There are fears that the $2 million threshold for the 1.5 percent corporate tax cut announced in last week’s budget will prove to be a disincentive for businesses to grow, says Peter Bembrick, tax partner, at HLB Mann Judd Sydney.
The much-promised 1.5 per cent corporate tax cut is now a reality, but has been limited to small businesses with annual turnover less than $2 million. These businesses will have a company tax rate of 28.5 per cent from 1 July 2015.
“There are several definitions of small business in tax legislation, but in recent years the less than $2 million “aggregated turnover” has become the most common definition, and is in line with the rules used to determine eligibility for the “small business entity” concessions,” Mr Bembrick said.
“The issue is that the 1.5 per cent tax saving is lost as soon as the company’s turnover goes over $2 million, so there is some concern that the system provides a disincentive for businesses around this level to grow,” Mr Bembrick said.
Nevertheless, the change is good news for the 780,000 companies that will benefit from the new 28.5 per cent tax rate and they represent 90 per cent of all incorporated businesses. They will feel the benefits of the tax cut from October 2015, when the first quarterly installment for the 2015/16 financial year becomes payable.
“It is important to note that the existing small business concessions (which can reduce the capital gains tax (CGT) payable on a sale, and also cover such things as the instant write-off for certain fixed assets, and cash accounting for income and expenses) are confined to businesses and don’t extend to investment companies with a turnover less than $2 million. By contrast, the Federal Budget papers make no such distinction for the 1.5 per cent company tax cut, which appears to apply to all companies with less than $2 million aggregated turnover, not just those companies carrying on a business,” Mr Bembrick said.
“Encouragingly, the franking rate of 30 per cent will remain unchanged, so there is no need to address the impact of the tax rate change on small business companies that have built up franking credits by paying tax at 30 per cent.
“As well as making things simpler, this decision will also provide a benefit to the many companies out there that have excess franking credits, that is, franking credits that are greater than the amount that could be paid out using their existing level of retained profits.
“While the calculations can get a bit complicated, one way to illustrate the benefit is to think of a company having a taxable profit of $100,000 in the 2016 tax year, on which it will pay company tax of $28,500, leaving net retained profits of $71,500, which can be paid out as a fully franked dividend.
“If the franking simply used the new 28.5 per cent rate, the shareholder would receive a franking credit of $28,500 and that would be the end of it. By allowing the existing 30% franking rate to be used, however, the franking credit claimed by the shareholder would rise to $30,643 (assuming the company has enough excess credits to ensure its franking account does not go into negative). For a shareholder on the top tax rate this provides a net tax saving of just over $1,000,” Mr Bembrick said.
Perhaps the most publicised Federal Budget concession for small business was the accelerated depreciation write off for up to $20,000.
“This will allow any small business to acquire depreciable assets costing less than $20,000 (up from the previous limit of $1,000) and claim an immediate tax deduction. It applies to any assets acquired and installed ready for use from 7.30pm on 12 May 2015 up to 30 June 2017, and there is no limit on the number of assets that each business can claim for.
“It is an extremely generous concession and one that should achieve its aim of generating a significant amount of business capital expenditure over the next two and a bit years.”
However, there is some confusion among small businesses owners of the nature of this $20,000 concession,” Mr Bembrick said.
“Many seem to have formed the impression that this is a $20,000 cash handout for small businesses to use as they like. This is not the case, rather it is a tax deduction of $20,000. Even for a sole trader on the top tax rate of 49%, every capital purchase of $20,000 represents a net cash outlay of just over $10,000 for the business.
“Another misconception is that this is an extra benefit. In fact ,it can’t even be accurately described as a hand-out because any such capital purchases have always been tax-deductible for a business, the tax deduction was simply spread over a number of years as an annual depreciation charge.
“So the real benefit from this concession is to allow the business to claim an up-front tax deduction instead of spreading the tax saving over, say, five years.
“This is a very helpful timing benefit, and the cash-flow effect of bringing forward the tax deduction for many capital purchases will be a huge boost to many small businesses, but we shouldn’t lose sight of the fact that this is simply bringing forward a benefit that already exists.
“The key message for small businesses is only buy something that is needed for the business and that you may have been considering buying anyway at some point.
“There have been reports of people looking to buy a variety of assets such as computers, scanners, cars and vans, to less common business items such coffee machines, fridges and even a table tennis table for the staff recreation room. Some of these purchases should be carefully considered,” Mr Bembrick said.
Start-up businesses are also positively affected by the Federal Budget initiatives.
“There are additional concessions for start-up businesses, including the ability to write-off professional expenses relating to establishing a business entity, such as legal, accounting and other such services,” Mr Bembrick said.
“These amounts are currently written off over five years under the “black-hole” provisions, offering a significant timing benefit in bringing forward the deductions, and potentially a useful cash-flow boost during a time when the business is establishing itself in the market.”
The Federal Budget also contained good news in terms of capital gain tax (CGT) rollover relief, for those small businesses that restructure due to expansion.
“Typically a small business may start out as a sole trader or partnership, and as it grows there is a need to use other types of structures such as companies and trusts. Changing the structure may currently trigger CGT liabilities, which become a barrier to restructuring and further efficiencies. The Federal Budget measures will ensure this does not occur.
“There is already rollover for a sole trader moving to a single shareholder company, but other restructures are not necessarily covered. One example given in the budget papers is the sole trader wanting to start trading through a trust instead.
“What is not made clear with this example is whether this would only be a unit trust with the individual as a unitholder, or whether the rules may allow the business to be transferred to a discretionary trust set up for the family of the relevant individual, perhaps requiring a family trust election to be made as a condition of the CGT rollover.
“It will be necessary to see more of the detail of how these new rollovers are intended to work before we can get a good feel for how useful they might be, and how widely they might be applied,” Mr Bembrick said.
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and a member of the HLB Mann Judd Australasian Association.
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Franking credit example
With the franking rate of 30 per cent remaining unchanged, there is no need to address the impact of any tax rate change on small business companies that have built up franking credits by paying tax at 30 per cent.
As well as making things simpler, this decision also provides a benefit to the many companies out there that have excess franking credits, that is, franking credits that are greater than the amount that could be paid out using their existing level of retained profits.
By way of example, say that Dragon Pty Limited has retained profits of $700,000, and a franking account balance of $325,000.
If it pays out the whole $700,000 as a franked dividend on 30 June 2015, there will be an associated franking credit of $300,000, leaving a balance of $25,000 in the franking account that is not currently able to be used, and might never be used if it were not for the changes proposed in this Budget.
For the year ended 30 June 2016 Dragon has a taxable income of $100,000, and pays tax of $28,500, leaving retained profits of $71,500 and a franking account balance of $53,500 once the 2016 company tax has been paid (ignoring for simplicity any tax installments that might also have been paid for the following year, and any subsequent year’s profits). The company pays a franked dividend of $71,500 during the 2017 tax year.
Using a franking rate of 30 per cent, the associated franking credit will be $30,643.
Even though only $28,500 tax was paid during the year, the shareholders will be able to claim an extra tax credit of $2,143, taken out of the excess franking credits of $25,000 (that is, the company has enough excess credits to ensure its franking account does not go into negative). For a shareholder on the top tax rate this provides a net tax saving of just over $1,000.