DIY funds still an option for business

Twenty years ago, before they started to attract wider appeal, do-it-yourself superannuation funds were mostly used by people in small family businesses introduced to them by accountants who looked after their finances and gave them tax advice.

They were known as small or excluded super funds (excluded because the rules applying to them were not the same as those that applied to large super funds).

Because of this business connection, small funds were often incorporated as part of a family wealth strategy that tied in with other business structures such as a family trust or a family company.

While many DIY funds are these days used purely as retirement savings arrangements for the wider investment community, for anyone in business today they still offer interesting ways of creating wealth.

Family business strategies

Take a strategy for a profitable husband-and-wife family business run through a family trust, suggested by Melbourne accountant and financial planner Mathew Cassidy.

With the husband and wife in their ’60s, the business pays each $80,000 of income and the current $35,000 maximum tax-concessional super contribution currently allowed for anyone who is older than 59.

For the additional net $200,000 of profit the business earns, Cassidy suggests an investment company be established to act as a corporate beneficiary of the family trust.

This is an alternative to the trust paying distributions to the owners as individual beneficiaries.

While total tax of $60,000 must be paid on this distribution at the company tax rate of 30 per cent, there will be a tax saving of about $17,000 compared to what they might have paid if the family trust profit was paid to them as personal income.

Trust obligations

Under tax rules, family trusts are required to pay out all their income to beneficiaries or face tax at the top personal tax rate.

This tax saving can be added to the after-tax income in the company and then invested in fixed interest. Cassidy suggests higher-yielding hybrid investments rather than shares as a risk-management idea and because investments that can earn capital gains are not as favourably treated in a company structure.

The direction this strategy then follows is that once the couple has moved into retirement and started pensions from their super (which will be tax-exempt given their age), they can then pay themselves fully-franked dividends from the investment company when it suits them.

On the basis that their taxable income will be nil or relatively low, the franking credits attached to the dividends will be refunded to them, giving them enhanced income.

This tax-saving strategy, says Cassidy, gives an extra benefit in the last few years of their working lives and could save the couple about $120,000 of tax over five years.

Implementation costs

Regarding the cost of implementing this strategy, Cassidy says his firm’s charge would usually be based on the time involved; for a new client this might be $3000 to $4000. For an existing client on an ongoing fee arrangement, such suggestions would be part of the advice process.

Expanding on this strategy, super and tax lawyer Robert O’Donohue, a partner with HWL Ebsworth Lawyers in Melbourne, says the first thing to check is that the trust deed of the family trust allows income to be distributed to the company. Assuming it does, the benefit of distributing income from a trust to a company is that it will be taxed at the company tax rate of 30 per cent.

By leaving the money in the company and investing it, any further income or capital gain from those investments will also be taxed at 30 per cent. It could suit anyone who faces paying more tax if the income is distributed to them from the trust. Accordingly, the money quarantined in the company compounding on a tax rate of 30 per cent over many years may save a large amount of tax.

One reason, explains O’Donohue, that companies are sometimes considered inferior for holding assets with capital growth potential is they cannot access the 50 per cent capital gains tax discount available to trusts and individuals or the 33.33 per cent CGT discount available to super funds, for assets held longer than 12 months.

As far as the future strategy of taking fully franked benefits from the company, assuming most other income comes from tax-free super and marginal tax rates remain where they are, the couple in this example could each receive just under $100,000 per year in fully-franked dividends from the company that holds the fixed-interest investments and not be required to pay any tax.

This is due to the franking credits which give a credit for the 30 per cent tax already paid by the company.

The couple also need to be mindful of Part IVA of the Tax Act (an anti-avoidance provision intended to counter schemes that have a dominant purpose of avoiding tax), so it is best to seek professional advice.

O’Donohue says while the strategy looks to be a sound idea for anyone with a business, one aspect that should also be considered is the benefits of using the small business capital gains tax concessions.

The Australian Financial Review