Many Australian business owners reach a point where leaving every dollar of profit in their own name becomes less efficient. They may be paying tax at higher personal marginal rates while also wanting capital to fund growth, build investments or create a stronger financial buffer.
A bucket company can be useful in the right structure, but it is not a simple tax-saving switch. It must fit the trust deed, the business’s cash flow, the family group’s wider tax position and strict rules around private company money. Used well, it can help defer personal tax and retain capital for future opportunities. Used poorly, it can create unexpected tax, compliance costs and Division 7A problems.
What is a bucket company?
A bucket company is usually a private company that is included as an eligible beneficiary of a discretionary family trust. The trust may distribute part of its income to the company, rather than distributing all income to individual family members.
The company is then assessed on its share of the trust’s taxable income. It is often called a “bucket” company because it can receive income that would otherwise push individuals into higher personal tax brackets.
For the current income tax rules, a company that qualifies as a base rate entity is taxed at 25%. Other companies are taxed at 30%. Broadly, a base rate entity must have aggregated turnover below $50 million and no more than 80% of its assessable income can be base rate entity passive income.
This can create a timing advantage where profits are not needed personally in the short term. Rather than distributing all available income to an individual taxpayer, the trustee may distribute an amount to the corporate beneficiary and the after-tax funds can potentially be retained for business or investment purposes.
A bucket company is not the same thing as the company that operates the business, although in some groups a company may perform more than one role. In many cases, owners choose to keep the roles separate:
– a trading company or trust that runs the business;
– a discretionary trust that receives business or investment income;
– a corporate trustee that acts only as trustee; and
– a separate bucket company that receives trust distributions in its own right.
Keeping roles clear can improve administration and make it easier to understand where profits, assets, liabilities and tax obligations sit.
How a bucket company may reduce tax now, but not necessarily forever
The main benefit of a bucket company is generally tax deferral, not permanent tax elimination.
If a discretionary trust distributes income to an adult individual, that person is taxed at the personal income tax rates that apply to them, together with other relevant charges and offsets. If the same income is validly distributed to a corporate beneficiary, the company pays tax at the applicable company rate.
This may leave more after-tax cash inside the group for a period. That cash could potentially be used to support working capital, fund equipment, repay external debt, invest in a new venture or build reserves for quieter trading periods.
However, the money does not become tax-free simply because it enters a company. When the company later pays profits to shareholders as dividends, those dividends may carry franking credits. The shareholder generally includes the dividend and associated franking credit in assessable income, then claims the franking credit as a tax offset where the relevant requirements are met.
The final tax cost depends on the shareholder’s circumstances at the time the dividend is paid. If the shareholder’s tax rate is higher than the company tax rate that generated the franking credits, additional tax may be payable. If their circumstances are different in a later year, the overall outcome may be more favourable.
This is why the strategy is usually most useful where there is a genuine reason to retain and deploy capital, rather than simply moving income into a company with no plan for the funds.
A bucket company can be particularly worth considering where business owners expect to:
– reinvest profits in business growth;
– build a buffer for stock, wages, tax obligations or seasonal fluctuations;
– fund a future acquisition or expansion;
– invest surplus capital for the longer term;
– manage uneven income between financial years; or
– defer personal drawings until a time when they are genuinely required.
The strategy is less compelling where the owners need most profits for household spending each year. In that situation, the money may ultimately need to be paid out as salary, dividends or other properly documented payments, which can reduce the benefit of deferral.
The trust deed and distribution process come first
A bucket company cannot receive a trust distribution merely because the owners want it to. The company must be permitted to receive income under the trust deed, and the trustee must make a valid distribution in accordance with the deed and trust law.
This point is critical. A discretionary trust gives the trustee flexibility only within the boundaries set by the deed. Some deeds already include companies associated with named beneficiaries. Others may not. A deed may also contain particular requirements for trustee resolutions, income definitions, capital gains, franked distributions or default beneficiaries.
Before using a bucket company, it is important to confirm:
– the company is within the class of eligible beneficiaries;
– the trustee has the power to distribute the relevant type of income to the company;
– the company has been established and properly administered;
– the trustee resolution is made within the period required by the trust deed;
– the resolution is clear about the amount or proportion distributed;
– the trust accounts support the resolution; and
– any treatment of capital gains or franked distributions is properly documented.
A written trustee resolution is generally sensible even where the deed does not expressly require one. Clear records can help demonstrate what was decided, when it was decided and how the trust income was allocated.
Special care is needed where the trust has capital gains or franked dividend income. Tax law contains separate rules for how those amounts may be streamed or treated through a trust. A broad, generic distribution resolution may not deliver the intended result.
It is also important not to create a company solely at year-end and assume it will solve a tax issue. The structure, ownership, trust deed and records should be considered well before the distribution decision is made.
The cash is not automatically free to use
One of the biggest misunderstandings about bucket companies is the difference between a trust distribution and the physical movement of cash.
A trust may make a company presently entitled to income, but the trust may not immediately pay the cash to the company. This creates an unpaid present entitlement, often called a UPE. In practical terms, the trust owes money to the bucket company.
