Legal Tip 55: A Company Owning Property

Legal Tip 55: A Company Owning 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.

This was originally posted at somersoft - see the 4 pages of discussion here http://somersoft.com/forums/showthread.php?t=107280

 

Thanks for the post Terry. Something I've been looking at since we decided to shut down our part time business ran through a company, rather than close the company we wanted to keep it open to hopefully soon run a SMSF and use it as a way to avoid paying land tax in NSW which we are close to. From my understanding if we lent the company money to buy properties out right. The company would pay us back an agreed principal and interest sum or just interest. A lawyer has to do up the paperwork to sign. What would happen if we wanted to change the repayment amount would we have to go back to a lawyer or can the original have a clause allowing there to be changes to our discretion?

 

A definite strategy to ponder.

Thx Tez

 

It would depend on the terms of the agreement. You could generally change the conditions if both parties agree.

but you have to consider the tax side as well as the general legal side.

May also consider a discretionary trust lending the money.

 

We would still need to pay personal tax on the interest received back wouldn't we?

 

Interest received is income

 

Thought so, they don't miss a thing the old ato. Theoretically if we drew money from a equity release offset account and gifted/loaned it to the company, paid the interest in the offset with our own personal money. The company than buys a property once there is more equity after a Renovation or just general growth etc and we refinance with a bank and get the money from the bank can we pay ourselves back the original gifted/loan amount without having to pay PAYG?

 

If you have borrowed money and parked it in the offset account you probably have issues already. But if you later gifted that money to a trust the interest on the borrowings would not be deductible. If you loaned the money the interest may be deductible if you on lend the money at a higher rate.

If it is a loan to the company then the company can refinance that loan with a lender and pay you back. If it is a gift the company could not do this.

 

Thanks Terry definitely a strategy to think about

 

Thanks for the fantastic post Terry!!!! This is awesome information

Regarding the below snippet in blue from your example, could you please let me know where did the $54170.17 figure come from ? My understanding from your post is if the total capital gain ($339,606) gets distributed to a non-working beneficiary then this gets treated as dividend income ? And wouldn't a person on an annual income of $339,606 per year incur a total tax bill much higher than $54170.17 ?

'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'

Many many thanks

 

340k/2 = about $170k. Income tax on $170k wouldd be about $54k

This would not be dividend income if it is a captial gain coming from a trust.

 

Thanks Terry,

I see ..... so the 50% CGT discount benefit does get retained even if the asset is owned by a company in a DT ? This is awesome

Also, under what circumstances can land tax not be applied if the capital gain is distributed to non-working beneficiaries ? (if the asset is owned by a company, the trustee of DT)

 

There are 2 basic structures which you may be confusing here Honeydew

1. Company as trustee of a discretionary trust, and
2. Company acting in its own right with the shares owned by the trustee of a discretionary trust.

With 1 any capital gains will flow through to the beneficiaries who will then be taxed and who will receive 50% CGT discounts if the beneficiaries are individuals.

With 2 the company will pay pay CGT at the company rate and there will be no 50% discount available. The income then will change character from being capital gains so that when it comes out it would be either income from wages or dividends in the banks of the trustee who will then pass it out as dividends to the beneficiaries.


With land tax some states such as QLD will give the trust a threhold (currently $350k) while other states such as NSW will offer no threshold and tax the trust on the first $1 worth of land it owns.

 

So in that case for scenario1, Company as trustee of a discretionary trust: can the $339,606 CG gets retained in the trust and be distributed once the beneficiaries have stopped working in order to maximize the tax benefit ? Or does CG have to be distributed in the financial year the asset gets sold ?

And in scenario2, Company acting in its own right with the shares owned by the trustee of a discretionary trust. My understanding of how this structure look like is as below:

-CompanyA set up in it's own right with own ABN, not belonging to any trust.
-Then we have a DT set up with a companyB as trustee. This trustee then owns shares of companyA and distributes any CG (companyA made) to the beneficiaries in dividend form ?

Is this correct ?

Thanks Terry

 

Trusts can retain income, subject to the terms of trust, but the trustee will be taxed at the top marginal tax rate. Therefore it should be conisddered necessary, usually, that the income needs to be distributed in the year it is incurred. You might want to look at the tip of bucket companies. Legal Tip 93: Bucket Companies as Beneficiaries of Trusts

For scenario 2. company set up with its own ABN. Shares held by a trustee of a discretionary trust. Dividends of the company paid to the shareholders which is the discretionary trust.

 

Hi Terry

What are the tests to determine if a company is eligible for CGT tax concessions? And if they pass the requirements, does that mean the company have 50% CGT discount if the property is held over 12 months?

Thank you very much

 

Companies cannot get access to the 50% CGT discount.
Trustees can though, including company trustees, as it is the recipient that is usually taxed with trusts.

 

There can be complications to assuming that a CGT discount is available to a beneficiary of a trust.
- Residency issues
- Minors
- Trust deed v's streaming concerns
- Trust income proportioning issues
- Beneficiary has c/fwd cap losses (The discount would be lost since CGT rules offset the total gain v's the loss first then apply a discount if available)

and most importantly ensuring that the distribution complies with Tax law and the trust deed. In most instances the trustee must resolve to distribute trust income prior to the end of the tax year. Failure to do so may lead to argument that the trustee is assessed. Failure to ensure the resolution complies may invalidate the distribution too. Its a fave of the ATO where a streaming issue looks contrived. They review to ensure the distribution complies and may seek to attack it. The ATO commonly ask for trust minutes / resolutions now.

A great example of where advance tax advice may assist.

 

Thanks Terry!!!

 

Thanks Terry