Every June is an exciting time in the accounting industry as tax planning is high on the agenda. Accountants have been eagerly awaiting this time of year as it is the perfect time to introduce the "Bucket Company" to their highly profitable clients. However, their excitement quickly leads to exhaustion as they find themselves explaining the tax structure to their non-accounting language speaking clients. The outcome is mostly positive once the client understands that they don't understand, and finally agree to the Bucket Company proposal purely based on trust and a need to end the complicated conversation. A new Bucket Company is born.
Understanding Bucket Companies
For a Bucket Company to be considered, a family trust with growing profits and limited beneficiaries is the trigger. A 'Bucket Company' is a corporate entity most commonly used as a new beneficiary for a Family Trust. Once established, the company automatically becomes a beneficiary under most Family Trust deeds. It can be established any time.
The more beneficiaries you have in a Family Trust the better and the Australian Tax Office allows for beneficiaries that are ‘certain’ or ‘ascertainable’. The definition of beneficiaries generally includes ‘my spouse, children, grandchildren, great-grandchildren and any company I have an interest in, from time to time ‘. So generally, any company you have an interest in is also a beneficiary under your Family Trust. As soon as the bucket company is established, you can start distributing income from the family trust to this new corporate beneficiary.
Tax Advantages of a corporate beneficiary in a Family Trust
Your Family Trust distributes to human beneficiaries first.
This is mum, dad and the children up to their low marginal tax rates. What happens after the Family Trust runs out of beneficiaries on low marginal tax rates?
When there is no one left on low marginal tax rates then the family trust pours the rest of the income into the ‘bucket’ company. The company gets whatever income is left to be distributed.
Unlike humans, companies pay a fixed percentage rate of tax. Whether the company gets $10,000 or $100,000 in trust income it pays the same percentage tax rate.
Challenges of a bucket company
As with everything you do, there are challenges. If you decide to distribute Family Trust income to a bucket company, you must do the following:
1. complete a Family Trust distribution statement; and
2. then physically transfer the money into the bucket company’s bank account. This is before lodging the tax return.
You, therefore, need to have the actual cash in the Family Trust bank account. But rarely does a Family Trust have such ‘lazy money’ sitting in cash. So, if there is not enough cash you have a division 7A Loan.
Division 7A Loan Deed for a Bucket company
When a trust or a human owes money to a company then you need a Division 7A Loan Deed.
When a Family Trust fails to pay all the income to the bucket company then you need a Div 7A Loan Deed.
The Div 7A loan agreement is a loan between:
• the family trust that is distributing the income; – but actually does not physically pay the income; and
• the bucket company that has not actually been paid the Family Trust distribution income
If the family trust doesn’t pay all the distributions in cash before the tax return is lodged, then a Div 7A loan is required.
A Div 7A loan:
• Has a maximum term of 7 years
• Has a minimum annual repayment plan
• Has interest that is payable at a rate set by the government each financial year
• The minimum repayments can be met by the Family Trust physically making payments to the bucket company each year. However, it is possible for the bucket company to declare dividends that are offset against the minimum repayment obligation.
It's hard to get money out of a bucket company as you cannot just take money out.
What do you do with the money in the bucket company?
You saved tax by distributing money to a bucket company. Congratulations. But now you have a pile of cash sitting in the bucket company.
Cash from the Family Trust that is now in the bucket company needs to be invested. The bucket company is now an investment company. It seeks to generate an income source for the shareholder.
But, often, a company may not be the best vehicle to hold ‘appreciating’ assets.
When a human or a trust sells an asset, they often reduce their capital gain, automatically, by 50%. This is when they hold that asset for over 12 months. This may be one of the reasons why your accountant wanted you to set up a Family Trust in the first place. Companies do not get that capital gains tax relief.
A bucket company by definition is a holder of wealth. Therefore, for asset protection, it is best that your bucket company does not carry risk. It should just hold ‘safe’ passive assets like cash and shares.
Minimum requirements for a bucket company
• at least one director/secretary living in Australia
• a physical Australian address for the registered office
• at least one shareholder
You are a business owner, therefore, like all business owners are a risk of bankruptcy. It is poor asset protection to own valuable assets, including shares in an asset-rich company. For example, let us say your Family Trust distributes $100,000 to the company beneficiary each year for ten years.
Your bucket company now has $1m in it. If you own 50% of the company and you go bankrupt, the trustee in bankruptcy takes your shares which is 50% interest in the company. It takes $500,000.
Finally, as dividends can only be paid to the shareholders, a second family trust should be considered to own the shares in the bucket company.
