Australia Investment Planning
When it comes to structuring, whether it’s for property investment, property development, a business, or any other activity, there’s no one-size-fits-all solution. This is because everyone’s individual circumstances are different and we need to take into account those differences in coming up with a structure that is fit-for-purpose for the specific situation at hand.
The key issues we normally consider when putting a structure together for our clients include the following:
Whether we like it or not, life is full of potential liabilities and Australia is no different to any first world country. The more dealings you have with other parties, the higher the probability you might run into legal disputes with others, which might, in turn, expose your hard-earned assets to risk.
Structuring investment properties needs to take into account and quarantine these potential liabilities to the maximum extent possible, eg, you may consider ‘locking’ your valuable assets in an entity that is difficult for creditors or the trustee in bankruptcy to make a claim against you if you get sued.
While taxation should not be the sole or dominant motivator in any structuring exercise, the failure to take into account taxation could cost you plenty. A tax efficient structure ensures that the overall taxation position of your group is optimised. For instance, there is little point owning a negatively geared investment property in a discretionary trust that does not derive other income to take advantage of the negative gearing losses.
Likewise, if your investment property is returning net taxable income each year and you have tax losses in another entity within your group, where possible, your structure should be set up in such a way that the income can be offset against those tax losses to minimise your overall tax liability.
Structuring for a single family group is a very different exercise to structuring for multiple parties that come from different family groups. Multiple families introduce more complex dynamics and some of the commercial variables, eg, taxation, may dictate how the group may be structured. For example, using a discretionary trust to hold an investment property for two unrelated families may cause potential taxation issues such as the potential inability to recoup tax losses or for the trust to distribute income to both families without incurring the Family Trust Distribution Tax.
Succession and exit strategy
As we don’t live forever, any structure you put together needs to take into account future succession in addition to present considerations. This will raise questions such as – how would you like nominated people to inherit and manage your assets?
A common structure people use is a testamentary trust, which is essentially a trust created upon your death by your will. The terms of the trust allow you to lock in who will control the trust upon your passing, which may also provide certain ancillary taxation benefits. Similarly, if you have a reasonably clear exit strategy for your property, you will need to ensure that the structure you put together now will accommodate that eventuality.
Costs and complexity
We have seen plenty of ‘Frankenstein structures’ in my time. Sometimes the structure evolves as the underlying owners change over time while more entrepreneurial people tend to make snap decisions to get a deal done and they simply bolt on extra entities to an existing structure without giving much thought to streamlining it.
While the size and complexity of a structure are virtually limitless, having a complex structure translates to higher upfront establishment and ongoing maintenance costs. Having more ‘moving parts’ may also introduce additional technical complexities to the structure. To that end, we are strong proponents of the ‘KISS principle’ when it comes to structuring – keeping the structure relatively simple will save you both money and headaches in the long run.
Having regard to the above, tensions may sometimes exist between the different desirable features in a structure. A common example pertains to control and ownership versus asset protection – you may want to have absolute control and ownership of an asset by owning it in your own name but if you are a director of a company and are therefore exposed to the directors’ duties provisions in the Corporations Act, it may be better for you to not own the assets or at least only have partial ownership or control over the assets, just in case you get sued.
The building blocks
Australian Company And Investment Structures
Once you have decided to purchase one or more assets in Australia it is important to consider the best investment structure to use. An investment structure refers to the way your investments are legally owned. Many people simply purchase assets in their own name or joint names, when other ownership structures may be more suitable.
- Important Considerations
Here at Haskew Law we can guide you on the possible options available and how to set them in place.
Take the time to review all of the investment structure options before investing because getting it right at the beginning can have long-term benefits, and getting it wrong can be a disaster. There is no 'right' structure for all investors because each investor's circumstances are different.
You should read the basic outline of the various investment structures below and consider the following:
- Who should receive the income, both now and in the future?
- Who should receive the capital, both now and in the future?
- Is there a need for investment assets to be protected against potential future creditors?
- Are there are special family considerations related to who should own assets or receive income, both now and in the future?
- What level of flexibility is needed as far as debt and leverage are concerned?
- What are the tax implications of each structure?
- What estate planning issues need to be addressed?
There are four basic types of investment structure, each with its own advantages and disadvantages. As you can see from the above list, it is not just taxation that should be considered when choosing an appropriate structure.
The most common and simplest investment vehicle is a person holding investments in their own name. Investments in an individual name can be:
- Easy to set up and manage as income and capital gains are included in the individual's own tax returns.
- Easier to administer as there is much less paperwork in comparison to other structures.
- Much less expensive to set up and run.
- More tax effective, especially if the investment is negatively geared.
- Tax-advantaged if the investment is the family home.
