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Franking Credits Turn Company Tax Into Personal Tax Savings · My Accounting Advantage

• 0:04
  Speaker 1: Hello and welcome back to the podcast My Accounting Advantage.
• 0:08
  Speaker 1: Today we have another wonderful topic, and thank you for everyone who's provided feedback on the program of the incredible Mai Harris.
• 0:16
  Speaker 1: She joins us today.
• 0:18
  Speaker 1: Mai, welcome back.
• 0:19
  Speaker 1: Thank you, Lee.
• 0:20
  Speaker 1: Today is my favorite topic that I do not understand ever in my business life.
• 0:26
  Speaker 1: And it's Franking Account Explain.
• 0:29
  Speaker 1: Who's Frank and why is franking so important in this business world?
• 0:34
  Speaker: Well, it's really important.
• 0:36
  Speaker: If you are trading under a company or you have a company in your investment structure, so it comes into play when you want to take money out.
• 0:48
  Speaker 1: Explain Franking credits.
• 0:50
  Speaker: Okay, so franking credits are you know the tax credits, which is a prepaid tax.
• 0:56
  Speaker: Well, I call it prepay.
• 0:58
  Speaker: And you a lot of listeners may not think that it's prepaid because they think they're just paying company tax to the ATO and um it disappeared.
• 1:08
  Speaker: But it doesn't.
• 1:09
  Speaker: When you have a company structure and you pay in um income tax, which typically, if it's um a trading entity, a trading company, you pay 25% fixed rate.
• 1:22
  Speaker: And once you pay that tax, it converts into a tax credit.
• 1:28
  Speaker: What we do as accountants, we actually record that tax that you've paid under the company in a something called franking account.
• 1:38
  Speaker: So that franking account, if you started the business, it starts off with a balance of zero.
• 1:44
  Speaker: And as you pay the tax to the ATO, we credit that account with the amount of tax that you've paid.
• 1:52
  Speaker: So that credits is not lost.
• 1:55
  Speaker: It's actually stays there.
• 1:57
  Speaker: Just imagine, like you have a piggy bank.
• 2:00
  Speaker: You start off with no money and then you deposit um money into there.
• 2:05
  Speaker: Same same concept here.
• 2:08
  Speaker: You pay tax to the ATO, you get a credit, and then it keeps accumulating as you pay more tax each year.
• 2:17
  Speaker: And why do we need that?
• 2:19
  Speaker: Is we we keep a tally of how much tax the company had paid over the years.
• 2:24
  Speaker: And then when, you know, we decided to get the money out of the business because it has sufficient funds, we can take the money out for personal use, but we can, you know, take it out as dividends.
• 2:38
  Speaker: This time around, when you pay dividends, it's called franked dividend, which means that that income has tax credits attached to it, which is called franking credits.
• 2:48
  Speaker: And franking credits is the same amount as the tax that you pay, which is 25%.
• 2:55
  Speaker 1: Mai that was so well explained.
• 2:57
  Speaker 1: Can I ask you, are trusts dead yet?
• 3:03
  Speaker: Well, family trusts are, you know, under scrutiny of the proposed federal government plan.
• 3:10
  Speaker: It's not dead yet because the proposed plan is to tax family trust, and I have to say it's family trust only, not, you know, the fixed unit trust or anything like that.
• 3:22
  Speaker: The government is proposing to tax it a minimum of 30%.
• 3:26
  Speaker: And that's not starting until um the 1st of July 2018.
• 3:32
  Speaker: So we've still got roughly two years to use the family trust effectively.
• 3:37
  Speaker: So there is no need to, you know, get into a panic and change structure straight away.
• 3:43
  Speaker: Perhaps just utilise the current structure the best you can.
• 3:48
  Speaker: Have a review of how you can use it the most tax-effective way in the next couple of years.
• 3:56
  Speaker: Because they're also the um the government also give you time to um transition into a new structure if the tax and the trust structure is not quite working for you.
• 4:06
  Speaker: And that's why I want to talk about you know different types of companies today, because you need to start planning to see if your family trust trading structure will not work, well then what are the options in terms of other trading structure or investment structures that are out there?
• 4:28
  Speaker 1: Well, let's discuss those.
• 4:29
  Speaker 1: Take us into a holding company.
• 4:33
  Speaker 1: What do we need to know about that and how does this apply to our conversation?
• 4:37
  Speaker: There are three types of companies that are being, you know, companies that are at the moment and most popular.
• 4:46
  Speaker: I mean, there there's different types of companies, but the three that are very popular.
