Many Australian business owners reach a point where leaving all profits in their own name no longer feels efficient or practical. If your business operates through a discretionary trust, a bucket company can provide a way to retain profits for future business or investment purposes, rather than automatically distributing all income to individual beneficiaries each year.
Used properly, a bucket company may help manage the timing of tax and create a clearer separation between retained profits and the day-to-day trading business. It is not, however, a simple tax-saving shortcut. The structure must match the trust deed, the company’s records, the commercial purpose of the arrangement and the rules around private company loans.
What is a bucket company?
A bucket company is an informal term for a company that is included as a beneficiary of a discretionary trust. Near the end of an income year, the trustee may decide to distribute some of the trust’s income to that company.
The company is then assessed on its share of the trust’s taxable income. Rather than the income being taxed immediately in the hands of an individual beneficiary, it is taxed at the company tax rate that applies to that company.
In many small-business structures, the trading activities remain in a discretionary trust or trading company, while the bucket company is intended to receive and retain surplus profits. It may hold cash, make approved investments or lend funds under properly documented arrangements.
A bucket company is usually a proprietary company limited by shares. It is a separate legal entity, with its own property, rights, obligations, bank account, tax return and company records.
The company is not a bank account for the business owner. Once trust income has been distributed to the company, the money belongs to the company. That distinction is central to both the tax treatment and any potential asset-protection benefits.
How a bucket company may help manage tax
The main attraction of a bucket company is tax deferral, not tax elimination.
Individual beneficiaries are generally taxed at marginal rates that can increase as their taxable income rises. A company pays tax on its taxable income at the company rate applying to it. Under the current law, a base rate entity is taxed at 25%, while other companies are taxed at 30%. A company is generally a base rate entity only if its aggregated turnover is below the legislated threshold and no more than 80% of its assessable income is base rate entity passive income.
That means the company rate must be checked each year. A bucket company that mainly receives passive income, such as interest, rent, capital gains or certain corporate distributions, may not qualify for the lower company rate even where the wider business group is relatively small.
Where profits are retained in the company for legitimate future use, the structure can defer the point at which those profits are ultimately taxed in an individual’s hands. This can be useful where the business is building working capital, saving for expansion, funding a future acquisition or maintaining a reserve against seasonal cash flow changes.
If the company later pays a dividend to shareholders, the shareholders generally include the dividend and attached franking credits in their tax returns. The company tax already paid is then taken into account through Australia’s dividend imputation system. Depending on the recipient’s circumstances, further tax may be payable.
This is why a bucket company should not be marketed as a way to permanently turn personal income into low-taxed company income. If profits are ultimately extracted for private spending, the total tax outcome can be very different from the initial company tax bill.
When a bucket company may, and may not, suit your business
A bucket company can be worth considering where a discretionary trust earns genuine business income and does not need to distribute all available cash to family members each year.
It may suit a business owner who wants to:
- retain profits for future expansion or working capital;
- build an investment reserve outside the trading entity;
- reduce the amount of trust income distributed to individuals in a high-income year;
- create a more deliberate framework for business profits and private spending;
- separate accumulated funds from the entity carrying the main trading risks.
It may be less suitable where the business owner needs most profits personally each year to meet household expenses. A company distribution may only defer tax if the funds remain in the company. If the money is quickly taken out for private purposes, the compliance burden can outweigh the benefit.
It is also important to consider the source of the income. The personal services income rules can apply where income is mainly a reward for an individual’s own efforts or skills. If those rules apply and the income is not derived in the course of a personal services business, the net personal services income may be attributed to the individual who performed the work rather than being retained in a company or trust.
For example, a consultant operating alone may need a very different analysis from a retail, construction, manufacturing or professional practice business with staff, systems, business assets and income generated by more than one person.
How to set up a bucket company
Setting up the company itself is relatively straightforward. Designing the structure around it requires more care.
A practical process usually involves the following steps.
Review the trust deed
The trust deed determines who can receive distributions. Before creating or using a bucket company, check whether a company can be an eligible beneficiary under the existing deed.
Some deeds name particular beneficiaries. Others include broad classes that may cover companies controlled by specified family members or entities. If the company is not an eligible beneficiary, legal advice may be needed before any amendment is considered.
Also check whether the trust has made a family trust election or interposed entity election. A distribution outside the permitted family group can have serious tax consequences.
Decide who will own and control the company
Share ownership, directorships and the company constitution should be planned before registration. These choices affect control of the company, entitlement to future dividends, succession arrangements and the treatment of the company’s assets.
In many cases, business owners want the same people to control the trust and the company. That can simplify administration, but it also increases the need for clear records and properly documented related-party transactions.
Register the company
Most bucket companies are proprietary companies limited by shares. A proprietary company must have at least one director who ordinarily resides in Australia. Directors must obtain a director identification number before the company is registered.
