Investment Company

The shares in an investment company can be held by individuals or a related investment trust. If owned by a related trust rather than individuals there are asset protection advantages and also flexibility with the distribution of income from the company by way of dividends.

 

In certain circumstances, a company can receive distributions of income from a practice trust which qualifies as a small business. These distributions are taxed at 25%, rather than 30%.

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While a company does not benefit from the 50% capital gains tax exemption which applies to gains on assets sold which have been held for more than 12 months, it does, however, benefit from the dividend imputation system. Australia is now the only country in the world to have a full dividend imputation system. Dividend imputation means that a company effectively stores the tax it pays as a credit. The tax credit can be passed on to a shareholder when a dividend is paid. This means that the company tax is really only an instalment of tax. The ultimate amount of tax paid will be determined when a dividend is paid. When dividends are paid to an individual shareholder (or the beneficiary of a shareholder trust), a credit for the 30%/25% tax comes with the dividend. This means that the ultimate recipient of the dividend will pay more tax if their tax rate is above 30%/25% or less tax if it is below 30%/25%.

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For example, the tax credits could be stored and then dividends could be paid to adult children after they turn 18 but before they start receiving any significant income of their own. The period of time between reaching age 18 and commencing to earn significant income would probably persist for at least four years per child. Currently, the tax-free threshold is effectively $21,885 per person. Assuming a company tax rate of 30%, this means a dividend of $15,319 could be paid to an adult child, which would include a tax credit of $6,565. If the child has no other income, a refund of $6,565 would be received. The net result is that $21,885 of taxable income on which the company previously paid 30% tax has now been rendered tax-free.

 

These advantages may also apply to a practitioner and spouse when they are on a lower tax rate, which will probably not be until retirement after age 65. A 65yo couple pay no tax on combined taxable income of up to $57,948 (after accounting for the so-called Senior Australians Tax Offset). In addition, any drawings from superannuation are tax-free. This means franked dividends from an investment company of up to $40,563 p.a. (plus $17,384 tax credit) could be received tax free, assuming no other income. A refund of $17,384 would be paid. This can continue year after year.  This means, with careful planning it may be possible to get all the tax that the company previously paid refunded over time. The company income is then rendered tax-free. The only cost is the time value of money in having the credits locked up with the ATO until the tax-free dividends can be paid out.

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A company also does not die and so it can be used to pass wealth from one generation to another in perpetuity. This is a key advantage over a superannuation fund. Upon the death of both members of a couple, superannuation usually has to be transferred out of the fund, which can trigger large tax liabilities. This restriction does not apply to companies, so the investments can remain undisturbed. Superannuation funds also have limits on contributions, accumulations and restrictions on investment strategies and withdrawals, which do not apply to companies.

 

In summary, an investment company can form part of a two-pronged approach to investing and be set up to work hand-in-hand with a superannuation fund to provide long-term, tax effective, asset protected wealth accumulation for a family.

 

*Information accurate as of August 2023