Let’s have a discussion about the impact of lowering the Australian Company tax rate in Australia and the impact on small business and investors.
By way of background, the Australian Federal Government is reducing the company tax rate. Prior to 1 July 2015 the Company tax rate was 30%, but going forward, it is proposing the following rates:
|
Income year |
Turnover threshold |
Company tax rate for entities under the threshold |
Company tax rate for entities over the threshold |
|
2015–16 |
$2m |
28.5% |
30.0% |
|
2016–17 |
$10m |
27.5% |
30.0% |
|
2017–18 |
$25m |
27.5% |
30.0% |
|
2018–19 to 2023–24 |
$50m |
27.5% |
30.0% |
|
2024–25 |
$50m |
27.0% |
30.0% |
|
2025–26 |
$50m |
26.0% |
30.0% |
|
2026–27 |
$50m |
25.0% |
30.0% |
At first glance, it looks attractive, but looks can be deceiving.
Let me explain why.
Dividend Imputation v The Rest of the World
Australia adopted the dividend imputation system in 1987, which eliminates the double taxation of cash payouts from a Company to its shareholders. The shareholder does not have to pay tax on the dividend income. This is achieved through the use of tax credits called "franking credits" or "imputation credits".
In many other countries, corporate dividends are taxed twice i.e. the “classical model”. Double taxation of dividends occurs when both a Company and a shareholder pay tax on the same income. The Company pays taxes on profits and subsequently distributes a dividend out of its after-tax profits.
The dividend imputation regime makes it very attractive to invest in Australian shares.
So “what” you say!
Well, we all have superannuation and our superannuation funds have a significant exposure to Australian share market, so understanding the power of the Dividend Imputation is vital.
Let me illustrate how dividend imputation works as compared the “classical model” of double taxation.
Assume a Company has made a pre tax profit of $100,000 and the Company has a 30% tax rate and the shareholder has a tax rate of 32.5%.
|
|
Australia |
Classical Model |
|
Company pre tax profit |
100,000 |
100,000 |
|
Company tax payable @30% |
30,000 |
30,000 |
|
Dividend available to be paid to shareholders |
70,000 |
70,000 |
The respective shareholder’s tax position is as follows:
|
|
Australia |
Classical Model |
|
Cash dividend received |
70,000 |
70,000 |
|
Franking credit @30% |
30,000 |
0 |
|
Taxable income in the shareholders hands |
100,000 |
70,000 |
|
|
|
|
|
Tax payable by the shareholder @32.5% |
32,500 |
22,750 |
|
Less Franking credit @30% |
30,000 |
0 |
|
Net tax payable |
2,500 |
22,750 |
The cash position after tax for the respective shareholder is:
|
|
Australia |
Classical Model |
|
Cash dividend received |
70,000 |
70,000 |
|
Less Net tax payable |
2,500 |
22,750 |
|
After tax dividend available to the shareholder from $100,000 profit made by the Company |
67,500 |
47,250 |
Clearly, the Australian dividend imputation system generates a better result.
A discussion about headline Company tax rates is meaningless and is some sense misleading unless you understand how the individual is taxed on the dividends in each of the location.
In my next article, I will also explain why a reduction in the Australian corporate rate is meaningless, unless it is accompanied by personal tax rates.
If the Federal Government reduces the rate of Company tax in Australia without personal tax cuts, it will merely move the overall tax liability from the Company to the individual shareholder. So bit like smoke and mirrors. It looks attractive but does nothing for individual investors or superannuation funds.