Yahoo Finance Your small business tax rate just went down but your tax headache just went up
If you own a small company, the chances are the rate of tax you pay has just gone down.
Just a few years ago, all companies paid tax at a rate of 30 per cent.
Then, in 2015, the government introduced a lower 28.5 per cent tax rate for businesses with a turnover of less than $2 million.
Since then, there have been further changes that have seen the tax rate fall even further, to 27.5 per cent, and the number of qualifying businesses greatly increase, as the turnover threshold for the lower rate went up to $50 million.
Now, everyone likes a tax cut and the government has very effectively sold the lower rate of company tax as a win for Australian small businesses.
Perhaps it is, but unfortunately the win has come at the expense of Australian resident shareholders in those companies, who have actually seen the tax payable on their dividends increase as a result of the company tax cut.
How can that be, you might ask?
The best way to answer that is by way of a simple example.
Say a company earns $100 pre-tax profit and pays out all of its profits to its one Australian resident shareholder, who pays tax at the highest rate of 45 per cent.
Under the old rules, the company paid $30 in company tax.
The individual received a cash dividend of $70, which was then grossed back up to $100 to take into account the company tax paid.
The shareholder gets a franking credit of $30 to offset against the total dividend income giving the shareholder an additional “top-up” tax payment of $15.
Under the new rules, using the same scenario, the company pays $27.50 in company tax, which is then available to the shareholder as a franking credit to offset their total tax liability. This means that the shareholder now has an additional “top-up” tax payment of $17.50 (a $2.50 increase).
So, the overall tax bill hasn’t been cut at all; it has simply been redistributed from the company to the shareholder!
Is the tax cut good news for anyone?
Yes, it is. There are two groups of winners from the company tax cut.
The first is companies that don’t pay dividends but instead re-invest profits into their business.
Because their tax rate has gone down, these companies have more profits left over after tax to invest in and grow their business, perhaps by buying new equipment or hiring extra staff.
The second group of winners are non-resident shareholders.
If you’re an offshore investor into an Australian company that pays tax at the lower rate and pays dividends, the full benefit of the tax cut flows straight into your pocket.
This is because non-residents don’t pay the extra top-up tax, so the amount of cash dividend you receive in the scenario illustrated above will go up from $70 (under the old rules) to $72.50 (under the new rules).
Mark Chapman is the Director of Tax Communications at H&R Block.
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