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Buying shares - Trust vs Pty Ltd

Discussion in 'Accounting, Tax & Legal' started by ionic, 11th Jun, 2008.

  1. ionic

    ionic Member

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    Whats the best structure to buy shares?

    Some people say Company, as you can pay wages, dividend to people.

    While others say Discretionary Trusts......

    please discuss......
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Simple: company doesn't get the 50% capital gains discount, whereas trust passes this on to the beneficiaries.

    In my opinion, a company is almost always the wrong vehicle to use to hold investments - the only exception I can think of is if you are operating a business as a share trader (or a real estate developer is another example).

    The downside with trusts if you also have gearing is that losses are quarantined inside the trust and can only be offset against future gains (as opposed to being offset against other income sources if held in your own name).

    The cost of a trust is expensive if you only have a small amount invested - and unless you really need asset protection (eg high risk profession or business owner), then it may not be worthwhile.

    I use a discretionary trust for my investing.
     
  3. ionic

    ionic Member

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    Thanks, but i always thought the 50% discount doesn't apply to trust.


     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Not correct. The capital gains are distributed to the beneficiaries along with any CGT discounts applicable for assets held over 12 months. So the trust doesn't get the discount as such - it is the beneficiaries who get the discount.
     
  5. Rob G.

    Rob G. Well-Known Member

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    MTR 46.5%

    1) Investment company makes $100 taxable income, pays $30 tax and distributes $70 fully franked dividend.

    Shareholder derives $70 + $30 franking credit = $100 taxable income.
    Pays $46.50 less $30 franking credit = $16.50
    Total tax $46.5

    2) Individual employee, investment company pays $100 salary - tax $46.50

    3) Individual beneficiary receives $100 net income from trust investments - tax $46.50

    It really boils down to whether the loss of 50% CGT exemption for a company is worth perks of exempt benefits paid to employees.

    Also, there is a danger with loans to shareholders, limits on deductions for payments to related entities etc ...

    Cheers,

    Rob
     
  6. pjb89

    pjb89 Active Member

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    Hiya

    I would like to pick up on Sim's comment about the cost of trusts are more expensive if you only have a small sum invested. I see this general statement bandied around, but my personal experience is that this is not as significant as implied (well not in my case anyway).

    My accountant cost for my HDT Income Tax Return (ITR) continues to be only marginally higher than my personal ITR. We use our HDT specifically for investment and as an example last year bought 1 IP, sold 2 IP's, traded some shares & increased our ML for our NI managed fund etc. I religiously record all actions through meeting minutes and provide a spreadhseet that has all of the financial 'trading' of the HDT to the account (with a CD of the scanned reciepts, bank statements, minutes etc) at tax time. Should I be worried that I am 'missing' something, or are there others here who have similar experience.

    Sim please feel free to create a new thread if I have inadvertently diverted this thread....


    Pedro
     
  7. ionic

    ionic Member

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    Ok, for overseas beneficiaries(non residents for tax purpose), do they get the 50% discount on CGT as well when the Discretionary Trust distributes to them?
     
  8. ionic

    ionic Member

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    PJB,
    can you message me your accountant's details?

    last year i was whacked nearly $2900 in accounting bill. I swear I need a cheaper accountant!
     
  9. Waimate01

    Waimate01 Well-Known Member

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    Rob G correctly points out that no matter which way you slice it, when significant amounts of money ends up in your hands, you're gonna be paying your maximum MTR. Unavoidable.

    But one advantage of a company is to treat it as a "low tax environment cashbox". This can be a good thing if your goal is to let substantial assets build up in the company, with divs and capital gains being taxed at 'only' 30% (which is a whole lot better than 46.5%). You leave as much in the company as possible, ensuring the salaries of all employees stay at or below $140k (yields a personal MTR of 30%). Then, when you tire of generating new income, the company can continue to pay $140k salaries. So it can be a way of smoothing your income tax rate across decades. The lack of the CGT concession sucks, but not by all that much. When you figure in the benefits of letting your dividends and capital gain proceeds compound in a lower tax environment, the CGT disadvantage pretty much disappears altogether.
     
  10. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I think the outcome will largely depend on the nature of what you are investing in and the levels of income being paid out versus capital gains.

    If you only hold shares and rarely sell, then there won't be much in the way of capital gains.

