How do Bucket Companies work? What is a Bucket Company? Ensuring a business remains profitable is one of the most important responsibilities of a business owner. So, if the business starts to generate a healthy profit, there needs to be a plan. While maximising deductions has its place in any tax planning strategy, a tax minimisation strategy that solely relies on deductions can result in sacrificing profit to lower tax when other options are available. With you and your family relying on the profits generated by your business to fund your lifestyle, it’s essential to understand the most tax-effective manner for distributing income and the best business structures that allow you to do so. Consider how a bucket company might fit into your overall tax planning strategy. Uses of Bucket Companies A bucket company (otherwise known as a corporate beneficiary) is a company set up as a trust beneficiary. This arrangement allows any income the trust distributes to the bucket company to be payable at the company tax rate, currently 25% (only if it is a base-rate entity), as opposed to the individual marginal tax rate (the top tax rate for individuals for 2023-2024 is proposed to be 47%, including the Medicare levy). They’re called bucket companies because they sit below a trust like a bucket and are used to distribute income to it. It is important to remember that there are rules around family trusts and structures within a family group. Otherwise, family trust distributions tax may apply. How do Bucket Companies work? There are generally three elements present for a bucket company: There is usually a trust with surplus income to distribute. The corporate beneficiary must fall within the definition of ‘beneficiary’ under the trust deed. Consider whether the bucket company is part of a family group. Who should hold the company’s shares? One of the main reasons bucket companies are used is to access the tax benefits they provide, and you should keep this in mind when deciding who holds the company’s shares. If an individual holds the shares, there is less flexibility in how the dividends can be distributed; they will need to be distributed according to the shareholder percentage. However, if another kind of trust holds the shares, the excess profits may be distributed, allowing for less total tax paid. Tax rates of bucket companies The bucket company pays the corporate tax rate, which could be 25% or 30%, depending on the type of company. If the company is a base rate entity, a company tax rate of 25% will apply; however, if it is not, the company tax rate will likely be 30%. Taxing trust income The general principle is that a trust’s net income is taxed by its beneficiaries; individuals and company beneficiaries pay tax on their portion of the trust’s income at the rates that apply to them. The highest marginal tax rate for individuals (not including the Medicare levy) at the time of writing this article is 45% for people with taxable income of $180,000 or more. There is a flat tax rate of 30% for non-base rate entity companies. Due to the discrepancy between the highest marginal tax rate for individuals and the company tax rate, there is at least a 15% savings potential. To illustrate, on an income distribution of $100,000, a corporate beneficiary would pay at least $15,000 less tax. Commit to distributions You must ensure that when you distribute to the bucket company for the financial year, you also distribute the same amount to the company’s bank account before lodging the tax return. In particular, trusts must distribute to corporate beneficiaries; otherwise, the Unpaid Present Entitlement (UPE) rules may be triggered. What can be done with the money in the Bucket Company? So far, in this article, we have looked at how bucket companies can help individuals save tax by paying out dividends at company tax rates. However, this is not the only bucket company strategy available. A bucket company can also hold long-term investments, such as shares, properties, or investments. In this regard, the bucket company becomes an investment company that can generate another source of income for the owner. Companies cannot access the 50% Capital Gains Tax discount, but other compelling reasons exist to use a company structure. Getting money out of the Bucket Company As has been established, the trust distributes the income to the bucket company, which begs the question: How do you get money from a bucket company? There are three ways to extract money from a bucket company: Pay dividends to the shareholders. Because the dividend has been taxed at the company rate, the shareholder will receive a franking credit to the extent that the tax has already been paid. An individual will include the dividend income as taxable income. Any excess franking credits are refundable, or top-up tax may be required depending on the shareholder’s marginal tax rate. A loan from the bucket company. As with any other loan, you must pay back the principal and interest to the bucket company. The loan is a special type called a Division 7a Loan, with requirements you will need to be mindful of. A separate discretionary trust structure can receive the dividends. Whereas the first method requires profits to be distributed according to shareholding and the second method incurs interest, this last method distributes profits according to the Trust deed. For example, using a discretionary trust as a shareholder of the bucket company allows you to make the largest distribution to an individual with the lowest marginal tax rate. Note that there may be other rules to satisfy or consider, such as Section 100A. Will a family trust structure allow a Bucket Company? To function as intended, a bucket company must be an eligible beneficiary of a family trust. As a result, you must read the trust deed to ensure the bucket company falls within the general class of beneficiaries. Additionally, a Family Trust Election may be needed depending on the structure. Consider the family group, which may define or impact who the beneficiaries are. Appropriate bucket Company strategy While bucket companies are generally useful for investors and business owners, and there is no doubt that they can be one of the most tax-effective strategies, they may not be ideal for your unique situation. A bucket company strategy may be of benefit if you are any of the following: A business owner who wants to build a nest egg for their family. A business owner who experiences significant fluctuations in income from one financial year to the next. For business owners coming up to retirement or looking to sell their business and who won’t be earning as much business income moving forward as a result Using a bucket company will not work if caught under the Personal Services Income (PSI) rules. These rules prevent individuals from reducing or deferring their income tax by diverting income they receive from their personal services through companies, partnerships, or trusts. We encourage you to seek professional advice when deciding whether a bucket company suits you.

Practice Update March 2024