Forming a company to act as an investment vehicle can be a very smart move, especially if the shares are owned by a related investment trust. In certain circumstances, a company can receive distributions of income from a practice trust. These distributions are taxed at the corporate rate of 30%, which compares favourably to the top personal tax rate of 49%. After-tax savings could also be deposited in an investment company. Having the shares in the company owned by a related trust rather than individuals provide asset protection advantages and also flexibility with the distribution of income from the company by way of dividends.
While a company does not benefit from the 50% capital gains tax exemption which applies to gains on assets sold which have been held for more than 12 months, it does, however, benefit from the dividend imputation system. Australia is now the only country in the world to have a full dividend imputation system. Dividend imputation means that a company effectively stores the tax it pays as a credit. The tax credit can be passed on to a shareholder when a dividend is paid. This means then that the company tax is really only an instalment of tax. The ultimate amount of tax paid will be determined when a dividend is paid. When dividends are paid to a shareholder (or the beneficiary of a shareholder trust), a credit for the 30% tax comes with the dividend. This means that the ultimate recipient of the dividend will pay more tax if their tax rate is above 30% or less tax if it is below 30%.
Therefore, we can think of an investment company as like a second superannuation fund. In some respects, it is the superior investment vehicle. It can invest money (with no restrictions on how it invests or when you can withdraw money, unlike a superannuation fund), pays tax at 30% (much better than the current 49% top personal rate), but then dividends can be paid out to beneficiaries who are on a lower tax rate than 30% at the time. For example, the tax credits could be stored and then dividends could be paid to adult children after they turn 18 but before they start any significant income of their own. The period of time between reaching age 18 and commencing to earn significant income would probably persist for at least 4 years per child. Currently, the tax-free threshold is effectively $20,542 per person. This means a dividend of $14,379 could be paid to a child who turns 18, which would include a tax credit of $6,162. If the child has no other income, a refund of $6,162 would be received. The net result is that $20,542 of taxable income on which the company paid 30% tax has now been rendered tax-free. It could also apply to a practitioner and spouse when they are on a lower tax rate, which will probably not be until retirement after age 65. Using current tax rates, including the extra tax offset that so-called senior Australians receive, in retirement a couple can receive tax-free income of any amount from superannuation, plus franked dividends from an investment company of up to $57,948 p.a. ($40,563 cash plus $17,384 tax credit). Assuming this is the only income, there would be no tax payable and a refund of the 30% tax credit would be paid in full - $17,384. This means, with careful planning it could be possible to get all the tax that the company pays refunded over time. The company income is then tax-free. The only cost is the time value of money in having the credits locked up with the ATO until the tax-free dividends can be paid out.
A company also does not die and so it can be a powerful long-term investment vehicle used to pass wealth from one generation to another in perpetuity. This is a key advantage over a self-managed superannuation fund. Upon the death of both members of a couple, superannuation assets would usually have to be sold or transferred out of the fund, which can also trigger large tax liabilities. This restriction does not apply to companies so the assets can remain undisturbed. Superannuation funds also have limits on contributions and restrictions on investment strategies and withdrawals, which do not apply to companies. An investment company can form part of a two-pronged approach to investing and be set up to work hand-in-hand with a self-managed superannuation fund to provide long-term, tax effective, asset protected wealth accumulation for a family.