Following the Government’s retrospective changes to company tax rates in May 2017, there has been ongoing confusion over which tax rates and concessions currently apply.
For companies that are carrying on business, the thresholds for 2018 are:
- Tax rate of 27.5% where turnover is under $25 million;
- Cap on franking credits on dividends to 27.5% where 2017 turnover was under $25 million; and
- Access to small business provisions if turnover is under $10 million.
In working out if these thresholds apply it is important to also include the ordinary income of the company’s connected entities or affiliates (whether Australian or foreign sourced).
What are the implications of a company not carrying on a business?
If a company is not carrying on business it will continue to be taxed at 30%.
The Government has stated that the tax rate change “was not meant to apply to passive investment companies.” This raises concerns for companies whose activities are limited to:
- Owning shares in other companies; or
- Making loans to related parties (particularly if interest-free); and/or
- Owning rental properties or managed funds, or leasing equipment to related parties.
In these situations the intended benefit of the lower tax rate for companies may actually be lost where:
- The company is not carrying on business and receives a dividend franked at 27.5%, as it will have to pay 2.5% extra tax; or
- The company is carrying on business and receives a dividend franked at 30%, as it may be unable to use the 2.5% extra credits.
The initial ATO position is that companies investing in assets to make profits for shareholders are likely to be carrying on a business, even if their activities are “relatively passive and consist of receiving rents or returns on its investments”. This statement conflicts with the Government’s view.
Until the ATO clarifies its position, companies are faced with the ongoing uncertainty of not knowing which tax rates apply to them. In acknowledging this problem, the ATO stated that companies varying their income instalments believing the 27.5% tax rate applies, will not be penalised if they subsequently find out they don’t qualify.
A consequence of the tax rate reduction applying to companies is that they can only frank dividends to 27.5% from 1st July 2016 onwards. Simply put, for every $1 million in retained profits a company had at 30 June 2016, it may now have $25,000 in franking credits trapped in the company.
Companies that are not carrying on business therefore, should consider the potential impact these lower tax rates might have on their ability to pay future dividends to their shareholders, before deciding to commence business.
Furthermore, companies carrying on business with a turnover between $25 million and $50 million, will also be subject to the 27.5% tax rate and franking credit changes from 1 July 2018. Consequently, they should carefully consider their dividend policy / franking credit position prior to 30 June 2018.
If you would like more information about tax rates, and how these changes may affect your business, please contact your local adviser.
By Mark Reynolds, Tax Partner