This family-owned business was restructured to remove significant complexity, create substantial tax savings and free up cash that could be used to expand the business operations overseas.
Background
This very successful family business was established back in the late 1970s, and after a couple of years of successful trading, the owner was joined by his son. In the 80’s they formalised their business structure by establishing a discretionary trading trust, as it provided tax benefits and flexibility.
A few years later, the discretionary trading trust was aligned with a discretionary investment trust which held various assets including their business premises. As the business became more and more successful, turning over tens-of millions of dollars every year, it became extremely profitable. As was common at the time (and as remains common to this day), to assist in minimising tax for the group, significant business profits were distributed from the trust to a bucket company.
All was working well. Money pooling in the bucket company was being invested (either back into the business or into passive investments) and the family was well funded. Until 2009.
This was when the ATO had a change of heart when it came to the taxation treatment of Unpaid Present Entitlements (UPEs). Although a technical term, a UPE is a promised trust distribution where the physical cash has not been transferred. Historically, a large amount of UPEs had accrued with respect to the bucket company, but the actual cash this represented had been retained by the discretionary trading trust, to assist in funding working capital.
The ATO took the view that UPEs were akin to unpaid loans which had ramifications under Div. 7A legislation. Action was required to ensure the family complied with the ATO’s altered view.
Initially the solution was a constant cycle of moving significant cash funds from the discretionary trading trust to the bucket company, and this soon proved to be problematic on a number of fronts.
Firstly, a bucket company is a less-than-ideal long-term investment structure, which may have significant adverse tax implications such as the inability to access the capital gains tax discount.
It was also incredibly stressful for the family and finance staff, who were required to move cash into the bucket company away from their operating entity. This requirement was often at times when the family didn’t have abundant amounts of available cash, due to their significant inventory holdings and other working capital requirements. It also compromised funding their own lifestyles.
Further, the family was also looking to expand its operation overseas. They had a growing book of export clients and plans to establish a presence in Asia. The structure, which had become more focussed on appeasing the Div. 7A laws than providing any flexibility for growth, made it difficult to reinvest their surplus cash to fulfil their international expansion opportunities.
Our Recommendation
After exploring a range of options, we settled on a business re-structure that would provide asset protection, while minimising the complexity the family currently endured. It would also free up some of the cash currently locked away in the bucket company.
Initially the family was hesitant because on first blush, there was a significant transfer duty cost that needed to be considered. However, the family soon came to realise restructuring their business was an investment that significantly reduced their ongoing tax position, created flexibility to invest in growth assets, future-proofed their business and sustained their substantial personal wealth.
Our process
Collaborating with their financial advisers and solicitors, there were three main considerations for the re-structure.
The first was to overcome the significant ongoing obligation the business faced under the Div. 7A law and alleviate the considerable stress placed on the family and finance staff to constantly find cash and move it to the bucket company.
The next was to place their money where it could benefit from tax savings including potential access to the capital gains tax discount.
The third was to provide an environment where their significant profits could be used for investing in the business and growth assets, such as expanding internationally.
With our strategy agreed, we used the bucket company with its huge amount of cash reserves to purchase the business from the discretionary trust. The business became a subsidiary of the bucket company, and a tax consolidated group was formed, comprising the two companies.
This provided a number of key benefits.
The first is a stronger asset protection position for the family because the new subsidiary company was established as a limited liability company.
Further, and unlike the prior structure, profits can be retained in the subsidiary company eliminating the need for the family to constantly find and move money, freeing up their cash such that it can be directly reinvested as working capital, purchasing stock and establishing their overseas operations.
Other benefits included the opportunity to shift profits to the head company as dividends, for both asset protection and tax saving benefits.
With significant cash released from the bucket company to the discretionary trading trust as sale proceeds, this trust could commence undertaking passive investments, upon which the capital gains tax discount could be applied creating the opportunity for considerable future tax saving, along with funding the family’s lifestyle.
The outcomes
The re-structure successfully removed a significant amount of complexity that was causing the family stress – personal and financial. This extremely profitable business has been able to free up its cash and use it to reinvest in the business, expand overseas and reward its owners.
Tax efficiencies were achieved. Because the business was established in a pre-capital gains tax era there was no income tax payable when the business was sold by the trust to the bucket company.
The sale meant a significant amount of money held in the bucket company was released to the discretionary trust where it is eligible for the capital gains tax discount. This in itself is a major advantage as the tax savings difference between the discounted 23% capital gains tax and up to 47% on the capital gain is enormous for a business worth tens-of-millions of dollars.
Cost wise, the transfer duty paid on the sale transaction was substantial, but it can easily be defended as a worthwhile investment that is central to creating a seamless structure that will continue to provide flexibility, ongoing tax savings and opportunity to generate personal wealth that will serve the family for generations to come.
Overall this was a very successful process for the client, and we look forward to seeing the family and the business prosper in the years to come.
For further information and specialised advice relating to tax and business matters often unique to the mining and resources sector, please contact Craig Barry on +61 (0) 7 3007 2000 or email contact@resourcesunearthed.com.au.
Resources Unearthed is a solutions hub that provides integrated financial, legal, property and accounting and business advisory services for executives, professionals and business owners in the mining and resources sectors.
