/ beneficiaries.
It’s important to speak with an accountant before implementing a Bucket Company strategy, as they will be able to advise you on the risks and benefits associated with this type of structure.
A Bucket Company can be a useful tool to help you save on taxes; however you need to discuss this with us BEFORE you do it. There are different tax laws that affect the use of this strategy, and whether your “bucket company” can use a tax rate of 30% or 25%.
As your Accountants, we are very aware of these tax laws and can make this easy for you.
Imagine what you could do with your tax saved:
- Reduce your home loan
- Top up your Super
- Save for a holiday (when we can all travel again!)
- Deposit for an Investment Property
- Pay for your children’s education
- Upgrade your Car
Please note that this blog post is provided for informational purposes only and does not constitute tax, legal or financial advice. You should always speak with a qualified professional before making any decisions about your personal finances.