From 1 July 2015, companies with aggregated turnover of less than $2 million – called Small Business Entities or SBEs – had their tax rate reduced from 30% to 28.5%.
At that time, the franking rate for dividends paid by SBE companies was maintained at the general corporate tax rate of 30%.
This month, the Government introduced a Bill that will reduce the tax rate of SBE companies further, to 27.5%, with effect from July 1 2016, and also change the franking system.
It is the franking system changes that will present a significant challenge for SBE companies.
The Government has taken a different approach to the franking issue, requiring SBE companies to use a franking rate based on their current year tax rate of 27.5%, even though the underlying profits from which the dividends are paid might have been taxed at 28.5% or 30%. This creates a risk of "wasted" franking credits.
For example, if an SBE company had a taxable income of $100 in 2014/5, it would have paid $30 in tax, leaving $70 after paying tax.
Before these changes, this amount could be paid out as a dividend, with franking based on the 30% corporate tax rate as a $70 fully-franked dividend with $30 of franking credits.
If the same company were to pay the same $70 as a fully-franked dividend in the 2016/7 year, it could only frank the dividend using the franking rate of 27.5% which equates to $26.55 of franking credits (less than the tax actually paid on the underlying profit).
This means that potential franking credits are trapped in the company's franking account, as less credits can be attached to every dollar of profit, increasing the tax burden on shareholders by increasing their "top-up tax" payable on the dividend.
While in the short term this will impact on SBE companies, in the future this will impact on any company subject to the new 27.5% tax rate.
The changes outlined above were introduced into Parliament as part of the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016 on 1 September 2016 and when passed will take effect from 1 July 2016.