Once you have decided to purchase one or more assets it is important to consider the best investment structure to use. An investment structure refers to the way your investments are legally owned. Many people simply purchase assets in their own name or joint names, when other ownership structures may be more suitable.
Important considerations
Take the time to review all of the investment structure options before investing because getting it right at the beginning can have long term benefits, and getting it wrong can be a disaster. There is no ‘right’ structure for all investors because each investor’s circumstances are different.
You should read the basic outline of the various investment structures below and consider the following:
- Who should receive the income, both now and in the future?
- Who should receive the capital, both now and in the future?
- Is there a need for investment assets to be protected against potential future creditors?
- Are there are special family considerations related to who should own assets or receive income, both now and in the future?
- What level of flexibility is needed as far as debt and leverage is concerned?
- What are the tax implications of each structure?
- What estate planning issues need to be addressed?
There are four basic types of investment structure, each with its own advantages and disadvantages. As you can see from the above list, it is not just taxation that should be considered when choosing an appropriate structure.
Individuals
The most common and simplest investment vehicle is a person holding investments in their own name. Investments in an individual name can be:
- Easy to set up and manage as income and capital gains are included in the individual’s own tax returns.
- Easier to administer as there is much less paperwork in comparison to other structures.
- Much less expensive to set up and run.
- More tax effective, especially if the investment is negatively geared.
- Tax advantaged if the investment is the family home.
However, assets held by an individual offer no flexibility with the distribution of income. Individuals in high risk occupations could be sued and their assets exposed to risk from creditors. Negatively geared assets held by an individual will eventually become positively geared, resulting in an increased tax liability over time. The same advantages and disadvantages apply to assets held jointly.
Partnerships
A partnership is also a relatively simple structure and costs to set up are fairly low. A partnership (as opposed to holding an investment in joint names) is a separate entity for taxation purposes and as such requires its own tax file number and tax return. However, it does not pay tax but must distribute income to the partners. Partnerships offer limited distribution flexibility as any income derived has to be split according to the partnership agreement.
Holding a property as joint tenants or holding shares in joint names is usually not considered to be a partnership.
There is no risk protection in a partnership as the assets of either partner may be subject to a claim by a creditor as all partners are jointly and severally liable. This means that one partner could become personally liable for all the debts of the entire partnership.
Companies
Companies are most often used as a structure for business rather than for investments. The main benefit is that the tax rate on profits is 30% and they offer some protection for shareholders if the business fails or is sued.
However, there are also disadvantages, particularly for investments as losses can only be offset against future income and a company is not able to obtain the benefit of any capital gains discount on the sale of investments.
The costs to set up can be high and there is a requirement for a separate set of accounts and tax return each year. A company can distribute profit by paying a dividend, but there is limited flexibility when paying these.
Companies do have some advantages though and used appropriately in an overall investment strategy can work well for some investors.
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Case Study Tom is a farmer and a professional investor and he invests through a trust structure with himself, his wife and his three children (under 18) as beneficiaries. His wife does not earn any income from other sources and Tom’s income from farming fluctuates year to year. For the first few years his investing is moderately successful and each year the trust distributes the maximum amount to each of the children and depending on the farm income that he receives, the remaining amount is apportioned between himself and his wife in the most tax effective manner. Overall, he and his wife generally pay between 15 and 30 cents tax in the dollar on everything they earn. However, in one year, the trust has some large windfall capital gains and even after distributing to the children and his wife, so that she pays a maximum 30% tax, there is still a considerable amount of trust income to be distributed. If the income is distributed to Tom or retained in the trust it will be taxed at the top marginal rate plus the Medicare levy. How could Tom have avoided this situation? If Tom had also set up a company to be a trust beneficiary, the trust could have distributed the excess to the company which would only have paid 30% tax on the excess earnings and Tom would have saved himself 15% in tax on that amount. Note however, that this amount needs to be actually paid to the company and loaned back to the trust to avoid the deemed dividend and Div7A loan issues. |
Trusts
Trusts are a popular investment structure, but are often poorly understood.
Briefly, the trust is formed by executing a deed which documents the establishment of the trust. The ‘settlor’ gifts the settled sum for the set up of the trust for the benefit of another person or persons called ‘the beneficiaries’.
The settlor (often your accountant) is usually an independent person unrelated to the trustee or appointor of the trust because the settlor cannot be a beneficiary of the trust. The settled sum is usually a nominal sum of $10 to $20. The trustee may be either a natural person or persons or a company. The trustee determines to whom and in what proportion the income/assets of the trust are distributed.
The appointer (usually the person establishing the trust) has the discretionary power under the trust deed to remove and replace the trustee. The appointor has the power to nominate a successor on his or her death and failing any such appointment, the personal representative of the appointor will become the new appointor.
