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PKF Australia

Accountants and Business Advisers

Company tax rate cuts - A win for small business?

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Iain Spittal

Director

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Company tax rate cuts - A win for small business?

Posted 06 Apr 17 by Iain Spittal

After an extended Parliamentary sitting last week, the Government announced on Friday 27 March that an amended version of the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016 had successfully passed both Houses.

Rather than the original proposal put forward by the Government to progressively reduce the corporate tax rate for all entities, the revised proposal has, instead, focussed on a reduction in the corporate tax rate for companies who are carrying on a business with lower turnover thresholds.

The effect of these changes is summarised in the table below:

Income year Annual aggregated turnover for the year is less than Company tax rate
2016/17 $10m* 27.5%
2017/18 $25m 27.5%
2018/19 $50m 27.5%
2019/20 $50m 27.5%
2020/21 $50m 27.5%
2021/22 $50m 27.5%
2022/23 $50m 27.5%
2023/24 $50m 27.5%
2024/25 $50m 27%
2025/26 $50m 26%
2026/27 $50m 25%

*Note, the lower tax rate for this year applies to small business entities. Depending on the circumstances, a small business entity may include an entity with turnover less than $10m in the 2015/2016 year.

For all businesses who do not meet the criteria above, the corporate tax rate will remain at 30%.

Importantly, this provides businesses with a turnover of less than $10m an immediate reduction in the corporate tax rate for the year ended 30 June 2017.

Sting in the tail?

For small business owners focussed on the returns to individual shareholders, these tax cuts are no more than a deferral of tax due. When a dividend is paid to shareholders, those shareholders will pay tax at their marginal rate of tax (which is unchanged) and so, ultimately, when profits are returned to shareholders, the same amount of tax will be paid as under the previous regime. This is demonstrated in the table below:

Previous Regime New Regime
Company profits $100 $100
Tax liability – company ($30) ($27.5)
Retained earnings $70 $72.5
     
Cash dividend paid to shareholder (A) $70 $72.5
Franking credits $30 $27.5
Shareholder income $100 $100
Shareholder tax – assumed 49% tax rate ($49) ($49)
Franking credit for tax already paid at company level $30 $27.5
Additional tax payable by shareholder (B) ($19) ($21.5)
After-tax cash received by shareholder (A-B) $51 $51

The first issue with this new regime is that there is no change in the tax payable at the ultimate shareholder level. Thus, the small business tax cut is only a deferral of tax otherwise due, not a permanent reduction in the tax payable by the business owners.

Importantly, please also note that a company paying a franked dividend in a year will only be able to frank that dividend at the corporate tax rate applicable to that company in the prior year. Whilst this appears reasonable on a go-forward basis it does mean that any company with historical franking credits (as a result of tax payments historically paid at a 30% rate) will effectively have some of their historical tax payments wasted as the franking credits which have been paid by the company (at 30%) can only be passed through to shareholders at the lower corporate tax rate relevant in the year of paying the dividend (e.g. 27.5%). This is a particularly unfair outcome on companies which have a historical balance of retained earnings and franking credits and further complicates the tax planning landscape for small businesses, their owners and their advisers. It does appear a deliberate intention of the law, however, with the Bills Digest noting:

“These arrangements will lead to some companies facing a difference in the year that they qualify for the lower company tax rate as the turnover threshold progressively rises in the franking rate of 30 per cent and the lower company tax rate of 27.5 per cent. This may create some additional incentives to utilise the higher franking rate in paying dividends to shareholders, as this differential would only apply for one year.” (emphasis added)

Companies benefitting from a lower tax rate in the first year will, therefore, have a one-off opportunity to access franking credits at a higher rate based on the preceding year’s corporate tax rate. This will require careful consideration and cash-flow planning to ensure shareholders are not disadvantaged from the change to a lower company tax rate.

Other benefits for small businesses

One of the key outcomes of the changes is to increase the turnover threshold of a ‘small business’ from $2m to $10m. This should allow more businesses to access the various tax concessions available to small businesses which include:

  • The lower company tax rate for the 2016/2017 year
  • Simplified depreciation and pooling of assets, including access to the instant asset write off threshold of $20,000 (until 30 June 2017);
  • Immediate deductions for prepaid expenses;
  • 2 year amendment period with the Australian Taxation Office (ATO);
  • PAYG instalments calculated by the ATO;
  • FBT concessions on car parking;
  • Reporting GST on a cash basis and paying GST by instalments;
  • Access to small business restructure rollover relief;
  • Access to superannuation clearing houses.

Please note, however, that the turnover threshold for accessing the small business CGT concessions has remained at $2m.

Planning points for consideration

  • The cut in the tax rate is only applicable to a company carrying on a business which meets the relevant turnover threshold. Once such a business has been established, all income of that company is taxable at the lower rate. In other words, there is no distinction between passive income and business income when it comes to the applying the corporate tax rate to all income. This may encourage entities to carry on small businesses in order for other income earned by the company should be taxable at the lower corporate tax rate.
  • Consideration could be given to appropriate planning in relation to the turnover threshold in a particular year to accelerate (or defer) access to the small business rate and other tax concessions.
  • For companies with historical retained earnings (and franking credits) consideration should be given to the timing of paying a dividend in order to seek to maximise the benefit of those historical franking credits.
  • This change in tax rate may encourage the use of corporate entities (rather than trusts or sole traders) to carry on a business given the differential in marginal tax rates between individuals and companies will increase as a result of these small business tax cuts.
  • There is a small business offset for sole traders but this is capped at $1,000, hence, incorporation may be a better longer-term solution;
  • Ensure you are maximising the small business concessions which may now be available to you.
  • Confirm if you are a small business entity for the year ended 30 June 2017 (as this can depend on turnover thresholds in preceding years)

As always with tax changes, the devil is in the detail and so we encourage you to speak with your PKF adviser who can assist with the application of these changes to your particular circumstances.


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