Why it may be a good idea to use a company to own property

Companies are generally not recommended for holding growth assets in. This is mainly because:

1. No access to the 50% CGT discount
2. Income does not retain its character - e.g. capital gains incurred by the company come out to the shareholders as dividends and no capital gains.

But companies can be good structures for the ownership of property in several ways.
1. Asset protection - liability is generally limited to the company itself and the directors and shareholders are generally not liable for the debts of the company.

2. Ability to retain income. unlike trusts a company can hold its income, pay tax on it and distribute it at a later date.

3. Ability to own the shares via a discretionary trust which will aid asset protection if the individual were to go bankrupt.

4. Land tax threshold is available in most states - this is a biggie in NSW.

Take for instance a person who has used up their land tax threshold. They will pay land tax in their own name or if the property is owned by the trustee of a discretionary trust.

I have done some modelling with a hypothetical property valued at $500,000 with the land being 50% of the value of the property, CPI at 4% (land tax threshold increase) and values increasing by 6% pa.

If the property was owned for 10 years and then sold it the approx capital gain would be $339,606

An individual at the top tax rate would pay approx $79,807 in tax. Plus approx $60,987 in land tax over the 10 years = $140,794

A DT distributing to an individual on the top tax rate would be the same.

A DT distributing to a company would mean approx $101,882 plus land tax of $60,987 = $162,868

However, a company would pay $101,882 (30%) in tax plus there would be no land tax at all as the property is under the threshold.

However to be fair the trustee of the trust may be able to distribute to 5 individuals who each have no other income. In practice I have never seen this happen, but it is a possiblity. This could mean there is no tax payable at all, other than the land tax of $60,987


But if the trustee distributed all the gain to a non working spouse then they would pay $54170.17 in tax plus the land tax of $60,987 = $115,157

Summary Income tax and land tax payable:
Individual owner at top marginal rate before the gain = $140,794
DT flowing thru to a person on the top marginal rate = $162,868
DT flowing thru to a person with no other income = $115,157
DT flowing thru to 5 persons (adults) with no other income = $60,987
Company = $101,882

But it gets better.

Say the shares of the company were owned by a discretionary trust. The trustee of the trust could receive franked dividends from the company. There would be a tax credit for taxes the company has paid. This money could then come out potentially totally tax free to the 5 adults who are not working, assuming they are beneficiaries of this trust. That means no land tax at all and no income tax at all.

But even if there are no non working adults the company can retain the income and once the person or persons behind the company has stopped work they can cause the company to make a dividend payment to them, via the trust, when their income is low enough to maximise the use of the franking credits. It is therefore also possible that they could end up getting the money out of the company totally tax free and land tax free.
 
Hi Terry,

Thanks for the info.

Did you do any modelling from an overall perspective. i.e. incl. neg gearing benefits (or lack of), initial/ongoing costs for discretionary/company trusts? Would be interesting to see the impact.

What sort of ongoing costs would you expect for the company in this situation?
 
Top post Terry.

I have been told by a quite a few people that a company is not a good entity for holding growth assets. But I always felt that due to the nature of a company and its ability of retaining income and tax credit, it is a great tax deferring vehicle.

It would be a great structure (DT owning shares of a company) for someone who is in the prime of their working and earning ability (and therefore top tax rate), whose partner is in the same situation, both thinking about easing into early retirement, with non adult children who will turn 18 around that time, but not immediately working and earning an income (university).

Pay the 30% now, you can't pay any less anyway whatever other structure you use. Plan well and get the money back in retirement. Tax free money in the end! Who doesn't want that?:p

This is the structure that I am using for my development at the moment. Beats using a bucket company?

Kudos to you Sir, what vague ideas and understanding on company/trust I have, you put them into a post containing numbers, scenarios, and comparisons.
 
In addition to there being no CGT discount ... where there is depreciation or capital works deductions then there is insufficient franking credits for eventual distribution.

Unfranked dividends would subject to 64.3% tax overall including the company tax already paid.

Why do you think stapled securities exist ? Purely a response to the tax rules regarding the type of entity holding assets.
 
So if I am doing a development and purchase the property under a company - I would be up for the following taxes:

1. Income Tax of 30% (on profit made)
2. GST (less margin share)
3. CGT

Is that correct or is the CGT and income tax the same thing (this is the part that confuses me)?
 
So if I am doing a development and purchase the property under a company - I would be up for the following taxes:

1. Income Tax of 30% (on profit made)
2. GST (less margin share)
3. CGT

Is that correct or is the CGT and income tax the same thing (this is the part that confuses me)?

It depends.

You wont be hit with both Income tax and CGT. Either the property is held as 'stock' and therefore subject to GST and income tax. Or it will be held as an asset and therefore subject to Capital gains.
Usually residential property is not subject to GST (but sometimes it is).

Terry - while the company entity pays $101k in your example - to be fair there would be additional tax payable by the individual. At the top rate it would be an additional (correct me if I am wrong) ~$70,000 of tax on the dividend.

So the major advantage - for standard resi properties - is the ability to delay the income.
Of coarse there are other ways to use the funds (loans to other parties on commercial terms) while you wait for the 'low income' year.
Of coarse, having the ownership of the company, as a DT allows for additional flexibility also.