That debt must be taken seriously. The money belongs to the company, not automatically to the trust controller, shareholders or family members.
Where the trust keeps using the funds after the company’s entitlement is known, the ATO’s current published view is that the arrangement may amount to financial accommodation from the company to the trust. This can bring the arrangement within the extended loan rules in Division 7A.
Division 7A is designed to prevent private company profits being extracted by shareholders or their associates as tax-free payments, loans or debt forgiveness. It can apply directly where a private company makes a payment or loan to a shareholder or associate. It can also apply to more complex arrangements involving trusts and related parties.
If a UPE is effectively converted into a loan, the group may need to ensure that it is dealt with appropriately. Depending on the facts, options may include paying the amount to the company or putting in place a complying written loan agreement by the relevant lodgment day.
A complying Division 7A loan must meet legislative requirements, including requirements about documentation, interest and loan term. The benchmark interest rate is determined under the legislation by reference to a Reserve Bank housing loan indicator published before the relevant income year begins. The applicable rate should always be checked for the relevant year rather than assumed.
A practical rule is simple: do not treat the bucket company as a family bank account.
Common high-risk situations include:
– paying private expenses from the bucket company’s bank account;
– using company funds to buy personal assets;
– transferring money to shareholders without recording the purpose;
– leaving a UPE unresolved while the trust continues using the cash;
– relying on informal journal entries without supporting documents;
– making repayments that are funded by new loans or circular transactions; and
– assuming an accountant can “fix it later” after the relevant deadline has passed.
Good bookkeeping is central to this strategy. The trust’s accounts should clearly show its debt to the company, and the company’s accounts should show the corresponding receivable. Bank accounts, loan agreements, trustee resolutions and accounting entries need to tell the same story.
Using retained company profits to build wealth
Once tax has been paid, a bucket company may retain funds and invest them. This can be attractive for business owners who want to build capital outside the day-to-day trading operation.
Possible uses may include:
– lending funds to a related business under properly documented terms;
– acquiring business-related assets;
– investing in shares, managed investments or other assets;
– holding cash reserves for future business opportunities; or
– accumulating capital for a planned expansion.
However, investing through a company has trade-offs. Companies do not receive the general CGT discount available to eligible individuals and trusts. That means a company may be less attractive for assets expected to generate substantial long-term capital gains.
The nature of the income also matters. Interest, rent, dividends and other passive income can affect whether a company qualifies for the lower company tax rate. The company’s status must be reviewed each year, not assumed from a previous return.
Asset protection also needs careful thought. A company is a separate legal entity, but its assets can still be exposed to its own creditors and liabilities. Holding significant investments in the same company that receives distributions, makes loans or undertakes risky activities may not suit every family group.
A broader structure review may be appropriate where the business is growing, particularly if the group has trading risk, property, investments, employees, borrowing arrangements or multiple entities. Tax efficiency is only one part of a sound structure. Commercial risk, succession planning, ownership control and administration matter too.
Small business CGT concessions are another area where structure should be reviewed before major transactions occur. The availability of concessions can depend on detailed tests involving the business, asset ownership, connected entities, affiliates and other group circumstances. Introducing or using a bucket company without considering the whole group can have unintended consequences.
A practical example
Consider a family business operated through a discretionary trust. The business has a profitable year, but the owners do not need all available profits for living costs. They expect to replace equipment, strengthen working capital and potentially open another location in the future.
After reviewing the trust deed, the trustee resolves to distribute part of the trust income to adult family members and part to an eligible bucket company. The adult beneficiaries receive amounts that fit their personal circumstances, while the company receives the balance.
The company pays tax on its share of the trust income. The trust then either pays the company’s entitlement or formally addresses the amount owed under an appropriate arrangement. The company retains funds for a genuine commercial purpose, with all transactions recorded separately from personal spending.
Several years later, the owners may decide the company should pay a franked dividend. At that point, the tax impact is assessed based on the shareholder’s position in that later year.
The value in this scenario is not a guaranteed tax saving. It is the ability to manage timing, preserve capital and make deliberate decisions about when profits are reinvested or paid personally.
Is a bucket company right for your business?
A bucket company can be a useful part of an Australian business structure, but it is not suitable for every business owner or every profitable year.
It may be worth exploring when you have a discretionary trust, consistent profits, funds that can genuinely remain in the group and a clear plan for how retained capital will be used. It may be less suitable where profits are regularly needed for personal expenses, administration costs outweigh the benefit or the group cannot maintain disciplined records.
Before implementing the strategy, it is sensible to review the trust deed, entity structure, ownership of the bucket company, projected taxable income, personal cash needs, existing loans, UPEs, franking account position and longer-term investment plans.
The key takeaway is that a bucket company can help business owners manage the timing of tax and retain capital for growth, but only when the structure and cash movements are handled properly. It is not a shortcut around personal tax, and Division 7A, trust distribution rules and company obligations need ongoing attention.
This article is general information only and is not personal financial or tax advice. Tax outcomes depend on your circumstances, documents and transactions. Speak with a registered tax agent or accountant, such as Ample Finance, before establishing or using a bucket company in your business structure.