How corporate tax rate changes will impact franking credits
Tax Law - 16 Jun 2021
Less tax is great, right? Well, that isn’t always the case.
Reductions in the corporate tax rate for base rate entities over the past few years is having material implications on the tax your business pays and importantly, the franking credits you can attach to your dividends.
In considering these changes and implications, the first step is to determine whether your company is a base rate entity. There are two requirements to be classed as a base rate entity:
- The company’s aggregated turnover (i.e. total turnover plus turnover of any connected or affiliate entities) is less than $50m; and
- No more than 80% of the company’s turnover is passive income, which includes items such as interest, rent, trust distributions, and dividends where the company holds less than 10% of the shares in the company paying the dividend.
Where a company is classed as a base rate entity, the company’s income tax rate is reduced from the standard 30% rate. In the current income year, the reduced rate is 26%. From 1 July 2021, this will reduce further to 25% (noting there are no further planned reductions from 25%).
This has repercussions for your company in relation to the franking credits that can be attached to your dividends.
Australia uses an imputation system to avoid double taxation of company profits (where the company pays tax on profits and the shareholder pays tax on those same profits when they are paid out as dividends). Under the imputation system, the income tax paid by the company gives rise to franking credits. Generally, these franking credits can be attached to dividends paid to shareholders, which provides a credit against the shareholders’ income tax for the income tax already paid by the company.
The reduction of the corporate tax rate for base rate entities reduces the benefits of these franking credits. Even if the base rate entity has paid tax at 26% – 30% (depending on its circumstances) once it is taxed at 25% it can only frank dividends at the rate of 25%.
This introduces an important planning opportunity for shareholders in base rate entities. If the base rate entity declares a dividend prior to 30 June 2021, the franking percentage will be 26%. However, if the same entity declares the same dividend on 1 July 2021, the franking percentage will be 25%, increasing the tax costs for the shareholders and effectively trapping franking credits in the base rate entity.
Shareholders in base rate entities should consider whether to declare a dividend before or after 30 June 2021, weighing up:
- Declaring a dividend prior to 1 July will allow franking credits at 26% rather than 25%; and
- Declaring a dividend on or after 1 July will only allow franking credits at 25% however the dividend is paid in the 30 June 2022 income year, effectively providing a 12-month deferral of any additional income tax that may be payable.
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The information contained in this blog is general in nature and should not be considered to be legal, tax, accounting, consulting or any other professional advice. In all cases, you should consult with a professional advisor familiar with your factual situation for advice concerning specific matters before making any decisions. By reading this blog, you confirm your understanding of this disclaimer.