Reduction of tax rates for small businesses is now law (substantive enactment)

On 9 May 2017, the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016 was passed through the House of Representatives for a second time after various changes requested in the Senate in March 2017.

What are the changes?

One of the proposals in the 2016 Federal Government budget was to gradually reduce the company tax rate from 30% (or 28.5% for small businesses) to 25% by 2027.

While the full package of company tax cuts were not accepted in the Senate by the Xenophone Team, after some compromise, it was agreed that the corporate tax rate will reduce to 27.5% for companies carrying on a business with an aggregate turnover* not exceeding:

  • $10 million for the income tax year ending 30 June 2017
  • $25 million for the income tax year ending 30 June 2018, and
  • $50 million for the income tax year ending 30 June 2019.

*Aggregate turnover includes turnover of connected entities (including parent companies, subsidiary companies and sister subsidiary companies)

Are these changes considered to be ‘substantively enacted’?

AASB 112 Income Taxes requires that tax rates be ‘substantively enacted’ at the end of the reporting period in order to be able to use them in calculations for the entity’s current tax liability and deferred tax assets and liabilities.

Although AASB 112 does not define what is meant by ‘substantively enacted’, in Australia it is generally accepted that this means that the relevant Bill amending tax rates has passed through both Houses of Parliament.

Since the final approval for these amendments was given by the House of Representatives for a second time on 9 May 2017, it appears that that date is taken to constitute ‘substantive enactment’.

Which will be the first reporting periods to be impacted by these amendments?

Current tax liability

A reduction in corporate tax rates will only impact the measurement of current tax in the year in which the new rate becomes effective, i.e. generally for tax years ending 30 June 2017.

Deferred tax assets and liabilities

Deferred tax assets and liabilities must be measured at tax rates that are expected to apply to the period when the deferred tax asset is realised or the liability is settled. This means that deferred tax on temporary differences must be recalculated using the new rate where assessable or deductible temporary differences are expected to be settled or realised at the new rate.

Example

This example illustrates a simple scenario where it is easy to identify the financial year in which tax losses will be recouped, and therefore the applicable tax rate for calculating the deferred tax asset. We anticipate that it will not be this straightforward in practice.

Assume that ABC Limited has revenue of $40 million and $5 million of tax losses it expects to recover as follows:

  • $2 million during the year ending 30 June 2018
  • $3 million during the year ending 30 June 2019.

ABC Limited will incur a 30% tax rate for the years ending 30 June 2017 and 30 June 2018, and 27.5% for the year ending 30 June 2019.

As the tax rates were substantively enacted at 30 June 2017, ABC Limited will recalculate its deferred tax asset for its year ending 30 June 2017 financial statements based on the timing of when it expects to recover the deferred tax asset. 

Prior to substantive enactment

ABC Limited tax losses at 30 June 2017

$5 million

Tax rate before substantive enactment

30%

Deferred tax before substantive enactment

$1.5 million

The deferred tax asset is recalculated based on the timing when the tax losses are expected to be recovered across both the 2018 and 2019 financial years. This results in a deferred tax asset of:

 

Year ending 30 June 2018 Year ending 30 June 2019 Total
Tax losses expected to be recovered $2 million $3 million $5 million
Expected tax rate 30% 27.5%  
Deferred tax asset $600,000 $825,000 $1,425,000

This results in a total deferred tax asset to be recognised in ABC Limited's 30 June 2017 financial statements of $1,425,000. 

The $75,000 reduction in the deferred tax asset from $1.5 million to $1.425 million will impact income tax expense, and it will also be a reconciling item in ABC Limited’s effective tax rate note in its 30 June 2017 financial statements.

Which entities are likely to be impacted by the corporate tax rate reduction?

Large proprietary companies

Because the ‘large proprietary company’ test in s45A of the Corporations Act 2001 includes a $25 million revenue threshold for lodging financial statements with the Australian Securities and Investments Commission (ASIC), it is unlikely that large proprietary companies will benefit from the reduced tax rate until at least 1 July 2018, unless they meet the ‘large’ test via the other two criteria in s45A, i.e. number of employees and the ‘assets test’. In such cases, they would benefit from the 27.5% tax rate immediately if their aggregate turnover is $10 million or less, or from year ending 30 June 2018 if their aggregate turnover is $25 million or less.

Small proprietary companies

Small proprietary companies (with revenues less than $25 million under s45A) are only required to lodge financial statements with ASIC in certain circumstances, in which case, the reduced rate must be used for 30 June 2017 financial statements (and future year financial statements) in calculating current and deferred taxes based on the relevant tax rate applicable in the year in which it expects to recover the deferred tax asset.

Listed entities

In calculating current and deferred tax assets, listed entities whose revenue is below the thresholds for reduced tax rates would also need to apply the reduced tax rates in their 2017, 2018 or 2019 financial statements, as applicable, based on the relevant tax rate applicable in the year in which it expects to recover the asset.