Just over two months have passed since the Federal Government enacted the Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 to reduce the corporate tax rate in Australia. The new company tax rate is 27.5% for the 2016-17 tax year for companies with aggregated annual turnover of less than $10m. The Government plans to progressively reduce the corporate tax rate to 25% for all companies irrespective of their size. Anecdotally it seems that companies may already be factoring in the new company tax rate in calculating how much to pay out to investors in the form of dividends
Who is likely to benefit from the corporate tax cuts?
A number of commentators, however, are questioning the economic rationale behind the amended company tax rate and the extent to which any tangible benefit is provided. The principal reason behind such scepticism is simple: the less tax paid by companies, the more tax paid by their shareholders.
This is attributable to an aspect of Australia’s corporate tax system which has become rarer internationally, being the dividend imputation system, which imputes tax paid by companies to their shareholders. If a company pays tax on its profits of 30%, an equivalent amount is then credited against shareholders’ taxable income (called “franking credits”) so that shareholders don’t have to pay further tax on amounts that have already been taxed at the company level. The purpose of this is to avoid double taxation.
Internationally, the trend has been away from imputation systems in favour of greatly reduced corporate tax rates, e.g. from 30% to 19% in the UK. Some commentators have suggested that Australia should follow this trend.
As a result of Australia’s imputation system, any cut to the corporate tax rate will be accompanied by a corresponding reduction in the amount of franking credits granted to shareholders. Therefore, whatever tax is not paid by companies is eventually recouped from shareholders, provided such profits are distributed to shareholders as dividends.
Non-resident shareholders, however, are not entitled to a tax offset on franked dividends (but are instead exempt from paying withholding tax on fully franked dividends). This means that whilst non-resident shareholders benefit from the reduced tax rate applying to dividends at the company level, they are not affected by the corresponding reduction in the amount of franking credits that may be attached to dividends. Therefore, they benefit more from the reduction of the corporate tax rate than resident shareholders.
Passive companies may qualify for the new corporate tax rate
To qualify for the reduced company tax rate, it must be demonstrated that the company is carrying on a business for the income year: s 23AA, Income Tax Assessment Act 1997 (ITAA97). In a surprising move that has been welcomed by business groups but questioned by key figures including Federal Revenue Minister Kelly O’Dwyer, the ATO has indicated on its website and in a draft tax ruling that passive investment companies may satisfy this requirement, whilst providing the usual caveat that no conclusions can be reached without first considering the particular facts and circumstances of each individual case.
This means that family investment companies that make and retain money from passive investments may be eligible for the company tax cuts. Whilst the ATO’s provisional view may be disputed (and indeed has been by the Minister for Revenue and Financial Services Kelly O’Dwyer), it is nonetheless arguable that companies that engage in passive investing in addition to activities that are clearly carrying on a business may more readily qualify for the reduced corporate tax rates on all of their income.
Note, any companies that have been paying the incorrect amount of tax because they were unaware they qualified for the reduced corporate tax rate may be entitled to a refund for any tax paid at the full 30% corporate tax rate for the 2015-16 tax year (when the corporate tax rate was set at 28.5% for companies with an aggregate annual turnover of less than $2m) and may seek to have their 2016-17 return amended.
Corporate tax rate and the “corporate tax rate for imputation purposes” to be calculated by reference to different years of income
Of particular significance is the fact that the corporate tax rate and the “corporate tax rate for imputation purposes” are to be calculated by reference to different years of income. The corporate tax rate for imputation purposes is to be “worked out on the assumption that the entity’s aggregated turnover for the income year is equal to its aggregated turnover for the previous income year”: section 995-1(1) ITAA97. A simple reading of the provision suggests that the annual aggregate turnover threshold test is to be assessed based on the company’s turnover in the previous income year. On the other hand, for the purpose of determining the applicable corporate tax rate for income tax purposes, the turnover test is to be assessed based on the company’s turnover in the current income year. In many cases, this will lead to the unintended result whereby a company must pay tax at a rate of 30%, but for the same year can only pay franked dividends with an imputation rate equal to the reduced company tax rate of 27.5%. In such a circumstance, a portion of the company’s profits will be taxed twice due to a shortfall in the maximum amount of franking credits that are allowed to be distributed to shareholders. This problem is compounded by the fact that surplus amounts of franking credits may end up being trapped in a company’s franking account unable to be distributed to shareholders.
Compliance issues – over-franking
As the amended corporate tax rate applies retrospectively from the start of the 2016-17 tax year, many companies may have made fully franked distributions and calculated the maximum franking credit on the basis of the 30% tax rate, rather than the amended 27.5% tax rate. However, shareholders who have received such dividends are only entitled to a tax offset to an amount calculated by reference to the amended 27.5% tax rate. Companies are required to give written notice to shareholders of the amended franking credit amount to avoid penalties.
 Subsection 995-1(1) of the ITAA97 defines a “business” to include “any profession, trade, employment, vocation or calling, but does not include occupation as an employee.”
 TR 2017/D2 at footnote 3.