I guess the take home message is all of this is seek independent tax/legal advice BEFORE purchasing the property. Once its purchased it is too late!

Blacky
 
Bear in mind Section 29 Land Tax Management Act

http://www5.austlii.edu.au/au/legis/nsw/consol_act/ltma1956173/s29.html

ie be cautious with thinking you can have several companies each holding land up to the land tax limit and pay no land tax

Thats true. Its like payroll tax, people try and get around it by employing people in a few companies to avoid it but they get grouped togeter, state taxes @#%&*. What do you think Terry?

Also, if I wanted to do this setup could you just use a company at first with me as the director and then setup a disc trust later and have that buy the shares at a later date? Could do it now i suppose but i hate over complicating things and paying extra for now if i dont have to.
 
Thats true. Its like payroll tax, people try and get around it by employing people in a few companies to avoid it but they get grouped togeter, state taxes @#%&*. What do you think Terry?

No, it would be difficult to get around. Perhaps one company controlled by one person only.

Also, if I wanted to do this setup could you just use a company at first with me as the director and then setup a disc trust later and have that buy the shares at a later date? Could do it now i suppose but i hate over complicating things and paying extra for now if i dont have to.

You would have stamp duty (if NSW) and CGT on the transfer of shares plus kill off majority of the asset protection in the short term. Best to not over complicate things by paying extra now!
 
Terry - while the company entity pays $101k in your example - to be fair there would be additional tax payable by the individual. At the top rate it would be an additional (correct me if I am wrong) ~$70,000 of tax on the dividend.

Blacky - your are right, if a company with an individual shareholder or a DT shareholder with the income flowing through to a person on the top tax rate they will be paying more tax on the income as well.

i guess the flexibility of the discretionary trust and the ability to no pay land tax is the main thing here.
 
Terry, you mention that this scenario is based around a growth asset (and therefore one that is at some point sold).

I'm interested to hear whether your comments would change much if you were considering an asset which, while it will achieve at least decent CG, is primarily bought as a long-term cashflow asset?

In my mind, the benefit of being able to pay off the asset "hard" in the short-term without throwing a tax issue to the owners (let's say who are in either the 32.5c or 37c tax rates), therefore freeing up the income later, is a huge benefit. Do you have any thoughts about this "income asset" scenario?
 
I'm interested to hear whether your comments would change much if you were considering an asset which, while it will achieve at least decent CG, is primarily bought as a long-term cashflow asset?

In my mind, the benefit of being able to pay off the asset "hard" in the short-term without throwing a tax issue to the owners (let's say who are in either the 32.5c or 37c tax rates), therefore freeing up the income later, is a huge benefit. Do you have any thoughts about this "income asset" scenario?

In that scenario the benefit would be in the fact that you are able to hold the profits in the company entity - as previously mentioned.

However, in most other entities (DT, individual etc) the profits are distributed in the year in which they are generated.

Another consideration maybe the treatment of tax losses. Which can be a different kettle of fish all together.

Blacky

*I should point out I am not an accountant, lawyer, or tax specialist. In fact Im not qualified in any which way on this subject matter - and therefore I am probably wrong. So please - the only thing you should listen to what I say is "seek individual tax advice".*
 
You would have stamp duty (if NSW) and CGT on the transfer of shares plus kill off majority of the asset protection in the short term. Best to not over complicate things by paying extra now!

So you wouod need to do a tax return for the company and the trust that owns shares in the company? Is that correct?
 
Thanks, Blacky. The ability to hold profits in the company is what I was referring to when I said "pay off the asset hard in the short-term without throwing a tax issue to the owners" - ie the ability to retain the profits and put them towards paying down the principal, without the owners being forced to register income/distributions (and therefore pay tax on it/them).

And yes, we do have a tax specialist. :)
 
Hobo
As Terry said you could run it as a company, with a corporate trustee as the shareholder.

Divs could be distributed to the share holders (in a year you choose), then further distributed to individuals who have a low income (ie - a non-working spouse). The divs could even be paid out over a number of years.

I cant remember the Australian laws in regards to the payments - if a cash transaction has to take place or not - or if the accountant can just do a paper transaction (maybe Terry can advise).
In which case you may not even need the cash to be transferred, thus being able to 'pay' dividends, while in actual fact increasing debt reduction.
Additionally any money going into the entity (deposit) can be paid in as a loan (commercial terms required), and therefore moneys out can be loan payments.
In addition if you have spare cash in the entity, you can lend that money to other entities (again - commercial terms) to continue to grow the portfolio.

Another option might be to have a corporate trustee as owner - with one of the beneficiaries a company. It changes the treatment of some tax's but may also be a suitable structure. You can distribute profits to the company, and hold the profits there waiting for a low income year.

To me having company/trusts provides flexibility and options. Purchasing in individual names doesn't provide you with any options at all.

Options... so many options...

Blacky
 
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This is the structure that I am using for my development at the moment. Beats using a bucket company?

Kudos to you Sir, what vague ideas and understanding on company/trust I have, you put them into a post containing numbers, scenarios, and comparisons.

how could this inflexible set up beat using a bucket company?

I can't see anything here to suggest moving away from the tried and trusted way.... corp trustee, disc trust, bucket company and an array of individuals.
 
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