One of the main components of strategic financial advice is recommending the best structures for holding investment assets. When it comes to investments held for retirement, superannuation is clearly the best structure. When it comes to other investments or owning a small business, picking the wrong structure or entity can have disastrous tax consequences.
The various tax structures available include owning investments as individuals, jointly with other individuals, in a family discretionary trust, in a unit trust, or in a company. One client’s experience provides a great example of how using a company to own investments or a business can result in paying more income tax.
The client was the sole shareholder in a company he had formed to operate a business that started in 2004. The company structure was possibly recommended by an adviser more concerned with asset protection than considering the tax consequences if the business were to be sold in the future.
In September 2016, my client sold the profitable business for $750,000 plus stock. Having started the business from scratch, this resulted in the company having an assessable capital gain for the 2017 year of $750,000.
Although the company is classed as a small business entity, and therefore could access the small business capital gains tax concessions, the full $750,000 could not effectively be decreased by applying the 50 per cent active asset discount. When this concession is claimed by a company, it results in unfranked dividends and the owners pay tax on the total profit from those at their applicable marginal rate when they are distributed in the future.
Because the client owned the business 100 per cent, however, they met the significant individual test and could access the small business retirement exemption. The maximum available under this concession is a lifetime limit of $500,000. As the client was under preservation age, the amount claimed under the retirement exemption had to be contributed by the company, directly into a superannuation account in their name.
This still left $250,000 in capital gain that, if the client did nothing, would be taxed at the small business company tax rate of 27.5 per cent, and when the profits were taken by the client in the future, tax would be paid on the full amount of the $250,000 gain, but with the benefit of the imputation credit equal to the company income tax paid.
As the client was proposing to start another business, this time being operated through a family discretionary trust, there was another small business CGT concession available – the business roll over concession.
Under this concession, a replacement business asset must be purchased, such as a shop or warehouse, within two years of the date when the capital gain was made. The rollover concession does not result in a tax saving, it only delays the paying of tax on the original gain made until the replacement asset is sold.
If the sale of the replacement asset was made after my client had retired, and he was receiving only tax-free superannuation pension income at that time, an overall tax saving could be achieved by the company streaming dividend payments over a number of years.
Had the business originally been owned by my client as an individual, or through a family discretionary trust, the $750,000 gain would have been reduced by the 50 per cent general CGT concession available to individuals and halved again using the active asset discount. It would thus leave an amount of only $187,500 to be rolled into superannuation under the retirement exemption.
