Updated November 12th 2013

Using companies as a means for tax planning is just the start, not the finish. Unlike most taxes where once you pay them to the government you will never see them again, company income tax is different.

For many years now, companies, apart from their obvious asset protection benefits, have been a key tax planning entity, only paying 30% income tax as opposed to individual tax rates of 38.5-46.5% for people earning over $80,000 per year. It is from this point, however that most accountants and clients forget that the 30% company tax paid is simply on deposit with the Australian Taxation Office for future withdrawal to the shareholders when the tax conditions are right for the client.

Depending on where your tax situation is at the moment, most people reading this article will straight away believe this could not be available to them, but conditions could change in the future (or have already) which will make it available to you, in which case, you want to know that it exists.

A couple of examples to illustrate the benefits:

Sale of Business on Retirement

The first is a mum and dad who have sold their family business to retire. The new owners did not purchase the shares in the company due to the potential risk of past legal liabilities. As a result, Mum and Dad are left with a company with significant retained profits and related franking credits. Mum and Dad aged 60 + previously were paid a wage from the company’s business but now only receive a tax free pension from their self managed superannuation fund, leaving their taxable income at next to nothing.

In this example Mum and Dad can pay themselves a gross dividend of $37,000 each, provided either Mum and Dad are equal shareholders, or their family trust is the sole shareholder. Because their personal tax rate is 16.5% or less, compared to the 30% franking credits attached to the company’s dividends, they would expect to receive a refund of around $7,000 each. That’s $14,000 in one year from $51,800 in retained earnings. Given several companies I currently work with have on average $0.5m-1m in retained earnings, it is not unreasonable for Mum and Dad to continue this strategy for the next 10-20 years, receiving over $140,000-$280,000 back in tax refunds (with a smile) throughout their retirement. Sounds like we just found a great reason for a new set of golf clubs or that extra overseas holiday each year.

Now let us take it one step further. If Mum and Dad would like to contribute most of their dividends into their self managed superannuation fund to keep all their assets together, they can take an extra $50,000 gross dividend each and claim a $50,000 superannuation deduction in their own tax return (provided they meet the rules and noting this figure may reduce to $25,000 after this financial year depending on individual circumstances). This will mean that they will get an extra tax refund of $15,000 each (30%) per year, whilst their superannuation fund will only pay $7,500 each (15%) in tax per year. As a result, this extra step has the benefit of speeding up their refund amounts and gets these benefits out of a taxed environment (company or individual hands) into a tax free environment (super fund in pension phase). So over the long term, not only can you save tax at the time of making the money (10-20 years ago paying 30-36% company tax as opposed to higher individual tax rates) but saved a second time with the same money by choosing the best time to pay a dividend from the company.

The younger readers might quite rightly say at this point that this does not apply to them until they retire and sell the business, but here is another example.

Salary VS Franked Dividends

You might be working in the family business but your spouse and children are not. Y es, they could be employed in the business but there are several reasons why this might not be the best tax outcome. If your family trust owns the shares in the company, you can pay your spouse a gross dividend of $37,000 via the trust and she would normally expect to receive a refund of over $7,000 per year, assuming franking credits are available.

Yes, by not paying a wage you will save on workers compensation insurance, compulsory superannuation payments and possibly payroll tax, but the best reason for doing this is for when the business is going through a tougher year and would make a tax loss in the company. Paying the spouse a $37,000 salary would simply add to the loss carried forward to future years and have the company withhold around $4,000 in PAYG withholding tax and incur the other associated on costs. On the other hand, paying a $37,000 gross dividend could lead to a personal tax refund of over $7,000 with no PAYG withholding tax obligations and a cash flow turnaround of over $11,000. Some people might say that $11,000 per year is not much, but for many growing businesses, this saving could fund the extra order for inventory to keep the wheels moving in the right direction rather than the ‘one that got away’ due to tight cash flow. Once again, let us take it one step further. If your spouse owns the family’s passive investments (for asset protection purposes) which may include either a negatively geared property or share portfolio, they can take an extra gross dividend equivalent to the tax losses being achieved by the property or share portfolio. This will mean that they will get an extra tax refund of 30% of the tax losses each year, rather than the losses being carried forward waiting for future income. This strategy has the benefit of speeding up tax refunds.

Due to the change in rules from 1st July 2011, minors are no longer able to receive a $3,000 gross dividend to get around $1,000 back as a tax refund each year to only a $125 tax refund ($416 gross dividend). Oh well, we cannot win them all and it was great whilst it lasted.

As you can see by the second example, several variations could exist depending on your situation, which could mean this strategy is only a one year wonder in bad times, or a regular varying flow if you consistently have family members with a tax rate below 30%.

The key is that you are aware of the available tax strategies and that you contact us for a quick chat when your circumstances vary to see if you can take advantage of this and other tax saving measures.