No.47: Small Business Companies Income Tax Rate

There has been a lot in the Press recently regarding the reduction in the corporate income tax rate for small companies which carry on a business. The coverage has focussed on:

whether the tax cut applies to passive investment companies; and the impact the changes will have on the payment of franked dividends by companies which are eligible for the reduced income tax rate.

Summary of the Changes

Broadly, where a company which carries on a business has annual aggregated turnover (business turnover of the company and of entities connected with or affiliated with the company) of less than $10 million in either the year ended 30 June 2016 or 30 June 2017 it will be considered to be a small company and its tax rate for the 30 June 2017 financial year will be 27.5%. In future financial years the turnover thresholds and tax rates will change in accordance with the table below.

Application to Passive Investment Companies

There has been considerable commentary, discussion and disharmony as to whether these rules will apply to passive investment companies (including corporate beneficiaries of discretionary trusts) with the Australian Taxation Office (“ATO”) and the Government seemingly having differing views on the matter. As at the time of preparing this Client Alert, this matter has not been resolved but hopefully will be clarified relatively quickly. However, based on Government commentary, the current consensus view is that passive investment companies should continue to be taxed at 30%. If you have a private investment company (including a corporate beneficiary of a discretionary trust) you should discuss the implications of these new rules with your Blaze Acumen advisor.

Franking of Dividends in the Small Company Environment

In clear cut cases where these rules apply to a company, there are retrospective implications in relation to where dividends have been paid in the period 1 July 2016 to 30 June 2017. In this regard, the legislation was not passed until 19 May 2017 but the rules apply to dividends paid from 1 July 2016.

For franking purposes, a dividend can only be franked to the extent of the tax rate applicable to the company paying the dividend in the year in which the dividend is paid. However, as the aggregated turnover of a company may not be able to be ascertained until the end of the year in which the dividend is paid, the legislation requires that for the purpose of determining the rate at which a dividend can be franked the aggregated turnover of the prior year be used.

Therefore, in respect to dividends paid in the period 1 July 2016 to 30 June 2017, it is necessary to look at the turnover for the 30 June 2016 year. If it is less than $10 million, the dividend can only be franked with a franking credit of 27.5% and not 30%.

Where a dividend has been paid during the 30 June 2017 year and was franked at 30% but should have been franked at 27.5%, the shareholder needs to be notified by the company of the revised franking position. In this regard, the ATO has issued a Practical Compliance Guideline PCG 2017/D7 which allows for an amended statement to be issued or for the company to advise the shareholder of the revised franking credit attaching to the dividend without issuing an amended dividend statement. These can be done without attracting any penalty.

The issuing of the revised dividend statement or notification of the revised franking credit attaching to the dividend should be done as soon as possible to prevent the shareholders lodging 2017 income tax returns with the incorrect franking credit.

On an ongoing basis, it will be necessary for a company to reference the turnover of the previous year to determine the franking rate of dividends paid. For example, for dividends paid in the year ending 30 June 2018 if the turnover for the 30 June 2017 financial year was less than $25 million, the franking rate will be 27.5%. If a dividend is paid in the year ending 30 June 2019 and the turnover for the 30 June 2018 financial year was less than $50 million, the franking rate will be 27.5% and so on.

Additional Tax Payable by Corporate Shareholders

If dividends franked to 27.5% are paid to a company that is not a small business company (and note the commentary above regarding the application of these rules to passive investment companies) the company receiving the dividend will need to pay top up tax as the grossed-up dividend will be taxed at 30% but there will only be a franking credit for 27.5%. That company will then be able to pass the dividend on with franking at 30%, although the timing as to when the top up tax is payable (and the company’s franking account balance) will need to be considered.

Will Franking at 27.5% cause franking credits to be wasted?

The short answer is potentially yes. It may mean that a company has excess franking credits where the credits arose from paying income tax at 30% but the company is declaring dividends with 27.5% franking credits. As a result of this, the company may have insufficient retained earnings to support utilising all its franking credits.

In addition, an individual in receipt of the dividends from the company will be paying more top up tax than would be the case if the dividend was franked at 30%. The following simple example illustrates this.

Please contact your Blaze Acumen advisor should you have any queries in relation to any issue raised above or require assistance in dealing with changing the franking rate of dividends paid in the 30 June 2017 financial year.