• 4:51
  Speaker: Number one is the trading company.
• 4:54
  Speaker: Number two is the holding company that you're talking about.
• 4:57
  Speaker: Number three is the bucket company.
• 5:00
  Speaker: So I'll go through the holding company first since you um brought it up.
• 5:04
  Speaker: So the holding company is a company that designed to hold wealth.
• 5:09
  Speaker: Typically, if we structure it, we would structure, you know, your trading business under a trading company.
• 5:18
  Speaker: What a trading company is, it will um receive all the income and pay the expenses of the business and also takes all the liabilities of the business.
• 5:31
  Speaker: Once we actually realized the net profit from that business, that's when we um transfer that profit into the holding companies.
• 5:43
  Speaker: Why do we do that?
• 5:45
  Speaker 1: Why do we do that?
• 5:46
  Speaker: Well, the the the why is important that you need to understand.
• 5:51
  Speaker: You need to isolate that net profit, which is, you know, the the wealth that you created within that business away from you know the risk and liability that the trading companies currently hold.
• 6:06
  Speaker: How do we do that?
• 6:07
  Speaker: We pay dividend from the trading company into a holding company.
• 6:12
  Speaker: So to transfer um profits from the trading entities, which is the trading company in this case, to the holding company, you just transfer cash from the trading company over to the holding company.
• 6:29
  Speaker: And then what do you do with that cash in the holding companies?
• 6:33
  Speaker: You actually can invest further.
• 6:36
  Speaker 1: I can't just grab the cash and go.
• 6:38
  Speaker 1: I've got to invest.
• 6:39
  Speaker: You can grab the cash and go when it hits the holding companies, but you've got to understand that, you know, when you take cash out of your either your trading entity or your holding entity, it will be assessed under your marginal tax rates.
• 6:56
  Speaker: So it's income that's paid over to you.
• 6:58
  Speaker: Or otherwise, you take it as a director's loan.
• 7:02
  Speaker: And we covered this in the previous episode.
• 7:05
  Speaker: So if you don't really quite understand what or how the director's loan works, please go and have a listen and um to the episode in the uh kind of remember now what number, but it will be a useful insight for you.
• 7:21
  Speaker 1: If the money comes out of the trading company into the holding company, does the holding company have to pay tax at this point?
• 7:27
  Speaker: That's correct.
• 7:28
  Speaker: In order to transfer the profit between the trading company over to the holding company, the trading companies will need to pay tax first.
• 7:37
  Speaker: The incomes derived from trading activity, it will be taxed at 25%.
• 7:42
  Speaker: When it gets paid over to the holding companies, it will be in the form of franked dividend.
• 7:49
  Speaker: So it will have 25% credits attached to that income.
• 7:54
  Speaker: Yes, it will be treated as income to the holding company, but then the holding company receiving that income as a passive income.
• 8:03
  Speaker: So it will be taxed at 30%.
• 8:06
  Speaker: But with the 25% tax attached, you will only pay the extra 5% as a top-up tax under the holding company.
• 8:17
  Speaker 1: That's very good.
• 8:18
  Speaker 1: That all makes sense.
• 8:20
  Speaker: Yeah.
• 8:21
  Speaker 1: Bucket companies seem to be under an enormous attack from the government with up to 60% tax possible on this one.
• 8:30
  Speaker 1: Take us into that.
• 8:31
  Speaker: Yeah.
• 8:31
  Speaker: So basically, I'll I'll before I take you into that, I just wanted to touch on, you know, um the holding company.
• 8:39
  Speaker: Even though it's actually paying tax at 30, it still maintain the franking account for that 30% tax.
• 8:47
  Speaker: So you're not, you know, wasting the extra 5% that you've paid.
• 8:52
  Speaker: So when you um take the money out of the holding companies after you, you know, invested the money and throw your cash um with the return on investment and paying tax at 30, you still can take money out and then get the franking credits of 30.
• 9:09
  Speaker: So it's not going to waste.
• 9:11
  Speaker: So now, with the um bucket company, it's really is under the government radar because a lot of people have, you know, set up their structure with a family trust and as a trading entity, and then distribute income over from the family trust over to the bucket company and paying tax at 25%, because the income received from the family trust is actually a trading income.
• 9:38
  Speaker: And that's very attractive.
• 9:40
  Speaker: By doing that, a lot of people have capped their tax at 25%.
• 9:45
  Speaker: They're playing around with, you know, tax defer strategies.
• 9:50
  Speaker: They want to stamp that out.
