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What tax rate applies to my company?
With all the media attention on whether the company tax cuts will pass through Parliament, you’d be forgiven for wondering what tax rate applies to your company, or your client’s company. Should the company pay tax at the rate of 30%, or should it be 27.5%?
It’s even more confusing if the company pays a dividend. Does it frank using the 30% rate or the 27.5% rate? Could there be a difference between the rate used to calculate tax payments and the rate used for calculating franking credits?
This article unlocks the myths surrounding which tax rates and franking rates apply for 2018.
Why the confusion?
Much of the media hype in recent times has surrounded whether big businesses will get a reduction in their rate of tax from 30% to 27.5%. The important distinction is that this is a future tax rate cut, not something applying for the 2018 year.
What has received less media attention is a separate measure before Parliament to clarify whether companies earning passive style income (such as interest, dividends or rent) qualify to pay tax at the lower rate of 27.5%, or the standard 30% rate.
What does the law currently say?
The tax law currently provides that if a company is a ‘base rate entity’ for the 2018 year, it will pay tax at the rate of 27.5%, while other companies pay tax at 30%. A ‘base rate entity’ is defined as a company that:
- Carries on a business in the 2018 income year; and
- Has an aggregated turnover in 2018 (worked out at the end of the year) of less than $25 million.
Similarly, to determine what rate the company can frank dividends at, it uses the above methodology, but instead of looking at the current year (2018) aggregated turnover, the company looks at its prior year (2017) aggregated turnover. Hence, if in the prior year turnover was below $25 million (or the company did not exist in 2017), the company will frank dividends paid in 2018 at 27.5%.
The reason for the confusion with the current law is that when the tax cuts for ‘base rate entities’ passed Parliament last year, the Government intended that they would apply for businesses that actively traded – those businesses who employed staff, and bought and sold goods and services. However, the legislation didn’t explicitly state that limitation. This led to the ATO interpreting the tax cut as applying to nearly all companies (on the basis that most companies would be carrying on a business), irrespective of whether their earnings were from running an active trading business, or from passive investment earnings.
Because of this confusion, the Government recently introduced a bill to Parliament to clarify what types of companies could access the lower tax rate. Importantly though, this bill has not yet passed through Parliament and is therefore not yet law
How would the proposed changes impact the tax rate?
The proposed changes, which would apply for the 2018 year onwards, seek to modify the definition of a ‘base rate entity’ to be an entity that has:
- No more than 80% of its assessable income for the current year (2018) as ‘base rate entity passive income’; and
- Has an aggregated turnover for the current year (2018), worked out at the end of the year, of less than $25 million.
The ‘base rate entity passive income’ concept is specifically defined and includes amongst other items interest, royalties, rent, net capital gains, certain dividends and certain trust distributions.
For franking of dividends paid in 2018, it is proposed that if the above test was passed based on the company’s 2017 results, it will frank dividends at the 27.5% rate in 2018 i.e.:
- No more than 80% of its assessable income for 2017 is ‘base rate entity passive income’; and
- It had an aggregated turnover for the 2017 year of less than $25 million.
Given the way the company tax rate and franking rates are determined, it will not be an unusual situation for a company to pay tax at one rate (say 30%) but frank at a different rate (say 27.5%). Without careful planning, this could lead to extra tax being paid or franking credits being wasted. Conversely, it may be possible to frank at a higher rate than the company paid tax at, resulting in a tax benefit being achieved.
What should I do?
Given that the above changes have not yet passed parliament, it makes it difficult at this point in time for many companies (particularly those which earn some passive style income, including corporate beneficiaries) to determine whether the 27.5% or 30% tax rate or franking rate applies to them during 2018.
If the proposed changes are likely to impact on tax planning or dividend payment decisions, then a ‘wait and see’ approach is recommended. With Parliament sitting again during May and June 2018, it is hoped that a final position is arrived at well before year end.
Companies should also bear in mind that the $25 million threshold for the lower tax rate in the 2018 year increases to a $50 million threshold for 2019, as that piece of legislation has already been passed and is law. Accordingly, those mid-sized companies may have significant planning opportunities available during the current year, which will cease after year end.
If you are in any doubt as to how the tax rates or franking rates apply to your company, or your client’s company, or you would like to explore the associated tax planning opportunities, please contact us.
Disclaimer: The contents of this article are in the nature of general comments only, and are not to be used, relied or acted upon without seeking further professional advice. William Buck accepts no liability for errors or omissions, or for any loss or damage suffered as a result of any person using, relying on, or acting upon the comments, information and ideas contained in this article. Liability limited by a scheme approved under Professional Standards Legislation.