The ins and outs of the company tax cut initiative

The Federal Government’s company tax cut initiative is no doubt great news for small to medium businesses although local shareholders will ultimately be stung with higher personal tax bills being levied on taxed corporate profits paid as dividends. This is because the tax cuts will not be passed through to individuals. 
 
In other words, whilst this concession is welcome, a trade-off is the reduction in the maximum franking amount for dividends paid by companies that benefit for the tax cuts.
 
Although the policy is directed at active trading companies that carry on business, it will be interesting to observe whether the tax cuts are ultimately extended to companies with passive investments, that is, entities that do not carry on business but which hold say an investment in commercial property or receive trust distributions only.
 
Business owners across the land are cheering with the knowledge that their companies will have more disposal cash by looking at ways to maximise the benefits of the tax cuts due to significantly improved after tax profits, cash flow and better growth prospects.
 
Although not as generous as the “Ten Year Enterprise Tax Plan” company tax reform package announced in the Federal Budget last May, the Coalition will progressively deliver/phase in the tax savings for companies with aggregated revenue of up to $50m.

Political wrangling in Canberra inevitably ensured that the news was not so good for larger companies ($50m plus), at least in the shorter term. However, 2 days after the recent Federal Budget, the Government introduced a Bill into parliament to progressively extend the company tax cut to entities with a turnover of $50m or more. Under the proposed legislation which extends the rate cut to all companies, a rate of 27.5% will apply for the 2019-20 year ultimately falling to 25% in 2026-27 for all entities irrespective of their turnover.  

 
As summarised in the Table below, effective for the current year ending 30 June 2017, all taxable companies with aggregated annual turnover under $10m will pay tax at the rate of 27.5%. In calculating your company’s ‘aggregated annual turnover’, you need to take into account the annual turnover of connected entities and affiliates which are deemed to be related under the tax law.  The turnover test can be complex and you should seek the advice of your tax advisor if in doubt.  
 
The 27.5% rate will apply to companies with aggregated annual turnover under $25m and $50m in the 2017/18 and 2018/19 income years respectively.
 
From the 2024/25 income year, the company tax rate will be reduced each year for all companies under the $50m threshold until it reaches 25% in the 2026/27 income year.

Turnover

Tax Rate

Commencement

$10m

27.5%

2016/17

$25m

27.5%

2017/18

$50m

27.5%

2018/19

$50m

27%

2024/25

$50m

26%

2025/26

$50m

25%

2026/27

 
The company tax cuts will result in a cash flow benefit for companies under the $50m threshold either in the current income year or the following income years.
 
Companies with sales and other income of between $10m and $50m should be looking at legitimate strategies to access the tax savings in the current 2016/17 and next two tax years (2017/18 and 2018/19). 
 
Relatively simple measures such as deferring business and sales to later income years (ie. to on or after 1 July) and bringing forward allowable deductions to the current income year may result in substantial real cash savings. 
 
Prior to taking such steps, it is recommended that owners pay close regard to business contracts and commercial arrangements with suppliers and customers to ensure that the benefits of paying less tax are carefully measured against the potential negative impact and cost to your business in the longer term.
 
Other strategies worth looking at would include maximising deductions for prepaid expenses, reviewing contractual arrangements and income recognition methods (e.g. long term construction contracts) and managing timing of payments and receipts when dealing with foreign currencies.
 
For property developers and builders, Pty Ltd incorporated structures will potentially be a more attractive vehicle, as the inability of companies to access the CGT discount will have less effect as the rate is reduced towards 24.5%.
 
For eligible companies, Pay As You Go (PAYG) company tax instalments (quarterly tax payments) for the quarter ending 30 June 2017 will be automatically adjusted by the Australian Taxation office (ATO) to reflect lower PAYG tax obligations.
 
The company tax cuts will also reduce the level of “franking credits”, that is, company tax payments that can be passed by companies to shareholders through franked dividends.  As noted earlier in this article, the main implication here will be to increase the amount of ‘top-up’ tax paid (marginal rate of tax less franking credit) by shareholders receiving franked dividends.
 
The first step requires an assessment of which income tax rate applies to the company. This is called the “corporate tax rate for imputation purposes” which comprises the company’s income tax rate in the current year (dividend year), but based on its aggregated turnover for the previous income tax year.
 
This is best illustrated by example. In the case of a $100 dividend which has a corporate rate for imputation purposes of 27.5% (as compared to 30%), the shareholder will have to pay additional tax of $2.68.  The legislation governing the franking of dividends under the new regime is reasonably complex and it is advisable that business owners seek professional advice. 
 
Foreign shareholders of eligible companies will indirectly benefit from the tax cuts, as companies will have greater after-tax profit to distribute as dividends.
 
Foreign companies with Australian permanent establishments will also be affected by the reductions if they fall within the $50m threshold.