However, assets held by an individual offer no flexibility with the distribution of income. Individuals in high-risk occupations could be sued and their assets exposed to risk from creditors. Negatively geared assets held by an individual will eventually become positively geared, resulting in an increased tax liability over time. The same advantages and disadvantages apply to assets held jointly.
A partnership is also a relatively simple structure and costs to set up are fairly low. A partnership (as opposed to holding an investment in joint names) is a separate entity for taxation purposes and as such requires its own tax file number and tax return. However, it does not pay tax but must distribute income to the partners. Partnerships offer limited distribution flexibility as any income derived has to be split according to the partnership agreement.
Holding a property as joint tenants or holding shares in joint names is usually not considered to be a partnership.
There is no risk protection in a partnership as the assets of either partner may be subject to a claim by a creditor as all partners are jointly and severally liable. This means that one partner could become personally liable for all the debts of the entire partnership.
Companies are most often used as a structure for business rather than for investments. The main benefit is that the tax rate on profits is 30% and they offer some protection for shareholders if the business fails or is sued.
However, there are also disadvantages, particularly for investments as losses can only be offset against future income and a company is not able to obtain the benefit of any capital gains discount on the sale of investments.
The costs to set up can be high and there is a requirement for a separate set of accounts and tax return each year. A company can distribute profit by paying a dividend, but there is limited flexibility when paying these.
Companies do have some advantages though and used appropriately in an overall investment strategy can work well for some investors.
Trusts are a popular investment structure but are often poorly understood.
Briefly, the trust is formed by executing a deed which documents the establishment of the trust. The 'settlor' gifts the settled sum for the set up of the trust for the benefit of another person or persons called 'the beneficiaries'.
The settlor (often your accountant) is usually an independent person unrelated to the trustee or appointor of the trust because the settlor cannot be a beneficiary of the trust. The settled sum is usually a nominal sum of $10 to $20. The trustee may be either a natural person or persons or a company. The trustee determines to whom and in what proportion the income/assets of the trust are distributed.
The appointer (usually the person establishing the trust) has the discretionary power under the trust deed to remove and replace the trustee. The appointor has the power to nominate a successor on his or her death and failing any such appointment, the personal representative of the appointor will become the new appointor.
The specified beneficiary are usually the husband and wife or partner and so by definition, the range of beneficiaries include any children and any related entities (any companies of the which the specified beneficiaries are directors or shareholders).
A trust can distribute income and capital gains in accordance with the trust deed, however, it cannot distribute losses. Losses can be carried forward to be offset against future income. A trust can also retain income, and if that income is taxable, then tax is payable at the top marginal rate plus the Medicare levy.
There are four main types of trusts:
- Superannuation funds
Testamentary trusts which are formed upon the death of a person who has specified its creation in a will are discussed in Estate planning.
Note that Centrelink may include the income and assets of a trust when working out your social security payments if you are considered to be a controller of a trust.
The trustees of a discretionary trust are able to distribute income and capital gains to beneficiaries in whatever way they desire (typically the most tax effective).
The assets of the trust are also protected in the event of litigation against beneficiaries as there is no single individual that owns any assets so therefore creditors of an individual cannot access any assets held by a trust.
A 'family trust election' must also be made in some circumstances e.g. in order to distribute franking credits. In addition, franking credits cannot be distributed to beneficiaries unless the trust has net income.
A company can be a beneficiary of a trust ensuring that the tax rate is capped at 30%, however, unless this distribution is actually paid to the company there may be other tax consequences e.g. deemed dividends and Div 7A loan issues.
Beneficiaries who receive capital gains can claim the 50% capital gains discount where the asset has been held for more than 12 months.
A unit trust is one where the assets are held and administered by the trustee of the trust for the holders of units in the unit trust. This means that unit trusts pre-determine the unit holders entitlements, which may be for income, capital or both.
Unit trusts are often used where unrelated parties run a business together and where the units are then held by a family trust and for managed funds where investors hold units in the trust. They have limited application for most personal investments, although some use them to hold property with the unitholder being a family trust.
Hybrid discretionary trusts can be hybrid discretionary or hybrid unit trusts. The former are the more common and take the best features of both discretionary and unit trusts and mixes them together in the one entity to create a powerful and flexible tax planning solution.
They are typically used to gear into a property where an individual will borrow to purchase the units in the trust (usually using the property purchased by the trust as security) and then when the property is no longer geared, the trust can repurchase the units (often borrowing money to do so).
Care needs to be taken when establishing such a structure as not all trust deeds are adequate to allow the individual to claim the tax deduction for the interest expense on the loan.
Superannuation funds are also a type of trust and are an investment vehicle which can be used to contain investments purchased with your superannuation contributions.
For further information on setting up an investment structure or company in Australia contact us.