Many small to medium-sized businesses across Perth have used bucket companies to save on tax with the help of their Perth tax accountant. However, the tax benefits and structuring of bucket companies require thought and planning, and they also have tax downsides that need thought and preparation.
This blog will outline the tax saving strategies with a bucket company and explain how to set up a bucket company for a Perth business family.
What is a bucket company?
A bucket company is a regular company. The reference to a bucket is the concept that the company receives the leftover income generated by a family trust that is ultimately poured into the company. The bucket company is registered for all of Australia so setting up a bucket company in Perth is the same process as the rest of the country.
A benefit of a bucket company for families in business is that it pays a lower tax rate.
Base rate entities
If your bucket company qualifies as a base rate entity, it will pay tax at 25%
Other entities
Otherwise, the bucket company will pay tax at 30%.
These rates both compare favourably to the 47% marginal tax rate many business families are paying. While a self-managed superannuation fund can pay a lower rate of tax, the concessional contribution limits and the non-concessional contribution limits impact how much a business family can inject into that SMSF.
An SMSF also has a range of related party prohibitions that do not apply to bucket companies.
How to set up a bucket company
Creating a bucket company is the same as making any company. While the process is mechanically simple, it is essential to understand the different options for structuring the bucket company and its tax downsides.
A bucket company has income tax implications, capital gains tax implications, asset protection, estate planning and administration costs to consider.
Like any company, your bucket company will have a constitution, share certificates, member consents, director consents, a register of directors, and a shareholder register. It will also need a registered office. Your Perth tax accountant (or lawyer) can create your bucket company statutory documents.
What tax benefit does a bucket company generate?
If the family business paid the two parents a salary of $200k each (plus the maximum super contributions) and paid a $500k franked dividend to the family trust, a bucket company could help. If the franked dividends were also paid to the parents on top of their salaries, they would incur a tax bill of ~$147k. Their superannuation contributions would also incur another $8,250 in tax on their employer superannuation contributions through Division 293 tax.
So, the total tax on the franked dividend, including the impact of the Div 293 tax, would have been ~$154k.
If the same franked dividend were allocated to a bucket company, the tax rate on the franked dividend would be $33,333.
So, the bucket company would save that family ~$121k in tax.
If that family’s tax affairs were the same yearly, that tax benefit would be enjoyed yearly.
The above transaction will have administration costs from their Perth tax accountant. And those costs will depend on the complexity of the investments in the bucket company – but it would be rare for the costs to exceed the above tax benefits.
Downsides of a Bucket Company
If you allocate profits to a bucket company, tax law ultimately requires that you pay those profits in cash to the bucket company. While the requirement to pay those profits can be repaid gradually over 7 years (or potentially 25 years), the profits allocated to the bucket company will eventually need to be transferred and then remain in the bucket company.
Like a regular company, a bucket company also does not enjoy the 50% CGT discount that trusts and individuals enjoy.
If you are chasing the 50% CGT discount and want to enjoy a bucket company’s lower tax rates, using Division 7a deferred payment dates to structure your assets is a smart tax strategy.
The tax benefits of a bucket company are also deferred tax benefits. If you take cash out of your bucket company, your family will incur top-up tax on that money withdrawn.
Managing a bucket company also has advice costs from your Perth tax accountant to ensure the tax benefits are thoroughly and properly enjoyed. The use of cloud accounting can reduce the administration workload of bucket companies.
Who should own the bucket company?
Ultimately, the bucket company will be shut down. This might be on your retirement, your death, the death of your children or even great-great-grandchildren. So, the bucket company will declare dividends to reduce its net assets such that the company eventually.
And just like any succession planning event the tax structuring of your bucket company during creation should factor in tax strategies to shut down your bucket company later.
Ordinarily, a bucket company should be owned by a special purpose family discretionary trust. This will allow dividends from the bucket company to be declared to the most tax-advantaged individual later.
Can I open a bucket company after I open my family trust?
You can establish a bucket company after setting up your Family Trust; the timing is flexible. Upon its creation, the bucket company is seamlessly incorporated as a beneficiary within your Family Trust.
Does my bucket company become a Family Trust beneficiary?
Most family trust deeds describe a general class of beneficiaries when they are created. This allows the family beneficiaries of the family trust to expand and contract over time as the family changes.
Classically, a beneficiary of your family trust will include any company where a family member owns a share. So, ordinarily, a bucket company will automatically become a beneficiary of the family trust.
Your Perth tax accountant will advise you on structuring and reviewing your family trust deed. You will also need tax advice on the tax impact of family trust elections. Of course family trusts are not right for everybody and there can be many reasons why a family trust might not be a good idea.
Estate planning impacts
On your death, the bucket company will often hold significant wealth. So, your estate plan should consider your bucket company’s tax strategy and impact.
For families of substantial wealth tax, structuring several bucket companies (one for each estate beneficiary) to operate in a joint venture can be a good tax strategy for estate planning. You can then allow each child/estate beneficiary to take their assets in their own bucket company.
So just like your financial planner will give estate planning advice on the direction of your insurance proceeds on death, and your lawyer will draft the will, your Perth tax accountant should document the tax impact of your estate plan and do a funds flow showing the movement of money and the tax impact of your money on death.
How to get started with a bucket company
Using a bucket company is a classical tax strategy many business families use to reduce their tax burden, provide for their families, and protect their wealth. Structuring and managing the tax profile of bucket companies can profoundly impact the tax effectiveness of this strategy and support the long-term wealth of a family business – and this is where Westcourt is a wise choice. As a firm only focused on helping families in business, with our deep global network, commitment to independent-only advice and proven technical excellence in taxation, we are uniquely positioned to help business families grow – so why not call us today?
