• Federal Budget 2016 - Business

Ten Year Enterprise Tax Plan – Change of tax rates for small business entities

The Government’s Ten Year Enterprise Tax Plan includes a decrease to the current company tax rate as well as the discount applied to unincorporated small business entities (such as individuals and individuals trading through partnerships). These measures will commence from 1 July 2016, with further decreases to company tax rates to apply over the coming ten years.

The measures will work in partnership with the increase to the small business entity turnover threshold portion of the Ten Year Enterprise Tax Plan to provide tax relief to small business entities as part of the Treasurer’s growth friendly budget.

Increase of the unincorporated small business tax discount

From 1 July 2015, individuals and individual partners in a partnership with business income of less than $2 million have enjoyed a tax discount of 5% of tax paid on business income. This discount amount is capped to $1,000 per individual.

From 1 July 2016, the new measures seek to increase the annual aggregated turnover threshold to $5 million. This will allow more sole traders and individuals in business partnerships to access the tax discount.

The tax discount will also increase over the coming ten year period, with the first increase to 8% commencing on 1 July 2016. The increases will become effective as follows:

Income year

Discount Rate (%)

2016-17 to 2023/24

8%

2024/25

10%

2025/26

13%

2026/27

16%

The annual tax discount cap of $1,000 per individual will remain in place as the discount rate increases over the next ten years.

While the increase in the turnover threshold results in a larger pool of eligible individuals, retaining the annual tax discount cap provides limited benefit for those who were already eligible to access the concession.  These measures are in line with the Budget’s growth friendly theme. However, while the annual discount cap remains, the real dollar benefit to those eligible under the extended threshold and increased discount rate remains stagnant.

Reduction of the company tax rate

Companies that fit the small business entity definition (which includes entities with an aggregated annual turnover of less than $2 million) are subject to a company tax rate of 28.5% for the 2016 financial year. Those entities that do not meet the definition (for example those with turnover of more than $2 million) continue to be subject to a tax rate of 30% for the current financial year.

From 1 July 2016, the Ten Year Enterprise Tax Plan measures seek to reduce the applicable company tax rate for companies in conjunction with the increase in the small business entity threshold increases over the coming ten years. Accordingly, the company tax rate applicable to each company will be based on their aggregated annual turnover and their ability to meet the small business entity criteria.

The company tax rate reductions are as follows:

Income year

Applicable Turnover Threshold

Company Tax Rate (%)

2015-16

$2 million

28.5

2016-17

$10 million

27.5

2017-18

$25 million

27.5

2018-19

$50 million

27.5

2019-20

$100 million

27.5

2020-21

$250 million

27.5

2021-22

$500 million

27.5

2022-23

$1 billion

27.5

2023-24

all companies

27.5

2024-25

all companies

27

2025-26

all companies

26

2026-27

all companies

25

For the financial years prior to 2023, entities that do not meet the applicable turnover thresholds will remain subject to a tax rate of 30%.

Effect on company franking accounts

These progressive changes to the company tax rate will have a number of flow-on effects for company franking account balances and, ultimately, the individual shareholders of the companies affected.

Under the current law, where a dividend is paid to a shareholder, franking credits will be able to be distributed in line with the rate of tax paid by the company making the distribution. This does not change under the proposed amendment. However, the methodology to calculate the maximum franking credit will differ due to the change in corporate tax law. 

We have provided an example below that shows the tax impact for an individual shareholder receiving a dividend of $10,000 with a flat marginal tax rate of 40%. 

 

Company tax rate – 30%

Company tax rate – 25%

Dividend

$10,000

$10,000

Franking credit

$4,285

$3,333

Taxable income of shareholder

$14,285

$13,333

Tax at 40%

$5,714

$5,333

Franking credit offset

($4,285)

($3,333)

Tax payable by individual shareholder 

$1,429

$2,000

The progressive reduction in the company tax rates will also require the following considerations:

  • The company tax rate will affect how deferred tax balances are calculated for the purposes  of preparing audited company financial statements 
  • There will be franking account timing issues which will need to be considered. For example, where a company has paid company tax at a rate of 30% in the past and has not paid a dividend, the company may end up in a situation whereby it can only frank a dividend to 25% but has paid company tax in an earlier year at a rate of 30%, leading to an ineffective use of franking credits
  • Non-resident shareholders may benefit from the decreased company tax rate on distributions ultimately paid to them from company profits taxed at the lower company tax rates
  • Superannuation funds previously entitled to refunds franking credits at 30% will now only receive a refund for the lower company tax rate paid by the company. 

BDO Comment

The reduction to the company tax rate is a welcomed initiative that allows Australia to truly compete for foreign investment with other global tax jurisdictions. While appearing straight forward to implement, the transitional measures regarding the treatment of company franking accounts and changes in the deferred tax account balances need to be carefully considered to ensure companies are not left disadvantaged. How the additional compliance burden will be managed for companies that move between turnover thresholds each year also needs to be considered.