• 9:52
  Speaker: So that's why, you know, this new proposed rule coming in to tax the trust first at 30%.
• 10:00
  Speaker: In saying that, I still don't believe the bucket companies and trust setup is dead because you still got two years of um this setup.
• 10:10
  Speaker 1: To transition.
• 10:11
  Speaker: Yeah, to transition.
• 10:12
  Speaker: So use it.
• 10:13
  Speaker: You just need to plan to transition out if it doesn't work for you.
• 10:18
  Speaker: I'm not saying it will not work, but you need to have a review.
• 10:23
  Speaker 1: Mai, clarity moment for our listener, it seems like franking credits is like frequent flyer points or shopper dockets.
• 10:31
  Speaker 1: If you spend uh that they're rewarding you back later on.
• 10:35
  Speaker: Yeah, so you can think of it that way.
• 10:37
  Speaker: Uh that's a pretty good example of, you know, just accumulating points, isn't it?
• 10:42
  Speaker: If it makes it easier for you, as you pay tax under the company, you're accumulating points for you to use later.
• 10:50
  Speaker 1: Do they expire like frequent flights?
• 10:52
  Speaker: No, they don't.
• 10:53
  Speaker: So that's the main thing.
• 10:55
  Speaker: You can keep accumulated so that you can pay yourself dividends when you actually have lower income at one stage.
• 11:05
  Speaker: If you or you can choose to actually pay yourself as a dividend instead of wages, for example.
• 11:13
  Speaker: And that will save you a lot of tax.
• 11:15
  Speaker: Because if you choose to pay yourself wages, you pay PAYG withholding as you go.
• 11:23
  Speaker: It will be a pressure on your company cash because you have to pay it every quarter.
• 11:29
  Speaker: However, if you pay um yourselves with a bit of a hybrid, which is part wages, part dividends, that will take a lot of pressure off companies' cash flow in this case.
• 11:42
  Speaker: And why is that?
• 11:43
  Speaker: It's because dividends will already have 25% tax attached to it.
• 11:48
  Speaker: So you just have to pay top-up tax.
• 11:51
  Speaker: In um, for example, if your average tax under your personal individual tax return is 25%, typically, if you earn um less than 100 a bit between, well, up to $135,000 a year, your average tax will be 25%.
• 12:11
  Speaker: If you take dividends from the company on top of that, you'll find yourself paying top-up tax, but not a lot.
• 12:19
  Speaker: So it's worth doing.
• 12:21
  Speaker 1: Take us into one of the My Accounting Advantage frameworks for this.
• 12:26
  Speaker 1: What have we got?
• 12:27
  Speaker: Yeah.
• 12:27
  Speaker: So the framework in um whether or not you should transition from, you know, trading as a family trust into companies is you need to review whether you are earning income from a trading activity.
• 12:44
  Speaker: And if you are, it might be wise to transition from the family trust into a company instead.
• 12:55
  Speaker: The reason being you will be paying tax on that um trading income, but still have the ability of paying tax at 25% and then you still have the franking credits available to you because that's a refundable credit.
• 13:13
  Speaker: However, if you actually continue to um trade under a family trust and the um propo proposed um, you know, changes to family trust become law, you'll be paying tax at a fixed rate of 30.
• 13:31
  Speaker: But the clincher is, the tax that you've paid in the family trust will not be refundable.
• 13:39
  Speaker: So that could be, you know, um detrimental to someone who earn a lot less than, you know, $45,000 a year.
• 13:50
  Speaker: Like you're getting a distribution of $45,000, and typically your um, you know, average tax rate wouldn't be over 15%.
• 13:58
  Speaker: But in this case, you're paying 30%.
• 14:03
  Speaker 1: Mai such an important topic and this structural side of wealth, I think a lot of people are now bringing it to their attention that I do need advice, I do need guidance.
• 14:14
  Speaker 1: What's your final words for today?
• 14:16
  Speaker: My final word for today is if you're still structured the same way you were 10 to 10 to 15 years ago, there's a good chance that your current structure is no longer suits where the tax policy is heading.
• 14:32
  Speaker: So let's review your structure and make sure it works not just today, but in the future.
• 14:38
  Speaker: So it's important to um, you know, get in touch with your advisor.
• 14:42
  Speaker 1: Mai Harris, another brilliant podcast.
• 14:45
  Speaker 1: I look forward to speaking with you next week.
• 14:47
  Speaker 1: Thank you for joining us.
• 14:48
  Speaker 1: Thank you, Lee.
• 14:49
  Speaker: I'll be back.