A New Super Family Trust Tax Break - Best Practice News Alert No 148

HEALTH & LIFE’S BEST PRACTICE NEWS ALERT CURRENT CIRCULATION: DATE: ISSUE NO:

7023 10th August 2007 148

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Writer in charge: Mr David Dahm BA.Acc, CPA, FTIA, Ffin, FAAPM, GLFG.

A New Super Family Trust Tax Break Tax ruling ATO ID 2007/145 confirms a new tax break for tax payers that operate a family trust.

If your family trust uses a corporate trustee as opposed to an individual trustee for their family trust then you can access tax deductions of $50,000 p.a. if you are under 50 y.o, up to $100,000 p.a or if over 50’s. This can be doubled if both a husband and wife become directors of the corporate trustee.

This strategy can reduce your tax bill by up to an additional $50,000 p.a. by using superannuation or self managed super funds, including getting a tax deduction on interest borrowings previously unavailable to the self employed. This strategy is particularly attractive if you own your practice and are planning on building a new practice building that you want your self managed super fund to own.

As we have advised to all readers and clients, other than super, it is important to accumulate your savings in a family trust for taxation and asset protection purposes. The current limitation is that, it has not been clear that as a director of a corporate trustee you could claim a tax deduction as an employee director of the corporate trustee of the trust that looks after the running of the trust. This limitation has been clarified and it now means taxpayers can salary sacrifice superannuation in their family trust.

Clearly this makes the need for operating medical practice companies totally redundant.

In this edition we cover: 1. Introduction • • • • •

How to contribute to super using your family trust?

The tax break Corporate beneficiaries and practice companies for the self employed Better asset protection under the new bankruptcy rules A good tax strategy if you are acquiring a new practice building

2. Where to from here?

A New Super Family Trust Tax Break Introduction Commonly professionals are advised to own assets either in a superfund or a family trust, not in companies, their own name or in partnership arrangements as this can be disadvantageous from an asset protection and taxation point of view. We have also advised that, in order to improve your tax and asset protection position to use a corporate beneficiary to distribute any excess family trust profits that cannot be distributed (income split) to other family members at a lower tax rate. Effectively this can cap your maximum tax rate to 30c in the dollar. For practitioners that own their practice via service trust, on average this would save a full time doctor earning $180,000 p,a, net in excess of $15,000 p.a. by arranging your family trust to receive your practice service trust profit distributions. In addition to any other investment income from shares, units in a property trust and fixed term investments this means your family trust is now in a position to obtain substantial tax deductions by salary sacrificing a directors income from a related corporate trustee that manages your family trusts affairs. Therefore your total tax savings can increase from $15,000 to $65,000 p.a.

This in particular comes in handy for practitioners that are building a new practice building which is owned by their super fund. You can use your super to pay off your building and tax shelter rental income at a maximum rate of 15% p.a.

Why do you need a trustee?

The only reason for a trustee is because a trust is not a legal entity. Like a child needs a legal guardian or parent over the age of 18 to enter a contract, a trust requires a trustee to act on behalf of a trust. This can either be an individual or a company.

It is beneficial to use a company in the event the trust makes a bad investment the trustee is limited to the liability of the company’s capital normally “$2” rather than unlimited liability if it involves an individual.

This is usually an issue if your family trust is entering into speculative property developments or share market margin loan schemes that involve securities made against the trusts assets and the trustee. If individual trustees own assets such as the family home in their name this can be a problem if there is equity in the family home and the trust makes a bad investment. This exposes the family home.

The other reason people may use a corporate trustee is to remain anonymous on official documents if they are buying shares or real estate. Individual names do not have to appear on documents. There is also a continuity benefit. This means you do not have to keep changing the names on agreements if the trustee changes. This is why service trusts normally use a corporate trustee when a number of owner practitioners are involved as they can frequently change.

How to contribute to super using your family trust?

If you have a family trust it is important that your trustee is a company. For cost reasons, normally it is an individual. You can find this information by first looking at your family trust deed and noting whether the trustee has a “Pty Ltd” after its name.

If not check there has been no Trust Deed Variations where the Trustee has been replaced by a new trustee ending with a “Pty Ltd� after its name. Contact us if you are not sure.

Most family trusts do not have a corporate trustee. Normally mum and dad family trusts have the name of the individuals to keep set up and ongoing compliance costs to a minimum. Converting your trustee into a company is important if you want to access these tax benefits.

