By Steve Burnham
The recent cut to the tax rate for incorporated businesses that turnover less than $50 million a year, while generally welcomed, can bring with it some important considerations when it comes to distributing franked dividends.
The rate change to 27.5% is to be staggered, starting with companies that turnover up to $10 million a year, with retrospective effect from July 1, 2016. It will then apply to companies turning over up to $25 million in 2017-18, and to $50 million turnover companies for 2018-19.
Note: These tax cuts only apply to companies that actively “carry on a business”.
From 2016-17, a company’s maximum franking will be based on the company’s corporate tax rate for a particular income year, worked out having regard to the company’s aggregated turnover for the previous year.
This is because a company will not know its aggregated turnover for the year in which it pays a dividend (and therefore its corporate tax rate for the year) until after the end of that year.
Note that the ATO has issued a “practical compliance guideline” on this matter. Read it here.
How this works
In the 2015-16 income year, Company ABC has an aggregated turnover of $9 million. In the 2016-17 income year, its aggregated turnover increased to $11 million.
Therefore, for the 2016-17 income year, Company ABC will have:
- a corporate tax rate of 30% (having regard to its aggregated turnover of $11 million in the 2016-17 income year)
- a corporate tax rate for imputation purposes of 27.5% (based on an aggregated turnover of $9 million in the 2015-16 income year), and
- a corporate tax gross-up rate of 2.64 — that is, (100% – 27.5%)/27.5%.
As a result, if Company ABC makes a distribution of $100 in the 2016-17 income year, the maximum franking credit that can be attached to the distribution is $37.88 — that is, $100/2.64.
Possible broader impact on shareholders
Companies will benefit from the rate cuts provided that the funds are retained. However the tax burden will be shifted to the shareholder upon distribution of a franked dividend.
Australian resident shareholders will pay more top-up tax on dividends received from companies eligible for the tax cuts as the company tax rate decreases.
Ultimately, the total tax liability on the company’s pre-tax profits will still be at the shareholder’s marginal rate, but a greater proportion of the burden will shift from the company to the shareholder over time. As the table below shows (very small amounts shown for ease of calculations) the net cash received in relation to the dividend will remain the same.
| Company-aggregated turnover below $50m | 2015 | 2030 |
| Company pre-tax profit | $100 | $100 |
| Company tax rate | 30% | 25% |
| Franked dividend received | $70 | $75 |
| Franking credit (100% franked) | $30 | $25 |
| Total assessable | $100 | $100 |
| Gross tax payable (marginal rate 37%) | $37 | $37 |
| Less: franking credits | ($30) | ($25) |
| Top-up tax payable | $7 | $12 |
| Net cash received (dividend received less tax payable) | $63 | $63 |
ATO guidance
Note that the ATO has recently issued a Practical Compliance Guideline covering small business over-franking in the 2016-17 income year because of the tax rate change initiated by the government’s Enterprise tax plan.
The guideline (read it here) sets out a practical compliance approach that corporate tax entities may choose to use to inform shareholders of the correct amount of franking credit attached to their distribution. “The approach may reduce compliance costs for corporate tax entities by providing an alternative to seeking an exercise of the Commissioner’s discretion to allow amendment of distribution statements,” the ATO says.
Source: Tax & Super Australia