    If you hold actively managed funds, then you are likely to receive capital gains (hopefully a reasonable amount will be eligible for the 50% discount).

    Given that capital gains typically forms the majority of the returns from most investment portfolios - I think it would be unwise to dismiss the CGT discount.

    Don't forget that even if I am in the top tax bracket (45% + medicare ?? I can't keep up with all the changes!), then with the discount applied, I'm only paying 22.5% + medicare ... that's a lot less than the 30% I'll pay on those same gains if held through a company.

    My first property, which was bought 10 years ago in Adelaide for $150,000 is now arguably worth $500K+. Either way you slice it - the capital gain on that is huge and if I decided to sell (which I might, since I want to buy a new PPOR in Sydney one day), then I have to deal with the capital gains on that property - and paying less than 30% tax is definitely the goal!

    If you look at long term averages of returns for property and shares - they both come out at around 14-15% total return, of which income is typically low (4-5%) and capital gain makes up the rest. I think it would be foolish to ignore the benefits of a capital gains tax discount - unless you really really really believe that you will never sell (or I guess if you are cynical and believe that the CGT discount will disappear one day :rolleyes: )
     
  11. ionic

    ionic Member

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    Hi,

    I think probably the best way is to have a Discretionary Trust, with one of the beneficiaries as a pty ltd company, so that if you run out of individual beneficiaries with low tax bracket to give, u can distribute to the company at 30%.

    Yes the good thing about company is that u can use it to keep unlimited(?) income and paying only 30%. The money u keep in the company u can still use for many purpose such as buying car, daily expenses (phone bills, stationaries, equipments) just buy it all under the company.

    What do u think?

    I have a Hybrid Trust with 1 property, so I wont be using my Hybrid Trust to own shares, since i own units in the trust and may be hit with CGT when i sell the stocks I own too. Dont wanna pay too much accounting fees.

    Currently my plan is to start investing with my pty ltd company, and if the share portfolio grows bigger, I will start using a Discretionary Trust purely for shares and property.

    Actually most of my beneficiaries are overseas, do they get the 50% tax discount for CGT too?
     
  12. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I think there may be an issue with distributing to a company if a family trust election is made. I'm not sure of the details - haven't researched that yet.

    Perhaps one of our local experts can add more about the implications of distributing from a discretionary trust to a company in various situations?
     
  13. Waimate01

    Waimate01 Well-Known Member

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    I guess also it depends on where your new capital enters your eco-system. If it comes to you personally and you have to pay 46.5% before investing what is left over, then that would impact things a lot. But if your new capital enters your company, and you have the choice of investing 70% of it if it stays in the company, versus just 53.5% of it if you pay it out as a dividend or receive it directly in the first place, then clearly that skews things in favour of the company.

    To grossly over-simplify things:

    A) You get $100
    you pay $46.5 in tax
    you invest the remaining $53.5
    Three years later, your investment has grown (say) 113%
    You liquidate your investment for $114.10
    Capital gain is $60.60
    Pay CGT of $14.09
    Net proceeds of $100
    Repeat

    B) Your company gets $100
    It pays $30 in tax
    It invests the remaining $70.
    Three years later, your investment has grown the same 113%
    You liquidate your investment for $149.29
    Capital gain is $79.29
    Pay CGT of $23.79
    Net proceeds of $125.50
    Repeat
     
  14. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    This only applies for reinvesting income - and in most cases that is a relatively small percentage of the overall returns, although the benefit of compounding those lower-taxed returns will definitely help the company in the long term (whether it is enough to make up for the loss of the CGT discount will depend on a lot of things).

    For now, we've only been looking at things from a taxation point of view. Trusts have another benefit in the form of asset protection - which is something I think should not be dismissed (indeed is arguably the most important function of a trust - that is what they were designed for afterall).
     
  15. Waimate01

    Waimate01 Well-Known Member

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    I'm certainly not wanting to get into an argument on this, but it applies beyond reinvested income - it also applies to the initial capital. In some cases you may have a choice as to whether the initial capital comes into your hands or into that of a company. For example, one morning in the shower you invent teleportation and get $1B a year in royalties - do you collect them personally or form a corporate vehicle?

    It also applies to the proceeds from your capital gains.

