Transitional Tax Cuts Leave SME Owners Paying More Tax

By Alexis Kokkinos - September 12, 2016

Shareholders in SMEs with a turnover of between $2m and $10m will end up paying at least 1.76 per cent more tax in the 2016-17 transitional period between the 30% company tax rate and the 27.5% company tax rate, according to Pitcher Partners’ Alexis Kokkinos.

“There is a problem that creates a higher tax burden for SMEs moving to the new company tax rates,” said Kokkinos.

“Whilst the Government is giving out a tax cut of at the company level, if a company pays a franked dividend in the year after it paid the 30% tax rate, the shareholder will only be entitled to an imputation credit at 27.5%.

“For a small business owner, that receives a $100,000 dividend a year, the effective tax rate increases from 41% to 43%, after taking into account the tax rate cut.  This means that over a 7 year period, the small business owner is worse off by $20,345, even after taking into account the tax rate cut.

“If the small business owner is on the top marginal rate for the income year that they pay a dividend, they will end up paying 1.76% more overall tax as they are only able to claim franking credits at the 27.5% rate.

“This represents an increase in the effective top marginal tax rate from 49% to 50.76% for small business owners.

The following table explains the increase in the effective tax rate.  The top marginal tax rate has been used to keep the example simple, however the same issue arises for all marginal rates (as outlined above):

 

 

Existing rules

Proposed rules

 

 

2015/16

2016/17

2015/16

2016/17

 

 

 

 

 

 

Profit before tax

 

1,000,000

 

1,000,000

 

Tax (@ 30%)

[A]

300,000

 

300,000

 

Profit after tax

 

700,000

 

700,000

 
 

 

       

Dividend paid (franked component)

 

 

700,000

 

700,000

Franking credit

 

 

300,000

 

265,517

Total taxable dividend

 

 

1,000,000

 

965,517

Individual tax (@ 49%)

 

 

490,000

 

473,103

Individual tax after franking offset

[B]

 

$190,000

 

207,586

 

 

 

 

 

 

Total tax by company and individual

[A+B]

 

490,000

 

507,586

Effective tax rate on profit ($1M)

 

 

49.00%

 

50.76%

Additional tax %

 

     

1.76%

Additional tax amount

 

     

17,586

“Ultimately, the company will not be able to realise the difference between the 30% tax paid on profits and the 27.5% dividend imputed to shareholders,” said Alexis Kokkinos. 

“The difference will become an unused franking credit and will remain with government.

“Small business owners that transition into the new tax rates will be in an appreciably worse tax position as a result of the decrease in the company tax rate.

“The provisions should provide some transitional relief to small business owners. The provisions should either allow after tax profits that existed at a company’s transition date (e.g. 30 June 2016) to be franked at the 30% tax rate, or at least provide a transitional period where pre-existing profits can continue to be franked at 30%.  This would be a fair and equitable outcome for small business owners.

“There are no transitional provisions to address this issue. Furthermore, no warning was provided to transitioning companies where these rules apply retrospectively to 1 July 2016.”

For further information please contact:

Alexis Kokkinos, Partner, Pitcher Partners, 03 8610 5170

Sabine Wolff, Media and Communications Advisor, Pitcher Partners, 0419 529 577


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