These rules apply for the 2017/18 income year (from 1 July 2017 for companies with a June year end) and determine the:
a) franking credits attached to a dividend (27.5% or 30%); and
b) company tax rate applied to taxable income.
Now that Royal Assent has been received, it is critical all listed investment companies (“LIC’s”) applying a 27.5% tax rate for franking dividends or calculating their current tax liability review their position.
In October 2017, the Federal Government introduced legislation into Parliament (Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 (“the Bill”)) clarifying when the reduced corporate tax rate of 27.5% will apply to companies for the 2017/18 income year (e.g. 30 June 2018) and subsequent income years.
The Bill passed the House of Representatives on 8 February 2018, before being passed by the Senate on 23 August 2018. It received Royal Assent on 31 August 2018.
Prior to the Bill being passed by the Senate, the Australian Taxation Office (“ATO”) issued draft guidance (Practical Compliance Guideline PCG 2018/D5) in regards to the correct corporate tax rate applicable to companies and the tax rate applicable to franked dividend distributions.
The ATO has also issued Draft Law Companion Ruling LCR 2018/D7 on 24 August 2018 which provides guidance in relation to the practical application of the legislative provisions.
What are the implications for the 2017/18 and later income years?
A company will be entitled to the reduced corporate tax rate if:
a) its “aggregated turnover” is under the relevant threshold (i.e. $25 million for 2017/18 and $50 million for 2018/19); and
b) no more than 80 percent of the company’s assessable income is “passive income”.
Aggregated turnover includes turnover of other entities that are connected with, or affiliates of, the company.
Generally speaking, the aggregated turnover only includes total ordinary income that the company derives in the income year in the ordinary course of carrying on a business. The determination of aggregated turnover can be a complex exercise depending on the specific circumstances and tax profile of the taxpayer.
Given the complexities, if your company is applying a 27.5% income tax or franking rate we recommend you undertake an analysis of your income streams to determine the relevant turnover for income tax purposes and consult with your Pitcher Partners advisor.
What constitutes “passive income”?
As referred to by Peter Gillies in our general alert dated October 26, 2017, broadly, the passive income of a company will comprise dividends (and attached franking credits), interest, rent, royalties and net capital gains. In addition, a company’s entitlement to assessable income consisting of partnership or trust income will be regarded as passive income to the extent it is referable to an amount that is passive income as defined in the tax legislation. Further, the Bill requires tracing through interposed partnerships and trusts in determining whether the amount flowing to the company is referable to passive income. Helpfully, the Explanatory Memorandum that accompanied the Bill confirms that an amount flowing through a trust will retain its character.
Are there any exclusions from passive income?
It is important to understand whether gains on investments are on revenue account or capital account, as gains on revenue account are not included in passive income.
Do the changes affect franking?
If the dividend is paid on or after 1 July 2017, the rules for 2017/18 apply. Similarly, if the dividend is paid on or after 1 July 2018, the rules for 2018/19 apply.
What are the franking rules for 2017/18?
For 2017/18, the franking rate is based on the applicable company tax rate for that year worked out on the assumption that the company’s aggregated turnover was equal to its aggregated turnover for 2016/17.
If the aggregated turnover for 2016/17 was less than $25 million and no more than 80 percent of the company’s assessable income is passive income, the franking rate would be calculated by reference to the 27.5 percent rate. If one of those requirements was not satisfied, the franking rate would be calculated by reference to the 30 per cent rate.
What are the franking rules for 2018/19?
For 2018/19, the franking rate is based on the applicable company tax rate for that year worked out on the assumption that the company’s aggregated turnover was equal to its aggregated turnover for 2017/18.
If the aggregated turnover for 2017/18 was less than 50 million and no more than 80 percent of the company’s assessable income is passive income, the franking rate would be calculated by reference to the 27.5 percent rate. If one of those requirements was not satisfied, the franking rate would be calculated by reference to the 30 per cent rate.
Incorrect distribution statements due to change in corporate tax rate
As the Bill has retrospective effect in regards to the 2017/18 income year, it is possible some corporate taxpayers may have issued incorrect distribution statements for franked distributions made. In normal circumstances, taxpayers are usually required to apply to the Commissioner of Taxation for approval to amend and re-issue the statement to its members.
However, the ATO’s draft guidance (PCG 2018/D5) provides an administrative concession whereby the Commissioner’s approval is not required where the corporate taxpayer provides written notice of the revised distribution statement (with the correct franking credits, calculated by reference to the correct corporate tax rate) to its members, and complies with other specific requirements outlined in PCG 2018/D5.
What are the next steps?
Now that the Bill has received Royal Assent, it is critical that you carefully consider your LIC’s position, including the relevant disclosures made in your LIC’s statutory accounts. Where your accounts have already been lodged, then you may consider an announcement under the continuous disclosure requirements of the ASX, once you have considered the impacts on the company and your shareholders.
This includes reviewing whether dividends paid in 2017/18 have been franked at the correct rate, and (if not) what corrective action should be taken.
You will also need to determine the impact of the changes on your LIC’s 2018/19 dividend strategy.
If you need any assistance, please contact your Pitcher Partners representative.