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Business profits

Discussion in 'Accounting, Tax & Legal' started by Simon Hampel, 20th Oct, 2005.

  1. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Let's say I run a company that makes $10,000 profit.

    The shares in the company are owned by a discretionary trust of which I am a beneficiary.

    How do I (from an accounting point of view), take that $10,000 and use it in the trust ? Would it be a dividend ?

    Would the company have to pay tax on it, or can I let it be passed on to the trust untaxed - so the full tax liability passes to the trust ?

    Example - if I have losses in my trust, could I then use that $10,000 not-yet-taxed income from the company to offset the losses in the trust, hence leaving a smaller amount (or even zero) taxable income to be distributed to the beneficiaries ?

    ... or does the company have to pay tax on that profit regardless (for which the shareholders or eventual beneficiaries then get credit) ?
     
  2. NickM

    NickM Co-founder Staff Member

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    If your company makes a $10K profit then it will pay tax leaving you with $7K.

    You can pay a div to the trust and it will receive an imp credit for $3K which it can pass on to the beneficiaries.

    If you pay the dividend prior to 30/6 it can go through as an unfranked dividend and the trust will receive the income. The company will still pay tax of $3K later in the year as teh dividend will not affect the tax position of the company.
    NickM
     
    Last edited by a moderator: 21st Oct, 2005
  3. Dave

    Dave Well-Known Member

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    Hi,

    Wow 70% tax rate, remind me not to move to that country :eek:

    Cheers ;)
     
  4. NickM

    NickM Co-founder Staff Member

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    Whoops !
    should be $7K !
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Nick, have I got this right ...

    ==============================================
    Option 1 (dividend paid after 30/6)

    Company gets $10K income (let's assume it's all profit).

    Company declares $10K income and pays $3K tax.

    Company pays $7K fully franked dividend to trust

    Trust distributes $7K of income to beneficiaries with $3K of imputation credit.

    Beneficiaries declare income of $7K net dividend + $3K franking credit = $10K assessable income

    Tax liabilities:
    ----------------------------
    Option 2A (48.5% tax bracket)

    Beneficiary on 48.5% tax bracket has $4.85K tax liability, with $3K credit = $1.85K net tax owed

    Total tax paid by everyone = $3K by company + $1.85K by beneficiary = $4.85K
    ----------------------------
    Option 2B (30% tax bracket)

    Beneficiary on 30% tax bracket has $3K tax liability with $3K credit = 0 net tax owed

    Total tax paid by everyone = $3K by company + 0 by beneficiary = $3K
    ----------------------------
    Option 2C (0 tax bracket)

    Beneficiary on 0 tax bracket has 0 tax liability (less than $6K total) with $3K credit = $3K net

    tax returned

    Total tax paid by everyone = $3K by company + -$3K by beneficiary = $0


    =============================================


    Option 2 (dividend paid before 30/6)

    Company gets $10K income (let's assume it's all profit).

    Company pays unfranked dividend of $7K to the trust

    Trust distributes $7K of income to beneficiaries with zero credit.

    Beneficiaries declare income of $7K net dividend = $7K assessable income
    ----------------------------
    Option 2A (48.5% tax bracket)

    Beneficiary on 48.5% tax bracket has $3395 net tax liability

    Company has $3000 net tax liability

    Total tax paid by everyone = $6695
    ----------------------------
    Option 2B (30% tax bracket)

    Beneficiary on 30% tax bracket has $2100 net tax liability

    Company has $3000 net tax liability

    Total tax paid by everyone = $5100
    ----------------------------
    Option 2C (0% tax bracket)

    Beneficiary on 0% tax bracket has $150 net tax liability

    Company has $3000 net tax liability

    Total tax paid by everyone = $3150

    =============================================

    Option 3 (paid after 30/6 but no profits to distribute to beneficiary)

    Company gets $10K income (let's assume it's all profit).

    Company declares $10K income and pays $3K tax.

    Company pays $7K fully franked dividend to trust.

    Trust has at least $7K of losses.

    Trust distributes $0K of income to beneficiaries with $3K of imputation credit.

    Beneficiaries declare income of $0K net dividend + $3K franking credit = $3K assessable income

    Beneficiary has $0K tax liability, with $3K credit = $3K net tax returned

    Total tax paid by everyone = $3K + - $3K = $0

    =============================================

    Summary:

    Total tax paid is quite a bit higher if the dividend is paid before 30/6 and is unfranked. Fully franked dividend is a lot better taxwise.

    If the trust has losses to offset the dividend income, the unfranked dividend paid before 30/6, total tax paid is $3K by the company. If fully franked paid after 30/6, the trust pays $3K, but the beneficiaries get $3K of tax credit - net effect is zero.

    Did I get it right ? Option 2 seems really expensive taxwise, with only $3305 in after tax income left from the $10K. Surely this isn't right - you're basically paying double tax ?
     
  6. NickM

    NickM Co-founder Staff Member

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    Hi Sim
    OK, lets work through this :rolleyes:
    Option 1 All assumptions and answers are correct.

    Option 2
    Would not normally recommend a payment of a franked dividend.
    One would wait until 1/7/05 to take a loan from the company that would be repaid through a fully franked dividend prior to 30/6/06.

    From 30/6/05 the ato have allowed profitable start up companies with no franking credits to complete a franking account by 28/7/05 and pay the tax in relation to 30/6/05. This would enable the company to pay a fully franked div for 30/6/05.
    We actually did this for a client this year and took us about an hour on the phone to the ATO to find someone who had undertsood the change in legislation ! Strategy worked well.

    Option 3
    if the trust recoups its losses and has received imp credits the trustee is then entitled to the refund - so your trust would receive the $3K :)

    Clear as mud ?
    NickM
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Okay - thanks Nick. You are right - clear as mud.

    Let's try another approach!

    It's November now. My company will be profitable this financial year. I want to extract some of the cash from the company for use within the trust as soon as possible (ie now) in the most tax-effective way.

    The beneficiaries of the trust that owns the shares in the company will be in (or near) the top tax bracket, so no point distributing anything to them.

    I'm assuming the trust will make either a slight profit or a slight loss over the course of the financial year, ignoring any income from the company.

    I'm thinking this will all make a good article topic at some stage !! :D
     
  8. NickM

    NickM Co-founder Staff Member

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    Sim
    Depend on the net asset position of the company but you could borrow from the coy. Div 7A interest doesnt kick in until 1/7 so you could repay the loan or declare a div at that time and utilise the franiking credits due later in the year.