Incorporating a company this financial year has been halved to $400, so the costs are no longer as prohibitive. More importantly the benefits should outweigh your ongoing set up and ongoing compliance cost.

To make this arrangement work the Directors (mum and dad) of the company should be working managing the trusts affairs so the remuneration is consider reasonable. If not it may not be deductible or only part thereof. You are eligible for a tax deduction from writing cheques to monitoring and maintaining investments. The remuneration should be commercial – which is not difficult to achieve. Examples include time taken to monitor your investments including your practice if it owns its interest via the family trust.

The tax break Those who are self employed can claim a tax deduction on any super contribution up to the cap of $50,000 p.a. if you are under 50 or $100,000 if you are over 50, up and until 2011-12. Clearly this benefit can be doubled if both husband and wife become directors of the corporate trustee.

By contrast employees can obtain a tax break subject to the same aged based limits as determined by their employer. Accordingly if you are self employed, before this new ruling any family trust distributions could only be made after tax and no tax deduction could be claimed.

This is no longer the case. Note a 15% contribution tax applies on all tax deductible contributions. After you reach the age of 60 you can receive this income tax free subject to certain conditions. It is important that the superfund is a complying fund. This is very important if you are using a self managed super fund.

The key benefit is you can use cash from your family trust during the year to make tax deductible contributions and you do not have to wait until the end of the year once you know your profit distribution how much you can put into super. If your children are working and you can no longer make trust distributions into their names, this becomes another excellent strategy until you turn 60.

Corporate beneficiaries and practice companies for the self employed If you own your practice and are earning greater than $180k a year and paying tax at high marginal rates and do not have a corporate beneficiary and/or do not know what we are referring to you are probably paying too much tax and should seek further advice.

If you use a corporate beneficiary then you can now access this cash to make a legitimate contribution and claim the interest lent as a tax deduction (previously not allowed).

For taxpayers that use corporate beneficiaries to accumulate income this additional benefit means you can lend money to the corporate trustee and receive a tax deduction on the interest as well as the superannuation contribution. This is not achievable if you tried to make a similar loan to yourself as a self employed individual as the interest tax deduction will be non-deductible.

This means there is no longer a requirement to maintain a medical practice company and you can save a lot on accounting and compliance costs.

Better asset protection under the new bankruptcy rules

This is also a safer form of asset protection, because this is not from income generated from your professional practice which is open to the new bankruptcy law “claw back” provisions due to excessive super contributions that relate to one’s professional earnings. The fact these contributions are from passive earnings it makes it harder for the bankruptcy trustee to “claw back” these payments as they would be unrelated to any professional negligence claim. As a side note if you are paying off the family home you should use your family trust to make the payments for the same reason “claw back” reasons.

A good tax strategy if you are acquiring a new practice building A strategy we use with clients is to ensure your new practice building is owned in a property trust separate from your family and service trust. This allows other non-family related investors to buy into the practice building as well as your super fund should you wish to sell down. This is the only real significant exemption that self managed super funds have where it can own an in house asset without restrictions if it is a commercial premise.

Overtime with stamp duty (subject to land rich rules) on units being reduced and or eliminated around the country a useful long term strategy is to get your self managed super fund to incrementally buy units in the unit trusts and secure a tax deduction for the purchase via an in specie distribution. This also is a legitimate way to get access to your super earlier.

Making these contributions is like receiving a 100% tax deduction for repaying the principal component on your practice building loan. Structured correctly between $50,000 up to $100,000 is tax deductible per annum per employee director. Note that the property itself cannot be used as security. Security must be made against the property units only that actually own the building in the property trust. Some units will need to be owned directly by the trust.

It is important that you consult your financial adviser if you are going to use this strategy and that it is implemented properly. We recommend lenders who are familiar with this arrangement which can be problematic. This is more due to a lack of understanding of what are the correct security and entity arrangements. Contact us for further information.

2. Where to from here?

1. Consider incorporating your family trustee into a company; 2. Consult your professional adviser for strategies suggested; 3. If you are not sure about any issues raised in this broadcast contact David Dahm on 1800 077 222 for an initial free no obligation consult, or email us at pa@healthandlife.com.au.

Health and Life provides comprehensive practice consulting, accounting, taxation and financial planning advice for group practices and individuals.

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