Franking and the new corporate tax rates

 

As tax practitioners will know, the maximum franking credit that can be allocated to a frankable distribution paid by a corporate tax entity is based on its applicable corporate tax rate for imputation purposes.

This can differ from a corporate tax rate, which is the rate of tax payable on a company’s taxable income (which is determined by whether the company is a small business entity or a base rate entity).

But with changes to the corporate tax landscape, and with the new base rate entity regime made law only recently (see draft law companion ruling LCR 2018/D7), it is understandable that many practitioners have experienced near deafening sound volumes made by the head scratching of their business clients.

Under the new rules, a corporate tax entity will not know its aggregated turnover, the amount of its base rate entity passive income, or the amount of its assessable income for an income year until after the end of that income year. Therefore, for the purposes of working out its corporate tax rate for imputation purposes for an income year, a corporate tax entity must assume that:

  • its aggregated turnover for the income year is equal to its aggregated turnover for the previous income year;
  • its base rate entity passive income for the income year is equal to its base rate entity passive income for the previous income year; and
  • its assessable income for the income year is equal to its assessable income for the previous income year.

The ATO says for the 2017-18 income year, the corporate tax rate for imputation purposes is 27.5% if either of the following applies:

  • the entity’s aggregated turnover in the 2016-17 income year was less than $25 million, and 80% or less of its assessable income was base rate entity passive income
  • the entity didn’t exist in the previous income year.

Otherwise, its corporate tax rate for imputation purposes is 30%.

Maximum franking credit
From the 2016-17 income year onwards, the maximum franking credit is calculated using the following formula:

  • Amount of the frankable distribution × (1 ÷ Applicable gross-up rate).

The “applicable gross-up rate” is the entity’s corporate tax gross-up rate for the income year in which the distribution is being made. The ATO says the applicable gross-up rate is calculated using the following formula:

  • (100% – the corporate tax rate for imputation purposes for the income year) ÷ the corporate tax rate for imputation purposes for the income year.

The ATO then offers two examples, one at the 27.5% rate and one at 30%.

Example 1: Franking a distribution at 27.5% tax rate
Pederman Plastics is carrying on a business, and in the 2016-17 income year has an aggregated turnover of $18 million. Its assessable income is $20 million, which includes $2 million of base rate entity passive income.

When franking distributions for the 2017-18 income year, Pederman Plastics assumes its aggregated turnover will be the same as it was in 2016-17.

Its 2016-17 aggregated turnover was under $25 million and only 10% of its assessable income was base rate entity passive income. This means its corporate tax rate for imputation purposes for the 2017-18 income year is 27.5% and it will frank its 2017-18 distributions based on this rate.

Pederman Plastics wants to distribute $100,000 profit to shareholders. The maximum franking credit it can attach to that distribution (based on the above formulas) is calculated as follows:

  • applicable gross up rate = (100% − 27.5%) ÷ 27.5% = 2.6364
  • maximum franking credit = $100,000 × (1 ÷ 2.6364) = $37,930.51.

Example 2: Franking a distribution at 30% tax rate
In the 2016-17 income year, Dillmore Manufacture has an aggregated turnover of $27 million.

Even though Dillmore Manufacture’s 2017-18 first quarter sales decline and it only expects a $20 million aggregated turnover in 2017-18, it assumes aggregated turnover for 2017-18 will be $27 million when working out its corporate tax rate for imputation purposes.

As prior year aggregated turnover was more than $25 million, its 2017-18 corporate tax rate for imputation purposes is 30%. It will frank distributions based on this rate.

Dillmore Manufacture wants to distribute $100,000 profit to their shareholders. The maximum franking credit it can attach to that distribution (based on the above formulas) is calculated as follows:

  • applicable gross up rate = (100% − 30%) ÷ 30% = 2.3333
  • maximum franking credit = $100,000 × (1 ÷ 2.3333) = $42,857.75.

Previous years
For the 2016-17 income year, the corporate tax rate for imputation purposes is 27.5% if either of the following apply:

  • the 2015-16 aggregated turnover was less than $10 million, and the entity is carrying on a business
  • this is the first year the entity is in business.

Otherwise, the corporate tax rate for imputation purposes is 30%.

For the 2015-16 and previous income years, the maximum franking credit that can be allocated to a frankable distribution for all companies was 30%.

Distributions issued using an incorrect tax rate
A company may have issued 2016-17 or 2017-18 distribution statements using an incorrect corporate tax rate for imputation purposes if:

  • based on Draft Taxation Ruling 2017/D7, the company now considers it is carrying on a business and is a small business entity eligible for the lower company tax rate (2016-17 distributions)
  • more than 80% of its assessable income is base rate entity passive income, making it ineligible for the lower company tax rate (2017-18 distributions).

If it has issued 2016-17 or 2017-18 distribution statements using an incorrect corporate tax rate for imputation purposes, the company should notify its shareholders of the correct dividend and franking credit amounts. This can be done by sending a letter or email to shareholders, or a revised distribution statement. It will also need to ensure the correct amounts are reflected in its franking account.

The franking percentage
The extent to which an entity has allocated franking credits to a frankable distribution is referred to as the franking percentage. This is calculated by dividing the franking credit allocated to the distribution by the maximum franking credit that may be allocated to the distribution. It is expressed as a percentage of the frankable distribution, rather than the whole of the distribution. This means that in circumstances where only part of the total distribution is frankable, the franking percentage could still be 100%.

Example: Identifying the franking percentage for a distribution
On 30 June 2018, Marlyn Pty Ltd distributes $11,667 to its shareholders. Marlyn Pty Ltd allocates franking credits of only $3,000 to the distribution, rather than the $5,000 maximum allowable in its circumstances.

The franking percentage for this distribution is calculated as follows:

  • ($3,000 ÷ $5,000) × 100% = 60%.

A company may choose the extent to which it wants to allocate franking credits to a distribution. It will need to take into account the existing and expected surplus in its franking account and the rate at which earlier distributions have been franked. However it cannot frank a distribution at a percentage greater than 100%.

Generally the only restriction on the ability to frank a distribution is the requirement to frank all frankable distributions within the franking period to the same extent – known as the benchmark rule.

If a company issues a distribution statement showing an amount of franking credit that exceeds the maximum amount allowable, then:

  • its franking account is debited by the amount of the maximum franking credit allocation rather than the amount shown on the distribution statement
  • the recipient of the franked distribution will only include the franked distribution and the amount of franking credit up to the maximum that could have been allocated on the distribution in their assessable income
  • the recipient is only entitled to a franking credit equal to the maximum amount.

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