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The sting in the tail of the small business tax cut

In the 2017 May budget, there was some good news for small business – the Federal Government announced a measure whereby corporate tax rates would be reduced for small businesses entities across Australia.

It meant 870,000 businesses, employing 3.4 million Australians could look forward to having their tax rate reduced. Great news, right?

Well, yes…and no. Like many Government initiatives, the true nature of policy change is felt on the ground and, as it turns out, there’s a sharp sting in the tail of the small business tax cut.

 

Reductions that bite

Under the new arrangement, the maximum amount of franking credits (or tax credits) that can be allocated to a company dividend will be based on the income tax rate paid by that company in the current year (see table below).

 

Income Year Aggregated Turnover Corporate Tax Rate
2016 <$2 million 28.5%
2017 <$10 million 27.5%
2018 <$25 million 27.5%
2019 to 2024 <$50 million 27.5%
2025 <$50 million 27%
2026 <$50 million 26%
2027 and later <$50 million 25%

Any company that’s paid tax at 30% prior to the budget will feel the ‘sting’. Why? Because companies like these will only be able to pass on a tax credit to shareholders at the relevant tax rate they’re currently paying.

The following example explains how this plays out:

Company A which pays a dividend of $100,000 in the 2016/2017 financial year, will only be able on pass on tax credits of $37,931, instead of $42,857 – a shortfall of $4,926. And the size of the deficit only becomes greater as the tax rate reduces. These are not good numbers for small business.

 

Overtaxed for overachieving

SME owners who operate their businesses through a company structure ultimately pay tax as an individual – by receiving dividends from the company. So, any benefit is based on the tax already paid by the company.

The issue is this: business owners who don’t clear all the company profits as franked dividends, will effectively be “overtaxed”. And that’s because it’s quite normal for SMEs to set aside profit in order to better manage the cash flow pressures faced by their business. There’s little doubt that the number of small business owners facing a scenario such as this will be high.

The sting in the tail is not without a sense of irony either because the result is completely at odds with how the imputation system is supposed to work. It’s not simply unfair, it’s daft. What sensible system or policy penalises success?

In an economy that’s struggling to maintain momentum and growth, it makes no sense to punish businesses that dare to make a profit – particularly SMEs.

We’re calling this out for what it is – bad policy. And as we move into financial year 2017/18, we hope that common sense prevails and this legislation is amended accordingly.

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About the Author

I'm a chartered accountant with over 20 years experience providing small-to-medium businesses with accounting and taxation services. I have run my own accounting practice for over 10 years, so I understand what it’s like to be a business owner.