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Are you eligible for the reduced corporate tax rate?

Have you assessed when you may be eligible for the new corporate tax rate and the consequences of transitioning to such a change?
On 19 May 2017, legislation received Royal Assent to enact corporate tax rate reductions. This measure is consistent with the 2016-17 federal budget.
 
What are the corporate tax rate changes?
The new legislation reduces the corporate tax rate for companies that are carrying on a business with aggregated turnover below the relevant threshold for the applicable income year (worked out at the end of the income year). The turnover thresholds and the applicable income year are outlined in the following table.
 
Income year

Annual aggregated

Turnover threshold

Company

tax rate (%)
2016-17 $10 million 27.5
2017-18 $25 million 27.5
2018-19 $50 million 27.5
2024-25 $50 million 27
2025-26 $50 million 26
2026-27 and later income years $50 million 25
 
What is aggregated turnover?
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. Therefore, passive income (unrelated to a business) can generally be excluded.
The measure also groups turnover received by affiliates and connected entities, but excludes certain intra-group transactions.
 
Impact on franking (loss of 2.5%)?
A company will frank its dividends based on the prior year aggregated turnover, rather than the current year aggregated turnover. This can result in companies having a different tax rate as compared to their franking rate (and may result in franking errors – see below). This may impact companies that transition to a new (lower) tax rate and have retained earnings that have already been taxed at a higher rate.
The following table provides an example of the potential impact of the reduction in the corporate tax rate on franked distributions
 

Retained earnings
before change

Franking account
balance before
change

100% franked
distribution at the
lower rate (27.5%)

Loss of potential
franking credits
(additional tax
payable)
700,000 300,000 265,517 34,483
2,000,000 857,143 758,621 98,522
25,000,000 10,714,286 9,482,759 1,231,527
 
Can a company accidentally over-frank or under-frank?
Yes. This will especially be the case for the 30 June 2017 income year, where legislation has only recently been passed.
It may be mistakenly thought that a company is able to frank a dividend at the 30% tax rate in circumstances where the maximum franking credit is actually only 27.5%. This is because the current year tax rate is calculated on the current year turnover, while the franking percentage is calculated on the prior year threshold. This may result in over-franking or under-franking by 2.5%.
 
Can a corporate beneficiary apply the lower tax rate?
This depends. The change in tax rate will only apply to entities that carry on a business with aggregated turnover below the relevant threshold. If a corporate beneficiary does not carry on an active business, it will continue to be taxed at 30%.
 
What is the impact if you are operating through a trust?
If you operate through a trust (and distribute to a corporate beneficiary) future profits derived by the trust will likely be taxed at the 30% tax rate. However, whether the corporate tax rate changes provide a material difference will depend on the circumstances. The benefits associated with the corporate tax rate cut would prima facie amount to 2.5% of future taxable income retained by the company.
However, to the extent that the company pays a dividend, this difference can effectively be reversed through a lower franking percentage (and lower franking credits), resulting in a higher amount of tax being paid at the individual shareholder level. By way of example, if only $200,000 of before tax profits is retained in the company, then this would amount to a tax saving of only $5,000 at the lower corporate tax rate of 27.5%. This benefit would only be temporary until a dividend is paid by the company to an individual.
 
Should a trust restructure to a corporate vehicle?
If the corporate tax rate changes provide a material benefit, restructuring a group to access the lower corporate tax rate may be an option. However, any restructure should accommodate the broader strategies of the group. This requires consideration of a number of issues, such as (but not limited to): the tax implications on restructuring (including income tax, stamp duty, and GST); asset protection; the ongoing operations of the business; the ability to access tax losses within the group; and the impact of moving to a corporate structure on the disposal of business assets (including goodwill).
 
What options are available to restructure?
There are a number of ways to implement a restructure from a trust to a company. An effective restructure for many groups may be as simple as incorporating a services entity within a group of trusts or moving the business to a company through tax concessions and rollovers available. It is important to consider all of the possible options to determine the best structure for your group.
 
Do you need to restructure by 30 June 2017?
It may not be necessary to restructure by 30 June 2017, especially if the reduction in tax rate does not have a significant impact on the total amount of tax expected to be paid. However, it is important to properly consider the many issues associated with a restructure to ensure that adverse tax consequences are not inadvertently triggered by a rush to restructure by 30 June.
Are there other things you should consider before 30 June? You may need to consider whether you establish a new corporate beneficiary before 30 June 2017 (for example, if profits are to be quarantined outside of the operating group).
 
What about groups with aggregated turnover in excess of $50 million?
There is currently a bill before the House of Representatives which reduces the corporate tax rate for entities with aggregated turnover in excess of $50 million. There is some doubt as to whether this proposed change will pass. As this is not yet law, there is no immediate action required by groups with turnover greater than $50 million. However please be aware of the future application of the tax rate cut, particularly for entities with significant after-tax retained earnings.
 
For further information please contact Pitcher Partners on (02) 4911 2000, email newcastle@pitcherpartners.com.au or visit www.pitcherpartners.com.au

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