Reducing the company tax rate: What’s the impact on shareholders?

The Coalition’s federal budget announced company tax rate reductions, so that by 2016-27 all companies will have a tax rate of 25%, delivered progressively from 2016-17.

The government’s budget paper also stated that dividends will be frankable in line with the rate of tax paid by a company.

Of course this depends on 1), the Coalition being re-elected, and 2) the announced measures being passed by the resulting Parliament. However, assuming these come to pass, and assuming that personal marginal tax rates remain the same, this means that Australian resident shareholders will pay more top-up tax on dividends as the company tax rate decreases.

Ultimately, the total tax liability on a company’s pre-tax profits will still be at the shareholder’s marginal rate, but a greater proportion of the burden will shift from the company to the shareholder over time. However, as the following analysis shows, the net cash received from the dividend will remain the same even though the shareholder will pay more tax directly.

Example

2015-16 2022-23 2026-27
Company pre-tax profit $100 $100 $100
Company tax rate 30% 27.5% 25%
Franked dividend received $70 $72.50 $75
Franking credits (100% franked)^ $30 $27.50 $25
Total assessable $100 $100 $100
Gross tax payable (marginal rate 37%) $37 $37 $37
Less: franking credits ($30) ($27.50) ($25)
Top-up tax payable $7 $9.50 $12
Net cash received (dividend received less net tax payable) $63 $63 $63

^ This simplified example ignores timing issues that are likely to arise in practice. For example, a company may pay dividends in 2025-26, when the tax rate will be 26%, out of prior year profits that were taxed at 27%. The Coalition has not yet released details about how the franking mechanism will work during the transitional years. Presumably, the dividends will be franked at 26% even though 27% tax had been paid.

(The above is extracted from a much longer analysis of the potential affects of the Federal budget on businesses, which was published in the member magazine The Taxpayer, June 2016 issue. Members can download the full journal here).

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