Small business tax changes and franking

The changes to the company tax rates for small and medium businesses also means a change in franking… and the rules are…

The maximum franking credit that can be allocated to a frankable distribution paid by a corporate tax entity will be based on a tax rate of 27.5 per cent.

However, if the entity’s aggregated turnover for the prior income year is equal to or exceeds the aggregated turnover threshold for the current income year, then the maximum franking credit that can be allocated to a frankable distribution paid by the entity will be based on the headline corporate tax rate of 30 per cent.

So the first rule is that if your company tax rate for a year is 27.5% you can frank at 27.5%. But what if in previous years the tax rate was 30%? Won’t that mean we have trapped franking credits?

To solve this problem the Government put in the second rule. and to solve this rule the Government makes an amazing assumption…

1.71 Consequently, from the 2016-17 income year, the operation of imputation system for corporate tax entities will be based on the company’s corporate tax rate for a particular income year, worked out having regard to the entity’s aggregated turnover for the previous income year. This is necessary because corporate tax entities usually pay distributions to members for an income year during that income year.

We always pay out year one profits in year two is this amazing assumption. No business ever buys capital assets or pays down debt or loses money with their profits…

With this ridiculous assumption they offer a solution to the situation where a company previously paid tax at 30% but not has a tax rate of 27.5% and if they can only pay out franking credits at 27.5% they will have trapped franking credits.

Have a look at the only example they give and weep…

In the 2015-16 income year, Company A has an aggregated turnover of $18 million. In the 2016-17 income year, its aggregated turnover increased to $20 million.

Therefore, for the 2016-17 income year, Company A will have:

  • a corporate tax rate of 30 per cent (having regard to its aggregated turnover of $20 million in the 2016-17 income year);
  • a corporate tax rate for imputation purposes of 30 per cent (based on aggregated turnover of $18 million in the 2015-16 income year); and
  • a corporate tax gross-up rate of 2.33 — that is, (100% — 30%)/30%.

    As a result, if Company A makes a distribution of $100 in the 2016-17 income year, the maximum franking credit that can be attached to the distribution is $42.86 — that is, $100/2.33.

    In the 2017-18 income year, Company A will work out its corporate tax rate for imputation purposes based on its aggregated turnover for the 2016-17 income year — that is, $20 million. Therefore, for the 2017-18 income year, Company A will have:

  • a corporate tax rate for imputation purposes of 27.5 per cent; and
  • a corporate tax gross-up rate of 2.64 — that is, (100% — 27.5%)/27.5%.

    As a result, if Company A makes a distribution of $100 in the 2017-18 income year, the maximum franking credit that can be attached to the distribution is $37.88 — that is, $100/2.64.

The example shows their proposed solution does not work. Look at the example above. In the 2015/16 year their tax rate is 30%, and in the 2016/17 their tax rate is 30%. So they have lots of franking credits based on this 30% tax rate. In the following year they want to pay out all their retained profits (all taxed at 30%) but the example states in the 2017/18 year they can only frank at 27.5%.

How can they write law that is proven to be ineffective in the only example.

This is a mess.

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About Ken Mansell

As a stay at home Dad most of the week this is my way of pretending I am still the tax counsel of ASX and SEC listed companies, working at big 4 firms, working at the Federal Treasury, on the Henry Review and at Parliament House for the previous government.
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