The specified beneficiary are usually the husband and wife or partner and so by definition the range of beneficiaries include any children and any related entities (any companies of the which the specified beneficiaries are directors or shareholders).
A trust can distribute income and capital gains in accordance with the trust deed, however, it cannot distribute losses. Losses can be carried forward to be offset against future income. A trust can also retain income, and if that income is taxable, then tax is payable at the top marginal rate plus the Medicare levy.
There are four main types of trusts:
- Discretionary
- Unit
- Hybrid
- Superannuation funds
Testamentary trusts which are formed upon the death of a person who has specified its creation in a will are discussed in Estate planning.
Note that Centrelink may include the income and assets of a trust when working out your social security payments if you are considered to be a controller of a trust. Further information can be found at the Centrelink website.
Discretionary trusts
The trustees of a discretionary trust are able to distribute income and capital gains to beneficiaries in whatever way they desire (typically the most tax effective).
The assets of the trust are also protected in the event of litigation against beneficiaries as there is no single individual that owns any assets so therefore creditors of an individual cannot access any assets held by a trust.
A ‘family trust election’ must also be made in some circumstances e.g. in order to distribute franking credits. In addition, franking credits cannot be distributed to beneficiaries unless the trust has net income.
A company can be a beneficiary of a trust ensuring that the tax rate is capped at 30%, however, unless this distribution is actually paid to the company there may be other tax consequences e.g. deemed dividends and Div 7A loan issues.
Beneficiaries who receive capital gains can claim the 50% capital gains discount where the asset has been held for more than 12 months.
Unit trusts
A unit trust is one where the assets are held and administered by the trustee of the trust for the holders of units in the unit trust. This means that unit trusts pre-determine the unit holders entitlements, which may be for income, capital or both.
Unit trusts are often used where unrelated parties run a business together and where the units are then held by a family trust and for managed funds where investors hold units in the trust. They have limited application for most personal investments, although some use them to hold property with the unitholder being a family trust.
Hybrid trusts
Hybrid discretionary trusts can be hybrid discretionary or hybrid unit trusts. The former are the more common and take the best features of both discretionary and unit trusts and mixes them together in the one entity to create a powerful and flexible tax planning solution.
They are typically used to gear into property where an individual will borrow to purchase the units in the trust (usually using the property purchases by the trust as security) and then, when the property is no longer geared, the trust can repurchase the units (often borrowing money to do so).
Care needs to be taken when establish such a structure as not all trust deeds are adequate to allow the individual to claim the tax deduction for the interest expense on the loan.
For more detailed information on hybrid trusts read more on trust related definitions at All Trust Structures.
Superannuation funds
Superannuation funds are also a type of trust and are an investment vehicle which can be used to contain investments purchased with your superannuation contributions. Explore our superannuation section for details of the types of superannuation funds and other important information on superannuation.
Summary table
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|
Individual |
Partnership |
Company |
Unit trust |
Discretionary trust |
Superannuation fund |
Administered by |
Individual |
Partners |
Directors |
Trustee |
Trustee |
Trustee |
Responsible to |
N/A |
Partners |
Shareholders |
Unit Holders |
Appointer |
Members |
Cost to establish and run |
Low |
Fairly low |
Higher |
Higher |
Higher |
Higher |
Protection of assets from outside risk/claims |
No |
No |
Only if owned by a discretionary trust |
Only if owned by a discretionary trust |
Yes |
Yes |
|
Maximum tax rate |
Top Marginal Rate + Medicare Levy |
Top Marginal Rate + Medicare Levy or 30% if Partner is a Company |
30% |
Top Marginal rate or 30%if Unit Holder is a company |
Top Marginal rate or 30%if Beneficiary is a company |
15% if complying fund 45% if non-complying |
|
Flexibility |
Poor |
Fairly Poor |
Fair |
Good |
Very Good |
Fairly Poor |
|
Potential for splitting income |
No |
Between Partners |
Between Shareholders |
Between Unit Holders (Fixed) |
Between Beneficiaries |
No |
|
Streaming of income |
No |
Limited |
No |
Dependent on trust deed |
Yes, subject to trust deed |
No |
|
Taxable capital gains |
Paid by individual |
Paid by partners |
Paid by company |
Paid by unit holder |
Paid by beneficiary |
Paid by trustee |
|
Access to CGT discount |
Yes |
Yes |
No |
Yes |
Yes |
Yes (lower discount) |
|
Can losses be distributed? |
Yes |
Yes |
No |
No |
No |
No |
|
Admission of new parties |
New structure is required |
Usually permitted |
Usually permitted |
Usually permitted |
May be difficult for non family members |
Usually permitted |
|
Changing ownership |
N/A |
Partnership interest |
Shares |
Units |
By appointer |
N/A |