When registering, the company needs a name, registered office, principal place of business, internal governance rules, share structure, shareholders and directors. Written consents from proposed officeholders and members must be obtained and retained.
Arrange tax registrations and banking
The company will generally need its own tax file number and, where appropriate, an Australian business number and GST registration. Whether GST registration is necessary depends on what the company actually does, not merely on the fact that it receives a trust distribution.
Open a separate company bank account. Funds belonging to the bucket company should not be mixed with private funds, trust funds or operating-business cash without clear accounting and legal support.
Put accounting and governance processes in place
The company needs its own financial records, annual accounts, income tax return, company register and ASIC obligations. Directors are responsible for ensuring that the company keeps proper records and can meet its debts as they fall due.
Even a passive company with limited activity requires ongoing administration. There are annual review obligations, record-keeping duties and director responsibilities.
Make the trust distribution correctly
A discretionary trust normally needs to make a valid resolution by 30 June to make beneficiaries presently entitled to trust income for that income year. The trust deed may require an earlier date or specify particular processes for resolutions.
The resolution should clearly identify the company, the income being distributed and the methodology used. It should also deal properly with any franked distributions or capital gains where relevant.
Document how the entitlement will be paid or managed
The company may receive the distribution as cash. Alternatively, the trust may owe an amount to the company, creating an unpaid present entitlement.
This is where many bucket company arrangements become risky. The treatment of unpaid present entitlements, sub-trust arrangements and related-party loans must be considered carefully under the current ATO position and the particular facts of the arrangement.
Division 7A: the rule that cannot be ignored
Division 7A is designed to prevent private company profits being accessed tax-free through payments, loans or forgiven debts to shareholders or their associates.
It can apply directly where a private company pays money, lends money or forgives a debt for a shareholder or associate. It can also apply where a trust has an unpaid present entitlement owing to a private company and the funds are used for the benefit of the company’s shareholder or an associate. The ATO’s published view is that an unpaid present entitlement may amount to financial accommodation, and therefore a loan, in relevant circumstances.
In practical terms, these are the key points:
- do not use the bucket company’s funds to pay private expenses without recording the transaction properly;
- do not assume an unpaid trust distribution can sit indefinitely while the trust continues using the funds;
- do not transfer money from the company to family members, related trusts or related businesses without considering Division 7A;
- document genuine loans in writing, with appropriate terms, before the relevant lodgment deadline;
- make required repayments and account for interest where a complying loan arrangement is used.
A complying Division 7A loan requires a written agreement and must meet the legislated requirements for interest and maximum loan term. The maximum term is generally seven years, or up to 25 years for certain loans secured by a registered mortgage over real property. The applicable benchmark interest rate is updated annually and should always be checked for the relevant income year.
Failure to manage these rules can lead to an amount being treated as an unfranked dividend for tax purposes. That can create an unexpected tax liability without the benefit of franking credits.
The ATO has also indicated that it closely examines arrangements involving unpaid present entitlements, circular financing, private use of company funds and related-party transactions that appear designed to avoid Division 7A.
Protecting profits: useful separation, not absolute protection
A bucket company can assist with risk management because it is a separate legal entity from the trust or company conducting the trading business. If surplus profits are genuinely distributed to, and retained by, a separate company, those funds may be less exposed to the ordinary trading risks of the operating entity.
That is not the same as guaranteed asset protection.
The protection available will depend on the full legal and commercial position, including:
- whether the bucket company has guaranteed business debts;
- whether funds have been mixed or moved without proper records;
- whether the arrangement is documented and commercially defensible;
- whether the company itself has liabilities;
- whether directors have breached their duties;
- whether a transaction could be challenged in an insolvency context;
- whether assets have been transferred in a way that creates tax, duty or creditor risks.
A company structure does not protect a director who gives a personal guarantee, trades while insolvent or fails to meet legal duties. Directors can face personal consequences in certain circumstances, including where a company incurs debts while insolvent.
Consider a growing business that operates through a discretionary trust. At EOFY, the trustee distributes part of the year’s income to an eligible bucket company rather than allocating all income to the business owners personally. The company receives the funds into its own account and retains them for a future business opportunity.
That arrangement may be commercially sensible if the funds are genuinely held for the company’s purposes. It becomes problematic if the business owners treat the company account as their private spending account, or if the trust keeps using the money without addressing the unpaid entitlement and Division 7A consequences.
Key takeaway
A bucket company can be a valuable part of an Australian business structure where there are ongoing profits to retain, a discretionary trust can validly distribute to the company, and the owners are prepared to maintain proper records and follow the related-party rules.
The tax benefit is usually about managing timing and retaining capital, not making tax disappear. The asset-protection benefit is also only as strong as the structure, documentation and behaviour behind it.
This article is general information only and is not personal financial or tax advice. Before setting up or using a bucket company, speak with a registered tax agent or accountant, such as, about your trust deed, income source, business risks, cash needs and long-term plans.