Tips and Traps in Working Out a Company’s Imputation Credits
In our Spring 2018 Quarterly Tax Bulletin, we discussed the new rules on the reduced corporate tax rate effective from the 2017/18 income year. In this article, we will discuss how the new rules operate in determining the applicable rate for imputation purposes. This is particularly relevant for companies paying franked dividends in the 2017/18 and later income years. Depending on the facts, the operation of the new rules may result in a mismatch between the company tax rate and the rate for imputation purposes.
In short, a company must apply the lower rate of 27.5% for imputation purposes in an income year if both of the following requirements are satisfied:
- no more than 80% of the company’s assessable income for the previous income year is base rate entity passive income; and
- the aggregated turnover of the company’s for the previous income year is less than the aggregated turnover threshold applicable in that income year.
Therefore, in determining the applicable rate for imputation purposes in the current income year, a company must use the assessable income, base rate entity passive income and aggregated turnover from the previous income year (as opposed to the figures from the current year) in determining the applicable corporate tax rate).
This may result in a mismatch between the company tax paid and the franking credits, particularly for companies that have aggregated turnovers between $25 million and $50 million in the 2017/18 and 2018/2019 income years. The mismatch is mainly caused by the transition of the aggregated turnover threshold from $25 million in the 2017/18 income year to $50 million in the 2018/19 and subsequent income years.
For example, a company with an aggregated turnover of $30 million in the 2017/18 income year has a corporate tax rate of 30% in that income year. However, if the company pays franked dividends in the 2018/19 income year out of the previous year’s retained profits, the applicable rate for imputation purposes is 27.5% in that income year. This gap may eventually result in wasted franking credits sitting in the company’s franking account.
The new rules also adversely affect small business companies with significant retained profits where the tax rate of 30% has been paid in the past. For most of these companies, the applicable rate for imputation purposes is likely to be 27.5% for the 2017/18 and subsequent income years.
Depending on the circumstances, it is possible to minimise the “leakage” or wasted franking credits in the scenarios illustrated above. For example, if a company is in an early or growth stage of its business cycle, most of the profits are usually reinvested back into the business. In this case, the company usually pays dividends that are smaller than its net profits. Therefore, the leakage (if any) is minimal at this stage.
When the company sells or winds down its business in a later income year, the company may then put all or most of the cash in an interest-bearing deposit or other investments. This may result in the company’s passive income exceeding 80% of its assessable income in those income years. The applicable rate for imputation purposes should then revert back to 30% enabling the company to pay out franked dividends with minimal leakage. This is just one of the many options that directors of a company may consider to maximise the use of franking credits in an SME company.