Profits sitting in a construction trading company are exposed to business risk. Options to protect accumulated profits include: (1) dividends to shareholders (triggers immediate tax), (2) holding company distributions (can be tax-free between companies), (3) trust distributions (depends on structure), and (4) director loan accounts (requires careful Division 7A compliance). The right approach depends on your specific structure and tax position.
Key Takeaways
- Profits in your trading company are exposed if projects go wrong
- Cash accumulates due to working capital needs, bank comfort, and tax deferral
- Multiple legitimate options exist to move profits to protected structures
- Holding company structures can defer tax while protecting assets
Too Much Profit Sitting in Your Construction Company?
You have had a few good years. The work kept coming, the margins held up, and now there is a lot of money sitting in your company. But is that actually a good thing?
If those profits are sitting in an entity that also carries trading risk, they are exposed. A bad project, a major client default, a claim that goes wrong. That cash becomes a target.
Why Profits Build Up in Construction Companies
Most construction business owners do not deliberately let profits accumulate in risky entities. It happens because:
1. Working capital needs.
Construction has long cash cycles. You may need to fund materials, labour, and subcontractors for months before receiving payment. Cash reserves provide the buffer to manage these cycles without relying on expensive overdrafts.
2. Bank comfort.
Lenders like seeing cash in the business. Strong cash reserves improve your borrowing capacity and may reduce guarantee requirements. Taking money out can affect your relationship with the bank.
3. Tax timing.
Drawing money out as dividends triggers immediate personal tax at marginal rates up to 47%. Leaving it in the company means it has only been taxed at 25% or 30% company rate. The deferral benefit is real, but it comes with risk.
4. Uncertainty about what to do.
You know you should probably move some money somewhere safer, but the options seem complicated. Division 7A, franking credits, trust distributions – it feels overwhelming, so the money stays where it is.
These are all understandable reasons. But the status quo leaves significant value exposed to business risk.
The Problem With Cash in Your Trading Entity
If your profits sit in the same company that takes on construction contracts:
Liquidator access
If the company becomes insolvent, a liquidator can access that cash to pay creditors. Years of accumulated profit disappear.
Creditor target
Creditors and litigants research company finances. A company with large cash reserves is a more attractive target than one with modest working capital.
Litigation magnet
Plaintiff lawyers assess capacity to pay when advising clients on claims. Cash-rich companies attract more claims and face more aggressive litigation.
Frozen in disputes
During litigation, assets may be frozen. You cannot easily access those funds when you need them most.
Options for Protecting Your Profits
There are several legitimate ways to get profits out of risk zones:
Dividend to shareholders
This gets money out of the company and into shareholders’ hands. Fully franked dividends carry tax credits that offset personal tax, but you still pay the difference between the 25-30% company rate and your marginal rate. For high earners, this means an additional 17-22% tax on extraction.
Holding company distributions
If structured correctly, a holding company can receive dividends from your trading company completely tax-free under the inter-corporate dividend exemption. The profits move from the risky trading entity to a protected holding entity, without triggering personal tax until you choose to extract them. This is one of the most powerful profit protection strategies available.
Trust distributions
If your trading company is owned by a trust, or if you have a family trust in your structure, trust distributions may provide flexibility. However, the rules around company profits flowing through trusts are complex and require careful planning.
Director loan accounts
Taking money as a loan from your company defers tax, but creates Division 7A compliance obligations. The loan must be documented with a compliant loan agreement, interest must be charged at the benchmark rate, and minimum repayments must be made. Failure to comply converts the loan to an unfranked dividend with penalties.
The right approach depends entirely on your specific structure, tax position, and goals. There is no one-size-fits-all answer.
What About a Holding Company?
You may have heard about holding company structures. In the right circumstances, a holding company can receive dividends from your trading company tax-free and hold them in a protected structure while deferring personal tax until you choose to access the funds.
The inter-corporate dividend exemption under Division 44 of the ITAA 1936 means that dividends paid between Australian resident companies are generally not taxable income for the receiving company. This allows profits to move from your trading company to a holding company without triggering additional tax.
But holding structures are not always the answer. They add complexity, cost, and administrative burden. Annual financial statements, tax returns, and ASIC fees apply to each company. They make sense for some construction businesses and not others – typically those with consistently strong profits and a medium-term intention to accumulate wealth.
Case Study: Protecting $2.1M in Accumulated Profits
A civil construction company with $42M turnover had accumulated $2.1M in retained earnings over five profitable years. The owners were nervous about their exposure following a near-miss on a project claim, but dreaded the tax hit of extracting the money as dividends. At their marginal tax rate, extraction would have cost over $400,000 in additional tax.
We implemented a holding company structure. A new company was established with the same shareholders as the trading company. The trading company then paid a fully franked dividend of $2.1M to the holding company. Under the inter-corporate dividend exemption, no additional tax was payable.
The holding company now holds the $2.1M separate from trading risk. The trading company continues operating with appropriate working capital. The owners can access the funds by drawing dividends from the holding company when it suits their personal tax planning – perhaps in retirement when their marginal rate is lower, or gradually over many years to manage tax brackets.
Frequently Asked Questions
1. How much profit should I leave in my trading company?
Retain enough for working capital needs (typically 2-3 months of operating expenses plus project funding requirements) and any amount needed to meet QBCC Minimum Financial Requirements. Profits beyond this working capital buffer should generally be moved to protected structures. The right amount varies by business size and project profile.
2. What is Division 7A and why does it matter?
Division 7A of the Income Tax Assessment Act 1936 prevents shareholders from extracting company profits tax-free by disguising them as loans. If you take money from your company as a loan without a compliant written agreement, benchmark interest, and minimum repayments, the ATO treats it as an unfranked dividend with penalties. Any profit extraction strategy must consider Division 7A compliance.
3. Can I set up a holding company after profits have already accumulated?
Yes, a holding company can be established at any time. The trading company pays a dividend to the new holding company, which receives it tax-free under the inter-corporate dividend exemption. However, the trading company must have sufficient franking credits to frank the dividend, and the structure should be established before any specific problems arise to avoid challengeable transaction arguments.
4. What are the ongoing costs of a holding company?
A holding company has annual compliance costs including ASIC annual review fee (currently $290), preparation of financial statements, tax return preparation, and potentially audit requirements depending on size and structure. Typically expect $2,000-$5,000 per year in additional accounting and compliance costs. The asset protection and tax deferral benefits usually outweigh these costs for businesses with significant accumulated profits.
5. Does moving profits to a holding company affect my QBCC MFR?
The QBCC Minimum Financial Requirements apply to the licensed entity. Moving profits out of your licensed trading company reduces its net tangible assets, which could affect MFR compliance. We always model the MFR impact before recommending any dividend extraction strategy for QBCC-licensed entities.
Get Clear on Your Profit Protection Options
Our Construction Business Structure Review includes a complete analysis of where your profits currently sit and how they could be better protected. We consider your tax position, your risk exposure, and your long-term goals to recommend specific strategies.
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