What is a bucket company?
A bucket company is a company that is set up as a beneficiary to a trust. The term ‘bucket’ is used because the company sits below your trust and is used to pour money into it to reduce tax. This allows you to cap your tax payable at a corporate tax rate.
Capped tax rates:
The corporate tax rate (using bucket company) is 25% for Base Rate Entities and 30% for all other companies*
The individual top marginal tax rate (without a bucket company) is 49%*
*Per 2023 Financial Year tax rate
Who is a bucket company strategy for?
A bucket company strategy is ideally for:
Business owners (or investors)
Running their business or receiving income through a discretionary trust structure
Not caught under the Personal Services Income (PSI) rules
Bucket Companies are incredibly useful:
When business owners are having big fluctuations in incomes between financial years as they can be used to make the tax bills more consistent; and
For business owners coming up to retirement or selling their business, and no longer earning as much business income moving forward
How Does it work?
Here we think it is best to use a simplified example to show you in action how the strategy works.
Let’s say your Australian business had a profit of $200,000. If this profit were to be paid to you as an individual, under 2023 tax rates, you would have a tax payable of $64,667 including Medicare Levy.
If we were to use a bucket company for this business, then the most tax-effective way to distribute the $200,000 in profit is to allocate the first $45,000 in profits to you. You will pay $0 tax on the first $18,200 distributed to you and then 19 cents in every dollar until $45,000.
After you have paid yourself $45,000, it becomes tax effective to distribute the remaining profits to your bucket company. If you distribute to a company, then for every dollar after $45,000, you will pay the tax rate of 25 cents of every dollar in tax.
If you chose to receive the income yourself, from $45,000 onwards, you would pay 32.5 cents of tax in every dollar up to $120,000. You would then pay 37 cents for each dollar after $120,000 and 45 cents for each dollar after $180,000, as well as a 2% Medicare levy.
So let’s do a quick tally:
Tax paid without a bucket company: $64,667 – this is an average rate of tax of 32.33%
Tax paid with a bucket company (by the group): $43,142 – this is an average rate of tax of 21.57%
Total savings: $21,525
Amazeballs right? But what is the catch You ask? And why is not everyone is doing this? Well, due to the enormous potential tax savings that this strategy can afford you, you can imagine that the ATO is not a fan.
Technically, the cash should follow the distribution, so each year after determining how the trust distribution works, the trust should promptly make the cash payment to the bucket company.
Then, how can you get the cash out of the bucket company?
There are two options:
Loan the money from the company aka Division 7A loans; or
Pay dividends to the shareholders of the company
Let’s go into detail about this.
A loan from the bucket company
If the trust doesn’t pay all the distributions in cash before the tax return is lodged, then a Div7a loan is created upon the unpaid amount for each income year.
Essentially Your Bucket Company effectively becomes a bank, and you loan money from it by using the cash the company was supposed to receive.
In terms of the characteristic of the loan, it:
Has a maximum term of 7 years (unsecured) or 25 years if it is secured (on a property let’s say)
Has a minimum annual repayment plan (principal and interest calculated each year)
Has interest that is payable at a commercial rate prescribed by the government (5%-7%)
So it’s kind of treating your company at arm’s length, like a bank, without dealing with the bankers (lovely bunch we know).
The minimum repayment needs to be met by the trust physically making payments to the bucket company each year (or pay for the company’s expenses or taxed). However, it may be possible for the bucket company to declare dividends that can be offsets against the minimum repayment obligation – as discussed below.
Dividends paid to the shareholders of the company
An alternative way to get money out of a bucket company is through paying a dividend to the shareholders of the company.
The shareholders are who ‘own’ the shares in the company.
Now when we pay a dividend, the shareholders get taxed on that dividend, but they receive a ‘franking credit’ for the tax that the company has already paid.
Sidenote on franking credits: The company has paid 30% or 25% tax on their income. When the company pays dividends, the shareholder is taxed on the full amount of the dividend (or profit the company has already paid tax on). But the franking credit offsets the tax bill for the shareholder. For instance, if the shareholder will pay on average 30% in tax on the dividend they receive, they get a 25% franking credit, only having to pay ‘top up tax’ of 5% on the dividend they received.
So you should always consider the tax impact of paying that dividend.
There’s a third option!
You can create a separate discretionary trust (asset holdings/investment) to hold 100% of the shares in the bucket company. So that when the bucket company pays a dividend, the trust has the flexibility to distribute according to the trust deed rather than a fixed percentage as discussed above.
The pro is you have an added structure to secure your assets from business risks, as well as achieving the most tax saving effectiveness.
The con is the associated fees as well as the increased administration to manage the structures.
As you can see, there isn’t a straightforward solution to achieving tax saving easily. And that’s why we recommend you speaking with us if you would like to review the effectiveness of your current structure.
As to how to best manage the current Div7a loans in the bucket company, contact us for the cheat sheet which is exclusive to SAACS clients!