19 – Integrating your practice with your investments


Trust based structures are the best way to set up and run a financial planning practice (and virtually any other small to medium sized enterprise). They are cheap, flexible and tax efficient. Their discretionary nature means its easy to comply with the ATO’s rules for distributing professional practice income, while at the same time making sure the financial planner’s tax profile is as efficient as possible.

Don’t forget Dover advisers can set trusts up for free at www.legaledocs.com.au

Once advisers have got their practice structure in order the next step is their investment structure, and its integration with their practice structure. The idea is to channel profit from the business structure to to the investment structure paying the least amount of tax possible. 

The Australian Financial Planning Handbook 2012-13 (Thomson Reuters) looks at the example of John, a 32 year-old financial planner buying a practice and expecting to make a profit of $400,000 to $500,000 a year.

John is engaged to Erin and expects to start a family soon. “John wants to invest free cash flow, including utilising appropriate gearing.” The suggested approach is outlined here:

Integrating your practice with your investments

The author, Mr Paul Banister of Grant Thornton explains his diagram as follows:

“John’s business would be conducted through a company acting as trustee for a discretionary trust. John would be employed by this entity and draw a salary. He would be superannuated from this entity. Excess profits beyond  living needs and tax needs could be distributed to a family company.

The benefit of this approach would be that excess profits would only suffer tax of 30% rather than higher marginal tax rates…

…Given the future objectives of starting a family (including that Erin may be out of the workforce for a potentially lengthy period), a second trust should own the shares in the corporate beneficiary company. This will  permit flexibility in later profit distribution.

The second discretionary trust should also be the investment vehicle. This has the benefit of insulating the investment activities from the business activities, thus affording asset protection benefits….

…This structure would provide considerable flexibility for distributing income to optimise the family tax position as well as to meet family needs. This could include  having surpluses  in one  entity being applied to absorb any losses in another entity. To do this, family trust elections and interposed entity elections (are needed)…

Clever use of franking credits

Having the shares in company 2 owned by a discretionary trust is a crucial aspect of planning the structure of John’s operations. Once John and Erin have children, if Erin is earning little or no income, the second discretionary trust could distribute the franked distributions to her. If Erin has no other  income she could receive $99,261 tax-free each year (based on 2012-13 rates). If she receives less a refund of franking credits would arise. If Erin received more, at least she will receive tax concessions for the franking credits that are attached.

If the dividends are declared when the children are adults, their marginal rates could be used. In this regard, consider the following table (using 2012-13 rates).

Tax rate 20.5% 34.0% 38.5% 46.5% 15% 0%
Franked dividend $700 $700 $700 $700 $700 $700
Gross-up $300 $300 $300 $300 $300 $300
Assessable income $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
Tax payable $205 $340 $385 $465 $150 $0
Less imputation credit $300 $300 $300 $300 $300 $300
Tax payable (refund) ($95) $40 $85 $165 ($150) ($300)
Effective tax rate (13.6%) 5.7% 12.1% 23.6% (21.4%) (42.9%)

What do we think about this structure?

We do not agree with everything the author says. We believe the author over-emphasizes the tax advantages and under-emphasizes, or even fails to mention, other advantages that should dominate the analysis.

These dominating advantages are not connected to tax, and include:

  • asset protection, that is making sure valuable assets are outside the reach of litigious patients and other claimants, which drives most trust based strategies
  • the business structure interacts efficiently with the investment structure, allowing cash to move between the two without being derived by individual family members. This means:
  • if cash is needed for an investment it can be accessed from the business structure without triggering an unnecessary tax charge and
  • if cash is needed for the business it can be accessed from the investment structure without triggering an unnecessary tax charge
  • the structure genuinely enriches the family trust and creates a real and substantial investment vehicle to provide for the children, and grandchildren after them
  • the investment side of the structure is an effective complement to a SMSF for a long-term retirement strategy and for advisers concerned about the pace and direction of future legislative change concerning SMSFs and super generally, it is an effective alternative long-term retirement strategy and
  • the structure allows monies to be invested in allied investments, such as business premises or further business start-ups or acquisitions that can further improve the profitability and value of the advisers businesses.

Further relevant reading

You can read further on tax efficient investing here: The Dover Way. Tax Efficient Investing.

You can read further on tax planning for financial planners here: The Dover Way. Tax Planning for Financial Planners.

The Dover Group