Amidst the significant negative response to the Abbott Government’s first Federal Budget, one issue that has been somewhat buried amongst the outcry is the collective impact of the expected loss in the value of company franking credits, coupled with the new deficit levy that is being imposed on individuals.
The Scoping Paper sets out Treasury’s assessment of the risks facing the Australian corporate tax system and analyses a range of policy options to tackle the risks and makes findings and recommendations on reforms.
Dilution of franking credits
Whilst the Government has kept their election promise of reducing the company tax rate to 28.5% effective from 1 July 2015, in the absence of special transitional rules, this measure will come at the cost of diluting the value of franking credits available in a company. As an aside, it is also noted that large companies that are subject to the paid parental leave 1.5% levy are not expected to obtain a franking benefit from this impost.
Currently, a fully franked dividend of $70 has a $30 franking credit attached to it, which a shareholder can use to offset against the shareholder’s tax payable on the dividend. By reducing the company tax rate to 28.5%, assuming no transitional measures will be introduced, the $30 franking credit will only be worth $28.50, presumably from 1 July 2015. Therefore the shareholder will receive a lower franking credit to offset against his or her tax payable, which in the 2015/2016 financial year, is at the top marginal tax rate of 49%.
Impact of new deficit levy
The new deficit levy will kick in on 1 July 2014, which means that the top personal rate, inclusive of Medicare Levy, will rise to 49% from that date.
What is the collective impact of these changes?
The combined impact of these changes means that tax payable on franked dividends will increase, particularly for investors on the top marginal rate of tax.
To provide a simple illustration of the position for franked profits of a company that have suffered tax at 30%:
* net of franking credit offset
+ cumulative – ie compared to 2013/14 as the base year
^ Illustration is of dividend payable during 2015/16 that has suffered tax at 30% rate, before reduction of corporate tax rate to 28.5%
What does this mean?
For shareholders that are merely passive recipients of dividends without any ability to influence the timing of company dividends, the above simply means that shareholders need to be prepared to suffer more tax leakage on franked dividends.
However, in circumstances where the timing of dividends is somewhat discretionary, having regard to the circumstances of shareholders, as may be the case in some closely held private companies, it may be appropriate for a holistic view to be taken and for the timing of dividends to be potentially accelerated.
One common circumstance where this may be appropriate to consider is where private companies have made Division 7A complying loans to related parties which are being progressively repaid via franked dividends on an annual basis.
Depending on the circumstances, it may be appropriate to consider maximising dividends in earlier years that can be applied to meet required annual repayments in later years. The downside of such action is that it will be crystallising a tax liability earlier than would otherwise be the case, but the advantage is that it is crystallising a lower tax liability than would be the case for the same dividend declared in subsequent years. Obviously the time value of money is important to bear in mind in this regard, and whether the benefits of lower tax now is, in present value terms, superior to higher tax later is something that each taxpayer would need to determine having regard to their own circumstances.
As 30 June 2014 is fast approaching, taxpayers should carefully consider the impact of the tax rate changes on them. To the extent that the timing of dividends from companies is discretionary, all factors should be carefully considered in order to obtain the best possible tax outcome.
If you wish to discuss the content of this article, or seek advice on tax and/or investment planning strategies, please speak to one of our Moore Stephens advisors.
Ian Kearney, Partner – Moore Stephens Melbourne
Junie Cheng , Manager Taxation – Moore Stephens Melbourne