A company may be formed to own the property, the property belongs to the company and any rent generated by the property is received as income by the company. In these circumstances, owners become shareholders and often directors of the company. The value of their investment is calculated by dividing the value of the property by the number of shares held by each of the shareholders. Income and capital proceeds go directly to the company and the company incurs any tax liability. Company taxes are currently paid paid at a flat rate of 30 per cent for companies other than small businesses. Small businesses with a turnover of less than $10m will face a flat tax rate of 27.5% as of 1 July 2016. There are no discounts on capital gains in the way that there are for individuals.
The client as shareholder receives a financial benefit. Growth in the value of the investment property should lead to growth in the value of their shares in the company. Rental income is received by the company. The after tax profit of the company is usually paid to the shareholders as dividend, although it is at the discretion of the company directors as to whether a dividend is paid. This dividend is in two parts: cash dividend return (the client’s share of the cash after payment of tax) and imputation credits (better known as franking credits).
The shareholder’s portion of the tax paid by the company is credited to them for inclusion in their personal tax return. Imputation credits can be effective in tax planning. The company pays tax at 30 per cent and if the client’s marginal tax rate is less than this, the company will have paid more than the necessary personal tax payable. If this shareholder is credited the full 30 per cent, any extra tax credit payable can be used to reduce tax against other income earned by that client.
Similarly, a person on the highest marginal tax rate (45 percent at the time of writing) would receive their cash dividend and their imputation credit equal to 30 cents in every dollar of their share of the company income. The client would only now have to pay the additional 15 cents that being the difference between the company rate and the highest personal rate. As a benefit for a company set up in only the property purchaser’s name, this does not really make good sense as all that has happened is that a company with all its costs and compliance requirements, has been set up through which the income essentially funnels. The amount of tax paid remains the same as if the property were held in an individual structure and valuable benefits such as discounted capital gains tax are lost.
A company may purchase a property using borrowed funds. As with any loan application, the lender will require the borrower to meet ongoing loan repayments and directors and shareholders may need to contribute to the repayment of the loan. Where a loan is part of the company’s operation, the directors and shareholders may be asked to provide personal guarantees for the repayment of the loan should default occur.
The use of company ownership can benefit clients who are looking for a flexible way to receive their investment return and greater tax benefits than those of a sole owner. The company must have a set of accounts and prepare annual tax returns. In addition, registration of the company with the Australian Securities and Investments Commission (ASIC) must occur and the company will be liable to the laws covered in the Corporations Act.
These issues and the lack of discount for capital gains may be offset by the further tax advantage the company offers by retaining profits. The company pays the company tax, however, the after-tax profit can be retained by the company in order to fund such things as capital improvements.
In the event of death of a shareholder, the share of the company becomes part of the estate and their ownership distributed in the terms set out in the will.
It should be noted that any arrangement put in place with the dominating purpose to obtain a tax benefit may be disallowed by the Australian Tax Office. Setting up a company in which to buy property purely to pay less tax may be considered to fall within the anti- avoidance provisions of the tax law and you should not recommend this structure unless your client has another, overriding reason for using a company to buy property.
|What aspects of the Murdoch’s situation would indicate that a company would be an effective method of investment ownership for them?