Discretionary trusts are attractive business structures as they can provide the following benefits:
• Flexibility with income distributions (income can be allocated in different amounts and to different beneficiaries each year).
• Asset protection.
• Access to the 50% general CGT discount.
If a discretionary trust has a large taxable income, they may not want to distribute all the taxable income to individual taxpayers. This is because the individuals may end up paying tax on this income at up to 47%.
To avoid this situation, the trust may look at including a ‘bucket company’ as a beneficiary of the trust and distributing some income to it. The tax advantage of this strategy is that the company will only be taxed at 30% on this income. An additional benefit of this strategy is risk management, as investments are accumulated in an entity separate from the business structure (i.e. trust). The shares in the investment ‘bucket company’ should be owned by a low risk spouse or associate.
With this strategy the income distributed to the company for tax purposes will generally need to be physically paid across to the company prior to the date the company lodges its tax return with the ATO. Once the company receives the trust distribution it can pay the 30% tax liability and invest the other 70% into term deposits, shares or property.
Problems arise with this strategy when the trust doesn’t physically have the cash available to pay across to the company beneficiary. This then causes Division 7A loan issues which can result in more tax payable (See Tax Strategy 139).