Reduction in corporate tax rate - are you eligible?

By Matthew Hall - May 26, 2017

Companies with group turnover of up to $50 million may be eligible for the reduced corporate tax rate of 27.5%. Have you assessed when you may be eligible for the new corporate tax rate and the consequences of transitioning to such a change?

Overview

On 19 May 2017, legislation received Royal Assent to enact corporate tax rate reductions.  This measure is consistent with the 2016-17 federal budget. This bulletin explores issues and considerations associated with these changes.

What are the Corporate tax rate changes?

The new legislation reduces the corporate tax rate for companies that are carrying on a business with aggregated turnover below the relevant threshold for the applicable income year (worked out at the end of the income year).  The turnover thresholds and the applicable income year are outlined in the following table.

Income year

Annual aggregated turnover threshold

Company
tax rate (%)

2016-17

$10 million

27.5

2017-18

$25 million

27.5

2018-19

$50 million

27.5

2024-25

$50 million

27

2025-26

$50 million

26

2026-27 and
later income years

$50 million

25

What is aggregated turnover?

Generally speaking, the aggregated turnover only includes total ordinary income that the company derives in the income year in the ordinary course of carrying on a business.  Therefore, passive income (unrelated to a business) can generally be excluded from aggregated turnover.  The measure also groups turnover received by affiliates and connected entities, but excludes certain intra-group transactions. 

Impact on franking (loss of 2.5%)?

A company will frank its dividends based on the prior year aggregated turnover, rather than the current year aggregated turnover.  This can result in companies having a different tax rate as compared to their franking rate (and may result in franking errors – see below).  This may impact companies that transition to a new (lower) tax rate and have retained earnings that have already been taxed at a higher rate.

The following table provides an example of the potential impact of the reduction in the corporate tax rate on franked distributions.

Retained earnings before change

Franking account balance before change

100% franked distribution at the lower rate (27.5%)

Loss of potential franking credits (additional tax payable)

700,000

300,000

265,517

34,483

2,000,000

857,143

758,621

98,522

25,000,000

10,714,286

9,482,759

1,231,527

Can a company accidentally over-frank or under-frank?

Yes.  This will especially be the case for the 30 June 2017 income year, where legislation has only recently been passed. 

It may be mistakenly thought that a company is able to frank a dividend at the 30% tax rate in circumstances where the maximum franking credit is actually only 27.5%.  This is because the current year tax rate is calculated on the current year turnover, while the franking percentage is calculated on the prior year threshold.  This may result in over-franking or under-franking by 2.5%. 

Can a corporate beneficiary apply the lower tax rate?

This depends.  The change in tax rate will only apply to entities that carry on a business with aggregated turnover below the relevant threshold.  If a corporate beneficiary does not carry on an active business, it will not be able to access the lower corporate tax rate and thus will continue to be taxed at 30%.

What is the impact if you are operating through a trust?

If you currently operate through a trust (and distribute to a corporate beneficiary) future profits derived by the trust will likely be taxed at the 30% tax rate.  However, whether the corporate tax rate changes provide a material difference will depend on the circumstances. The benefits associated with the corporate tax rate cut would prima facie amount to 2.5% of future taxable income retained by the company. 

However, to the extent that the company pays a dividend, this difference can effectively be reversed through a lower franking percentage (and lower franking credits), resulting in a higher amount of tax being paid at the individual shareholder level.  It is therefore important to understand the extent to which profits will be retained in the corporate entity and the extent to which a dividend will need to be paid to shareholders on an annual basis.

By way of example, if only $200,000 of before tax profits is retained in the company, then this would amount to a tax saving of only $5,000 at the lower corporate tax rate of 27.5%.  This benefit would only be temporary until a dividend is paid by the company to an individual.  This can be compared to a company that retains profits of $4 million, which could amount to a temporary saving of $100,000.

Should a trust restructure to a corporate vehicle?

If the corporate tax rate changes provide a material benefit, restructuring a group to access the lower corporate tax rate may be an option.  However, any restructure should accommodate the broader strategies of the group and needs to be undertaken for commercial reasons. 

This requires consideration of a number of important issues, such as (but not limited to): the tax implications on restructuring (including income tax, stamp duty, and GST); asset protection; the ongoing operations of the business; the ability to access tax losses within the group; and the impact of moving to a corporate structure on the disposal of business assets (including goodwill).

What options are available to restructure?

There are a number of ways to implement a restructure from a trust to a company.  An effective restructure for many groups may be as simple as incorporating a services entity within a group of trusts or moving the business to a company through tax concessions and rollovers available. It is important to consider all of the possible options to determine the best structure for your group.  This will ultimately depend on the facts and circumstances of each group.

Do you need to restructure by 30 June 2017?

It may not be necessary to restructure by 30 June 2017, especially if the reduction in tax rate does not have a significant impact on the total amount of tax expected to be paid.  However, it is important to properly consider the many issues associated with a restructure to ensure that adverse tax consequences are not inadvertently triggered by a rush to restructure by 30 June.

Are there other things you should consider before 30 June?

You may need to consider whether you establish a new corporate beneficiary before 30 June 2017 (for example, if profits are to be quarantined outside of the operating group).

What about Groups with Aggregated turnover in excess of $50 million?

There is currently a Bill before the House of Representatives which reduces the corporate tax rate for entities with aggregated turnover in excess of $50 million. 

There is some doubt as to whether this proposed change will pass through Parliament.  As this is not yet law, there is no immediate action required by groups with turnover greater than $50 million.  However please be aware of the future application of the tax rate cut, particularly for entities with significant after-tax retained earnings. 

What should you do?

If you run a business, whether or not you currently use a corporate entity, you should consider the impacts outlined in this bulletin.  Please contact us if you wish to discuss any aspect of these measures further.


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