Choosing the Right Investment Structure: The First Step in Investing
When it comes to investing our hard-earned money, there are numerous options to consider. From shares to term deposits, investment properties to superannuation, deciding where to put our money can be difficult. However, before making any investment decisions, we should consider who owns the investment. In other words, what ownership structure should we use?
Fortunately, there are several ownership options available for most types of investments. These include personal ownership, joint ownership, ownership within superannuation, ownership within a trust structure, or even within a company. Each structure has its advantages and disadvantages, which should be carefully considered before making investment decisions.
One of the key differences between the various ownership structures is the tax treatment. Understanding the tax implications of each structure is crucial in determining which structure is best suited for your investment goals. While there are some exceptions, for the most part, each structure has its own unique tax implications that should be taken into account. By carefully considering ownership structures before making investment decisions, you can maximize your returns and minimize your tax liabilities.
Individuals
When you own an asset as an individual, the earnings are attributed to you personally; hence, you will need to pay tax at your marginal rate. You will also be eligible for a 50% capital gains discount if you hold assets for over 12 months. As you will be paying tax at your marginal rates, owning assets as an individual can be beneficial for someone with a low income and hence low marginal rate but detrimental for someone who is already on a high income and high marginal tax rate.
Joint
The tax rules around jointly owned assets are very similar to that of an individual with one main difference. The earnings and hence tax is split between each of the owners. A husband and wife for example can split the earnings 50/50 between the two of them. This comes in handy when both partners are on high incomes for example although other options may be preferable.
Superannuation
A common misconception is that superannuation is an asset in itself. This is not the case, it is simply a structure that owns the investments. The main benefit of superannuation funds is that the tax on the income is charged at 15% and capital gains (if the asset is held for longer than 12 months) are taxed at 10%. Current legislation also states that when the superannuation fund is turned into a pension account, the tax on the earnings within that pension account attracts 0% tax. This is clearly the best way to hold assets from a tax perspective however the obvious downside is that you aren’t allowed to access the money/investment until you meet a condition of release. The government has also put a cap on the amount of money that you are able to contribute into superannuation each year and also the amount of money that you can transfer into a pension account. These restrictions have been discussed in detail in previous articles so I will not go into them here.
Trusts
There are lots of different types of trusts (superannuation being one of them); however, here we will cover unit trusts and discretionary trusts in particular.
In the majority of circumstances, the trusts themselves do not pay any tax and instead, the tax is paid by the beneficiaries as all income is distributed through to the beneficiaries. For a unit trust, the distributions are paid according to the amount of units owned. For example, if a unit trust has 10 units, and person A owns 7 of those units, then person A will receive 70% of the distribution and hence will be required to pay tax on the amount. As the income flows through to an individual in this example, they will receive a 50% capital gains discount for the unit trust holding the asset for longer than 12 months. A unit trust may be applicable for someone running a business with other people who are not part of their family, with distributions to be allocated according to the % ownership.
A discretionary trust, while similar to a unit trust has one distinct advantage. The earnings can be distributed to any beneficiary on a discretionary basis. That is, you can choose how much of the distribution gets paid to each individual beneficiary and this can vary from year to year. You can therefore allocate more income to those on lower tax rates and less or even no income to those with higher tax rates. This is often used for family-owned businesses where money is often allocated to children, non-working spouses or even retired parents in order to keep the tax low and is where the name “Family Trust” originated from. This is the most flexible of structures to hold investments in, although you need to remember that all earnings need to be distributed to the unit holders, and costs are associated with setting up and running the trust.
Companies
Companies are similar to Unit Trusts in that the amount of income distributed to shareholders is determined by the share of the company they own. If you own 70% of the company, you get 70% of the distributions. However, there are some big differences.
The first one is that the company pays tax, ranging from 25% – 30% depending on the size of the company). This means that as dividends are distributed to the company owners, they receive what is known as franking credits to offset the tax already paid by the company.
The second difference is that, unlike a trust, earnings can be kept inside the company structure rather than paid out to the owners. This can help build the assets inside the company where the tax rate is only 25% compared to the individual, where that tax rate may be up to 45%, plus Medicare.
The main disadvantage when it comes to companies is that they are regulated by ASIC. Unlike other ownership options, there is some compliance that needs to be adhered to when running a company and hence more fees may be payable and more work is required.
Next Steps
Structuring your investments in the most tax-efficient way is undoubtedly crucial, but it’s not the only aspect that you should consider while making investment decisions. There are various factors that come into play, and it’s essential to weigh them all to create a well-rounded strategy that aligns with your goals and needs.
If you need any assistance in understanding your investment options and setting up a suitable structure, don’t hesitate to reach out to our team at JBS Financial. Our advice team can guide you towards making informed investment decisions that help you achieve your financial objectives.