Often, advisers limit their advice to investments being held in the name of what the law calls ‘natural people.’ Natural people are humans. The law also recognises entities other than humans as potential owners of investments. Taken together, natural persons and these ‘non-natural’ persons are called legal persons.
The most common of these non-natural persons are companies.
Another way of holding assets is via a trust. While not a legal person itself, a trust can also be used in preference to a natural person investing in their own name. A trust can have either a company or a natural person as its trustee. That is, a trust must have a legal person as the trustee.
Companies or trusts are typically used by highly-taxed clients looking to gain some greater control over when and how their investment returns are taxed. In the case of a company (without a trust), income is taxed at a flat rate of 30% (28.5% for smaller companies with turnover of less than $2million). Capital gains are taxed as income. The company pays the tax each year. Provided that the after-tax profits remain in the company, no further tax is paid on them. When the after-tax profits are eventually paid out to the shareholders of the company, they are received as franked dividends and the shareholder will only pay additional tax if they (i.e. the shareholder) are in a higher tax bracket in the year they receive the dividends. If the shareholder is in a lower tax bracket in the year they receive the dividend, they may even receive a tax credit.
This allows the client to ‘time’ the receipt of dividends from a company to a year in which their other taxable income is low. This might occur during a sabbatical, following retirement or a year in which a self-owned business did not produce much if any taxable income.
Using a company as a trustee of a trust creates some different variables again. These variables can also confer tax benefits on the client who is the ultimate recipient of the benefits of the trust.
Companies and trusts can also confer a degree of ‘asset protection.’ Because the owner of the investment asset is a separate legal person to the natural person client, under certain circumstances legal action that is taken against the natural person will not be able to ‘access’ assets owned in a company or trust.
It goes without saying that advisers should only recommend trusts and/or companies where those entities are warranted (they do impose some costs and otherwise need some special management) and where the adviser is competent to advise on such structures. But these structures are relatively easy to come to understand and should at least be considered for any client in a higher income tax bracket. Advisers are always welcome to contact our legal team at Dover to discuss their appropriateness for any particular client.