The tax structure determines how income can be paid out to the family members and a company structure allows dividends to be paid – franked or unfranked. A trust provides the distributions.
What is a family company?
A family company pays tax on the annual profits. The revenue determines the tax rate paid by the company.
The family can decide what percentage, if any, to pay in dividends to the shareholders. In many situations, families decide to keep profit in the company to contribute towards working capital or to invest further.
How are profits paid?
Profits can be paid via fully dividends which can be franked or unfranked. A fully franked dividend is when the company passes on a credit, called an imputation credit for the company tax already paid.
For example, Blue Oceans Pty Ltd decides to pay 10 per cent of their profits in a dividend. The company tax rate is 25 per cent and Blue Ocean Pty Ltd has a profit of $2m. Paul Ocean owns 50 percent of the company.
| $2m profit x 10 per cent |
$200,000 |
| Paul’s dividend is $200,000 x 50 per cent |
$100,000 |
| The imputation credit is 100,000 x 25/75 |
$33,333.33 |
Therefore, Paul will receive $100,000 cash. In his tax return, Paul’s dividend will be $133,333 and he will receive an imputation credit of $33,333.
An imputation credit (also known as a franking credit) represents the tax a business has already paid on its profits.
What does this mean?
Paul pays tax on the difference between his tax rate and the tax the company has already paid.
So, if his tax rate is 47 per cent and the company has paid 25 per cent, he pays 22 per cent top up tax when lodging his tax return. This ensures the profit isn’t double taxed. Rather, taxed to the tax rate of the person or entity who ultimately receives the income. That is, Paul’s tax rate is 47 per cent – the company pays 25 per cent and Paul personally pays 22 per cent.
Family Trust
A Family Trust is considered a flow through vehicle. What that means is ordinarily no tax is paid by the trust. The profits flow through to the beneficiary and tax is paid in the beneficiary’s name. Whether the trust is a unit trust or discretionary trust, the taxing point is generally alway the beneficiary.
For example, the Ocean Family Trust makes $2m and distributes 50 per cent to Paul Ocean, which is taxable income.
Paul will pay tax on $1m. If his tax rate is 47 per cent, that is $470,000. Should the trust receive dividends and franking credits are attached, they will also flow through and offset the tax.
What does this mean?
Paul receives $1m , his tax is $470,000 and $200,000 in imputation credits flow through. His tax will be:
| Tax |
$470,000 |
| Imputation Credit |
$200,000 |
| Tax Payable |
$270,000 |
This will be payable upon lodging the tax return.
Both trust distributions and company dividends are effective ways to distribute to family members. This is why it is so important to understand your family structure and how profits can be distributed.
We’re here to educate the next generation
The Family Trust can play a different role in each family structure – it’s important to understand how your own structure works.
If you would like to understand more, please don’t hesitate to contact us, or enquire further in relation to our financial acumen training course.
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