Why Using a Company for Your Joint Venture Might Not Work

As banks are tightening up their lending criteria and people look at doing Property Developments it is becoming more common for two or more parties to undertake a development together.

Sometimes this involves two or more parties as part of the deal.  

It could be one person contributing the land and another party undertaking the development.  Or it could involve three or four parties joining together to purchase land and undertake the development.

Structuring in these type of transactions are critical both from a legal perspective, asset protection perspective and tax perspective.

A common question is then well how do we structure this ?

A structure I commonly see is represented below

Property Development Accountant

During the development phase and sale phase this all seems to work nicely as the profits will be taxed at 25% (assuming Dev and Land Co Pty Ltd is a base rate entity)

But the issue that frequently arises is the distribution of profits on sale.

It is common for the parties to want access to the profits soon after sale so they can go their separate ways.

The issue we have however is from a tax perspective.

In order for the company to distribute the profits to the shareholders it will need to pay a dividend.

Until the company has paid tax however it may not have sufficient franking credits to pay out a fully franked dividend. 

I have seen some accountants suggest to prepay instalments to generate franking credits.

However s 205-20(3) ITAA 1997 states that “the requirement in paragraph (a) means that the entity cannot generate franking credits by making a “voluntary” payment of income tax (that is, paying an amount on account of income tax for which the entity is not liable at that time when the payment is made”

So in order to get the funds out it means that until a dividend can be paid the funds would have to be loaned.  This creates a potential Division 7a issue.

From a tax perspective , the company may pay a fully franked dividend even if it does not have sufficient franking credits.  

However, the company would be liable to pay franking deficit tax (FDT) if its franking account is in deficit at the end of an income year.  This means, if the company pays a franked dividend on or before 30 June it would incur a franking deficit tax.

The amount of FDT payable is the amount of the company’s franking deficit at that time.

A franking account tax return must be completed and any FDT liability paid by the last day of the month immediately following the end of the company’s income year.

FDT can be offset against the company’s income tax.  

However, where the deficit at the end of the year is more than 10% of the franking credits that arose during the year, the company’s franking deficit tax offset may be reduced by 30%.

The 30% offset reduction does not generally apply in the first income year in which a private company has an income tax liability.  This concessions allows a private company to make franked distributions in its first taxable year without incurring a penalty.  One of the conditions that must be met is that the amount of the income tax liability for the relevant year is at least 90% of the amount of the deficit in the company’s franking account at the end of the income year.

So as you can see it’s not simple.

It could well mean the company can’t be wound up as the parties wished until these things are finalised.

In another blog we will discuss an alternative structure that may be more suitable when parties are doing a “joint venture” together.

Frequently Asked Questions

Why can structuring a property development deal with multiple parties become complex from a tax perspective?

Structuring a property development deal with multiple parties can become complex due to the need to distribute profits post-sale. If a company is used, it needs to pay a dividend to distribute these profits. However, without having paid tax, the company may lack sufficient franking credits to pay out a fully franked dividend, potentially creating issues under Section 205-20(3) of the ITAA 1997.

What is a franking credit and why does it matter in a joint venture?

A franking credit is a type of tax credit that a company can pass on to its shareholders along with dividends. It matters in a joint venture because without sufficient franking credits, the company may face difficulties in distributing the profits to shareholders soon after the sale, which is usually what the parties desire.

What is Division 7a issue that can potentially be created in a joint venture?

The Division 7a issue refers to a set of provisions in the Income Tax Assessment Act 1936 of Australia. These provisions are designed to prevent profits or assets being provided to shareholders (or their associates) of private companies in the form of payments, loans, or debt forgiveness, without being taxed as dividends. In the context of joint ventures, this issue could arise if the company has to loan the profits to its shareholders before it can distribute dividends.

What is franking deficit tax (FDT) and when does a company have to pay it?

Franking Deficit Tax (FDT) is a tax that a company has to pay if it pays out more franking credits than it has available in its franking account at the end of an income year. This typically happens when the company pays a fully franked dividend without having enough franking credits. The FDT must be paid by the last day of the month immediately following the end of the company’s income year.

Why might a company used for a joint venture not be able to be wound up immediately after the project's completion?

A company might not be able to be wound up immediately because of the need to sort out tax obligations related to profit distribution. For instance, the company may need to pay FDT if it distributed a dividend without sufficient franking credits. Also, it may have to complete a franking account tax return and pay any FDT liability. Until these tax obligations are fulfilled, winding up the company might not be feasible.

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