Companies and income tax

[Tools]

Hi all,
Can someone please tell me if my understanding is correct please.

Let's say I am one of two directors of a company that has undertaken a small development of three units. There was a profit of $200,000 from this so the company is required to pay tax at 30% or $60,000. That leaves $140,000 and let's assume that the whole thing will distributed as dividends to the two directors, $70,000 each. Each director needs to pay income tax on that amount at their tax rate. It is added to their other taxable income so if they had $100,000 of other income they would pay $50,847 plus medicare levy. But there would also be a franking credit of $21,000 (70,000 x 30%) so the tax payable would be $29,847. Is this correct?

Tools

 

[alexlee]

Hi all,
Can someone please tell me if my understanding is correct please.

Let's say I am one of two directors of a company that has undertaken a small development of three units. There was a profit of $200,000 from this so the company is required to pay tax at 30% or $60,000. That leaves $140,000 and let's assume that the whole thing will distributed as dividends to the two directors, $70,000 each. Each director needs to pay income tax on that amount at their tax rate. It is added to their other taxable income so if they had $100,000 of other income they would pay $50,847 plus medicare levy. But there would also be a franking credit of $21,000 (70,000 x 30%) so the tax payable would be $29,847. Is this correct?

Fundamental mistake: directors don't receive dividends, shareholders do. Just because you're a director doesn't mean you're a shareholder, and vice versa. And there can be different classes of shares.

However, assume you were referring to two equal shareholders of ordinary shares. The taxable income from the dividend for each individual is actually 100k each (being 70k franked dividends + 30k franking credits). Assuming dividends are fully franked. The whole point of dividend franking is to treat dividends as if they had been earned by the taxpayer, before tax, but with corporate tax credited.

So each director's taxable income is 200k. The franking credit is 30k (70k x 3/7).

Tax payable is 63,550 (ignoring medicare levy etc) less 30,000 franking credit = 33,550.

 

[Tools]

The other thing that I am looking for clarification on please, if I was to borrow money in my name only and put it in to a company that my wife and I were both directors of (say a 90/10 split), for the purpose of buying a property and developing, would all the interest on that loan be deductible for me if my wife didn't put any other money in?

 

[Tools]

Thank you Alexlee. That makes sense now.

Tools

 

[alexlee]

The other thing that I am looking for clarification on please, if I was to borrow money in my name only and put it in to a company that my wife and I were both directors of (say a 90/10 split), for the purpose of buying a property and developing, would all the interest on that loan be deductible for me if my wife didn't put any other money in?

The loan would be from you to the company. The company's ownership is irrelevant (you can't have 90/10 split directorships, I hope you're talking about shareholdings).

However, to avoid tax avoidance provisions, the interest paid by the company would have to be at least the same as what you are paying your lender. The interest you pay would be deductible, but the company will be paying you the same rate (which you have to declare as interest income). i.e. the net tax effect for you personally is zero.

 

[alexlee]

Also, I suggest understanding the difference between director and shareholder. They're NOT the same thing.

 

[alexlee]

There are also lots of variations to this setup. For example, if your wife and yourself have different income levels, it might make sense to pay more dividends to one person than the other. One way to do this is via different classes of shares.

If you have adult children with little other income, they can also receive income and pay little tax. It might make sense to throw a family trust into the mix.

 

[Tools]

Also, I suggest understanding the difference between director and shareholder. They're NOT the same thing.

Thanks, I do understand. I meant that the directors are the only shareholders so they are one and the same.

Tools

 

[alexlee]

Thanks, I do understand. I meant that the directors are the only shareholders so they are one and the same.

Tools

Shareholders of which class of shares? Would having a trust hold one class of shares help you?

In any case, your first example would only work where the shareholdings are 50/50, but your second example assumes 90/10 split in shares. If you have 90/10 split in shares, you can't pay dividends 50/50.

Sure, the standard husband and wife each holding 50% of the ordinary shares and both being directors is simple, but that might not be the most tax efficient setup.

 

[Tools]

Yes, tax is the whole reason I am trying to sort this out. I assume they would be ordinary shares but my wife would hold more as she is home with the kids with no income (hence the 90/10 split)

Tools

 

[alexlee]

Yes, tax is the whole reason I am trying to sort this out. I assume they would be ordinary shares but my wife would hold more as she is home with the kids with no income (hence the 90/10 split)

Tools

So why 90/10? Why not just 100% to your wife? Are things going to change in the future, such as your wife going back to work?

Read up on special classes of shares. For example, you can have ordinary shares split 50/50, but issue class B shares solely to your wife. Then the company can (but doesn't have to) pay all its profits to your wife as the class B shareholder.

Assumptions are limited by your own knowledge.

 

[Tools]

90/10 was just a figure plucked out of my head. All I was getting at there was that I would not have the majority shareholding but would be providing all of the funding. I have no idea at this stage what the split might be.

Circumstances may change at some point during the life of the project with my wife going back to work, but that is still undecided at this stage

Tools

 

[Terry_w]

why not develop using a trust.

 

[Tools]

why not develop using a trust.

Terry, the advice received from my accountant who is a known property specialist was to use a company structure. Why do you suggest a trust might be more suitable?

 

[coastymike]

I can appreciate using a company instead of a trust provided the shares in that company where held by a trust. However I still don't think it is the best structure.

Advantage will be the ability to cap at the corporate tax rate of 30 percent. Could argue with a trust that the same could be achieved with a corporate beneficiary. However that stucture then requires three levels. Trust one. Company. And trust three to hold shares in beneficiary company.

With the company and shares held by the trust you don't need that extra layer and therefore reduces costs.

Similarly if you want to do another development and keep the funds in the company and lend them onto next development company then provided it is company to company then division 7a doesn't apply.

However risk there if company one is sued then it has an asset owing to it which isn't good asset protection. If the funds flowed from the development trust to the corporate beneficiary and that beneficiary then on lent those funds then the asset protection issue goes away.

So best structure is trust with a corporate beneficiary but there is an extra layer of cost. My view would be spend the extra money for ultimate flexibility and asset protection. Corporate trustee with trust. Corporate beneficiary with sharers held by another new trust. That trust could have individual trustees.

Haven't even dealt with the issues of a company holding an asset that you decide to keep after the development is finished. Very nasty.