    It applies equally to *any* new money - dividends, capital gains or teleportation royalties.

    The determiner of which approach is best depends, I think, on things like assumed rate of return and period over which assets are held. Things which are easy to assume but hard to predict.
     
  16. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    The initial capital has no bearing whatsoever on it.

    It doesn't matter whether I have $1m and invest it via a company or via a trust - it is still $1m. The source has no bearing on what happens next.

    If I got it from a business venture and only paid 30% tax on it - great, but it doesn't have an impact on what tax I pay in the future after investing that capital - which is what we are debating here.

    You certainly do NOT want to invest in other assets via the same vehicle as you operate a business through! That is Asset Protection 101.

    Yes, you will only pay 30% CGT on your capital gains in a company, but if the asset has been held for more than 12 months, then I will pay at most 22.5% + medicare on those gains if held in a trust - which is what I have been saying all along.

    I then have more capital available to reinvest via my trust than you would have available within the company.

    Do companies get to use franking credits passed onto them from the shares it owns? I'm not sure that they do? Have to check on that. If not - that's another good reason not to use a company to hold shares for investment purposes.
     
  17. Waimate01

    Waimate01 Well-Known Member

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    Agreed - but the point is it's *not* $1m in either case. Take $1m in royalties from the teleporter. After paying tax on the royalties, the individual has only $535k to invest. The company has $700k.

    The starting points are *not* equal unless you care to assume that $1m magically appears unencumbered in both scenarios.

    Yes, companies benefit from franking credits received, in a similar way to individuals.
     
  18. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    But the argument about where the money comes from is completely irrelevant to what you do next with it.

    If we both invent something new and both end up with $700K after tax, we're in exactly the same position. The argument we are having is about what to do next, not about where we got the money from.
     
  19. Waimate01

    Waimate01 Well-Known Member

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    Well, I'd like to think it's a discussion rather than an argument :)

    Agreed that if we both end up with $700k after tax we're in the same position. But the assumption following the word "if" is not correct.

    I'd end up with $700k after tax, and you'd end up with $535k. So we wouldn't be in exactly the same position, and the difference would be because of our differing choices of where to let our cashbox reside.
     
  20. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I think you are trying to argue the scenario where you control two companies:

    Your Investment Company Pty Ltd with you as shareholder and director
    Your Idea Company Pty Ltd with Your Investment Company Pty Ltd as shareholder and you as director

    Your Idea Company Pty Ltd makes $1m profit, pays 30% tax and then pays the remaining $700K to Your Investment Company Pty Ltd as a dividend.

    Now given that the dividend is fully franked (tax already paid), then Your Investment Company has access to the whole $700K to invest.

    My version of the scenario is where I have:

    My Investment Company Pty Ltd as trustee for My Investment Trust with me as director of the trustee company (non trading) and beneficiary of the trust.

    My Idea Company Pty Ltd has My Investment Company Pty Ltd ATF My Investment Trust as shareholder and me as director.

    My Idea Company makes $1m profit, pays 30% tax and then pays the remaining $700K to My Investment Company Pty Ltd ATF My Investment Trust as a dividend. Now, since the trust has to distribute all income to beneficiaries (and assuming I don't have losses within the trust to offset the income), then the $700 will eventually end up in my hands (and the hands of the other beneficiaries of the trust). Assuming we don't have more than 8 adult beneficiaries with zero other income (and thus nobody pays more than 30% tax anyway), then we will have an additional tax bill above and beyond the 30% paid in your scenario - hence less available to subsequently invest via a loan or gift back to the trust.

    That's fine - I accept that.

    However, this is not the way I'd suggest 99% of people get started investing - and so I think it is an unrealistic scenario and in no way proves your point.

    It may also be possible to structure a trust with a company beneficiary to achieve the same net result as your scenario - although I'm not sure of the full implications of doing so.

    At the end of the day - unless you are the only beneficiary of your trust (which kind of makes it a bit pointless unless only in it for asset protection), then there's all sorts of other Neato_Tricks you can use to minimise tax (eg streaming to the lowest income earners, pre-paying interest on investment loans, investing in various tax minimisation products, etc).

    I still maintain that in most situations, a company will not be better off over the long term compared to a trust. I haven't done any actual number crunching to show examples of the results yet though.