Will your company get the tax cut?

Tax cuts. There’s been a lot of talk and subsequently a lot of confusion about the Federal Government’s plans to reduce the company tax rate.

With much of the debate focusing on the merit of providing relief to the ‘big end of town’, it is not surprising that a recent change to the company tax rate for the millions of small to medium-sized operators received little attention.

In late August, amidst the turmoil of another Canberra leadership spill, the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018 passed quietly through the Senate. Despite its lack of fanfare, the amendment has a significant impact because it offers clarity for eligible companies on a substantial tax cut from 30% to 27.5%.  

While the new legislation provides a path forward for ‘the small end of town’, navigating its implementation will require expert tax planning. The changes have flow-on implications beyond the annual tax bill, especially for companies which have been established to receive returns from passive investments.

Will my company get the tax cut?

Before you excitedly start doing any calculations with the lower 27.5% tax rate, you need to find out if your company meets the criteria. Analysing current turnover alone is not enough to ascertain if the company qualifies for the cut, as there are different requirements for different financial years.

The new law is designed to provide the tax cut to companies conducting active businesses and prevent companies with mostly passive investment income from accessing the lower tax rate. So, for the 2017-18 financial year, the company will need to meet the new base rate entity definition which is determined by having:
  • an aggregated turnover, (i.e. the collective income of the company, its affiliates and connected entities) of less than $25 million; and
  • passive income being no more than 80% of your assessable income.
The 80% passive income rule also applies to the 2018-19 financial year, but the turnover test increases to $50 million.

The new 80% rule provides greater clarity to analyse if a company is a base rate entity. Essentially, a company is ineligible for the tax cut if more than 80% of its income comes from passive investments such as rent, net capital gains, royalties or interest. Distributions from trusts are similarly analysed to determine the nature of the income as it was derived by the trust, and whether it was from passive income sources.

Deferred Tax Assets

If your company records deferred tax balances, the new legislation may also throw you a curveball. Deferred tax assets and liabilities must be recorded at the tax rate in the year the company expects to unwind the tax balance. Therefore, there’s a possibility there will be a mismatch between the current year tax rate and the future year tax rate. This grey area is best navigated in conjunction with the company’s audit team, especially when accounting for any carried forward tax losses.

Dividend Franking Rate

It’s similarly complicated when determining the dividend franking rate. Ordinarily, the dividend franking rate is consistent with the company tax rate. However, many companies may now have their income tax rate changing from year to year between 27.5% and 30% and must consider annually the rules to determine the relevant franking rate.

Taxpayers will be required to apply the base rate entity rules to the prior year’s income in order to determine the current year franking rate. For example:
  FY 16-17 FY 17-18 FY 18-19
Base rate entity passive income 14% 17% 19%
Total income amount $23m $26m $30m
Company tax rate 30% 30% 27.5%
Franking rate 30% 27.5% 27.5%
To ensure you do not run afoul of the changing rules and interaction with other franking restrictions, it’s best to contact your preferred tax advisor.

Continual Assessment

While the new company tax criteria is clearer, many companies will need year-on-year advice as their structures grow or retract. Being proactive and having an early conversation with your Moore Stephens’ advisor can put in place the appropriate planning to effectively manage outcomes and improve your after-tax position.

As for those companies that exceed an annual turnover of $50 million, with the Opposition Leader Bill Shorten strongly against company tax cuts, and our new Prime Minister Scott Morrison already indicating this tax rate will remain unchanged for the foreseeable future, it’s unlikely a looming election will sway things in favour of the big end of town.