Structures Matter

We often ask ourselves what we should be investing in. Should we invest in shares? What shares should we buy? Is now a good time to be buying shares? Should I instead look at putting my money into a more defensive asset like a term deposit? Or even look at an investment property.

While all these questions are good, the first question we need to ask ourselves is who should own the investment, in other words what structure should we use?

When purchasing an investment we have a number of options available to us when it comes to ownership. Do we own the asset personally, jointly, within superannuation or another trust structure or even within a company of our own.

The majority of investments that we can choose can be owned by any of these entities. There are some exceptions however this article will not go into specifics. For the most part though, one of the main differences between the different ownership options is the tax treatment.

Individuals
When you own an asset as an individual, the earnings are attributed to you personally and hence you will need to pay tax at your marginal rate. You will also be eligible for a 50% capital gains discount when you hold assets for longer than 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 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 on 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 there are costs associated with the setting up and running of the trust.

Companies
Companies are similar to Unit Trusts in that the amount of income that is distributed to shareholders is determined by the share of the company that 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 27.5% – 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 being paid out to the company owners. This can help build the assets inside the company where the tax rate is only 27.5% compared to the individual where that tax rate may be up to 45%.

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.

Structuring the investments in the right way to ensure the minimum tax payable is extremely important but tax is only one factor that needs to be taken into account. If you want to know more, not just about investments but about setting up the correct structure for your goals and needs please contact our offices today.