1 July Company Tax Rate Reduction

In a time of economic uncertainty, the Australian Government is proceeding with a plan to progressively reduce the company tax rate for small and medium businesses. Starting from 1 July 2020, the company tax rate for eligible entities will decrease to 26%, down from 27.5%. This reduction is part of a broader initiative to further lower the rate to 25% by 1 July 2021, aiming to support growth, investment, and job creation within the small and medium business sector.

Who Benefits from the Reduced Tax Rate?

The tax reduction applies to base rate entities (BREs). These include companies, corporate unit trusts, and public trading trusts that meet the following criteria:

• Aggregated turnover: Less than $50 million.
• Passive income threshold: No more than 80% of the entity’s turnover can be classified as base rate entity passive income.

Larger companies with turnovers exceeding the $50 million threshold will continue to pay the standard 30% corporate tax rate.

The progressive tax reductions are outlined as follows:

	2018-19 and 2019-20	2020-21	2021-22
Base rate entities*	27.5%	26%	25%
Other corporate tax entities	30%	30%	30%

*aggregated turnover less than $50m and no more than 80% of the company’s assessable income is base rate entity passive income.

Impact on Dividend Franking Rates

The reduction in the corporate tax rate also affects the maximum franking rate that can be applied to dividends paid by base rate entities. Dividends distributed to shareholders are franked at a rate aligned with the company’s tax rate in the previous financial year.

For instance:

• A company classified as a BRE in the 2019 income year would have paid tax at 27.5%. As a result, dividends paid during the 2020 income year would be franked at a maximum rate of 27.5%.
• For the 2021 income year, the maximum franking rate drops to 26% for BREs taxed at the lower rate in the previous year.

This change means shareholders may receive dividends with a lower tax credit attached, depending on when the dividends are paid.

Strategies for Utilizing Franking Account Balances

Many companies accumulate franking credits over time, which reflect tax paid at historical rates. With the impending tax reductions, companies need to consider how best to utilize these credits efficiently.

Key Strategies

1. Bring Forward Dividend Payments:
   If a company has sufficient cash flow, it may be advantageous to pay dividends earlier to maximize the use of higher franking rates (e.g., 27.5% for dividends paid in the 2020 income year). This ensures shareholders benefit from larger tax offsets before the franking rate drops further.
2. Plan for Future Distributions:
   Companies can develop a long-term dividend strategy that aligns with cash flow and tax rate changes. For example, retaining some profits for future dividends may make sense when the tax rate stabilizes at 25%.
3. Communicate with Shareholders:
   Transparent communication with shareholders regarding franking rates and dividend strategies is essential, as changes may impact their tax position.
4. Seek Professional Advice:
   The interaction between corporate tax rates, franking credits, and shareholder taxation can be complex. Consulting with a tax professional can help businesses navigate these changes effectively and optimize outcomes for both the company and its shareholders.

Long-Term Implications of the Tax Reduction

The phased reduction in the company tax rate is designed to stimulate investment and economic activity by leaving more after-tax profits in the hands of businesses. For small and medium enterprises, the benefits include:

• Increased Retained Earnings: Lower tax rates mean businesses can reinvest a larger portion of their profits into operations, expansion, or innovation.
• Enhanced Competitiveness: A lower tax burden allows Australian businesses to compete more effectively on a global scale.
• Shareholder Benefits: While the reduced franking rates may initially appear less favorable, the overall tax savings at the company level can translate into higher net returns for shareholders in the long run.

Challenges to Consider

While the tax reductions are beneficial, there are challenges and considerations businesses must address, including:

• Cash Flow Management: Bringing forward dividend payments or adjusting financial strategies must be balanced with maintaining adequate working capital.
• Tax Planning: Navigating the transitional periods and aligning tax strategies with the new rates require careful planning.
• Administrative Complexity: Changes to franking rates and their impact on shareholder communications add an administrative burden for some companies.

The reduction in the company tax rate to 26% from 1 July 2020 is a welcome development for small and medium businesses. As the rate drops further to 25% in 2021, companies have an opportunity to capitalize on the savings and reinvest in growth. However, navigating the associated changes to dividend franking rates and planning for the future requires proactive management and, in many cases, professional advice.

If your business is impacted by these changes, now is the time to review your financial strategies. Speak to a tax expert to ensure you’re making the most of the new company tax rates and preparing for the opportunities ahead.