Investment company Century Australia wrote to shareholders last week to tell them it was recalculating the franking credits it had issued with dividend payments made during the 2016/17 financial year.
Century’s turnover in the 2016/17 financial was below $10 million, which means that under the new company tax rates, its rate for the year is 27.5 per cent.
For companies with turnover of up to $10 million in the financial year ended June 30, 2017, the company tax rate falls from 30 per cent to 27.5 per cent.
The maximum franking credit entitlement for a frankable distribution is based on the company’s tax rate in the prior income year.
And because the tax legislation has retrospective effect back to July 1, 2016, franking credits are affected.
In Century’s case, ordinary dividends were paid in September last year and May this year, and a special dividend was also paid in May. All were fully franked at 30 per cent.
Century says: “We are currently working with our share registry to recalculate the revised franking allocations for the dividends paid during the 2017 financial year.
“Once this is complete, we will inform shareholders impacted by this change and provide them with amended dividend statements.”
As Century’s case shows, dividend distribution statements previously provided to shareholders are no longer accurate if the franking credits were calculated at the higher company tax rate of 30 per cent and the company now qualifies for a lower tax rate.
Peter Bembrick, a taxation services partner at HLB Mann Judd, says he is seeing a number of clients that have been put in a similar position by the company tax change.
“In one case, a private company with a small number of shareholders paid dividends back in September. We had to provide an updated statement to the shareholders and update the franking account,” Bembrick says.
Bembrick says this may be an ongoing issue for companies, to the extent that they have paid tax at 30 per cent over a number of years and accumulated franking credits at that rate. “They will only be able to pay them out at the lower rate,” he says.
There is more to the change than an administrative hassle.
Robert Deutsch, senior tax counsel at the Tax Institute, explains: “The change to the imputation rules means a small business will have to frank dividends at the rate of 27.5 per cent. This could have the effect of ‘trapping’ franking credits in the company and lead to the real possibility that much excess credit will be wasted.
“While we support the reduction of the company tax rate for small business, we do not support the wastage of franking credits. This is an unfair burden to place on small business.”
Any company with historical franking credits as a result of tax payments paid at a 30 per cent rate will effectively have some of their historical tax payments wasted, as the tax that has been paid by the company at 30 per cent can only be passed through to shareholders at the lower corporate tax rate that applies in the year the dividend is paid – 27.5 per cent.
Tax commentators like Deutsch says this is an unfair outcome for companies that have a balance of retained earnings and franking credits.
More companies will be affected when the lower company tax rate applies to companies with turnover up to $25 million.
In a note to clients on the issue, chartered accountants Lowe Lippmann says: “While a reduction in the tax rate will clearly benefit companies, consider that the profits earned by the company will eventually be paid to shareholders in the form of dividends and it is necessary to consider the taxation of these dividends when determining the total tax paid on company profits.
“These changes will be important for small companies that have a small number of shareholders. A reduced franking credit rate may lead to a higher personal income tax liability.”