Banking on Tax, Issue 13

Article

Impact of company tax rate reduction and paid parental leave levy on capital management

Banking on Tax, Issue 13

In the lead up to 1 July 2015, three coinciding factors will require additional consideration be given to the franking account balances of companies to ensure that shareholder value is maximised.

In the lead up to 1 July 2015, three coinciding factors will require additional consideration be given to the franking account balances of companies to ensure that shareholder value is maximised.

  1. The corporate tax rate is expected to be reduced from 30% to 28.5%
  2. ‘Large’ companies are expected to be required to pay a paid parental leave (PPL) levy at a rate of 1.5%
  3. Currently, it is not expected that there will be any transitional or consequential amendments made to the dividend imputation system for these changes (but this should be monitored).

Based on the limited detail contained in the Coalition’s pre-election policy document, the PPL levy is expected to:

  • Apply to companies with taxable income in excess of $5 million, and only to the portion above that amount
  • Be non-deductible
  • Not generate franking credits.
Banking on Tax, Issue 13

A simple example of this is illustrated below (assuming pre-tax profits equals taxable income):

  Prior to 30 June 2015 From 1 July 2015
Pre-tax profits 100 100
Company income tax 30 28.5
PPL levy 0 1.5
After tax profits 70 70
Franking credits 30 28.5
Maximum franking amount on a $70 dividend  30 27.9

 

As a result, the after-tax profits of a large company will not change, even though the corporate tax rate has been reduced. 

As a result of the corporate tax rate reduction, the maximum franking amount for a dividend is likely to be reduced from 1 July 2015. The maximum franking amount is calculated under section 202-60 of the Income Tax Assessment Act 1997 (ITAA97) as the amount of the distribution x (corporate tax rate/1-corporate tax rate). So, a dividend of $70 currently has a maximum franking amount of $30. From 1 July 2015, the maximum franking amount would reduce to $27.90 for the same $70 dividend. This will result in ‘trapped’ franking credits. In other words, fewer franking credits will be distributed for the benefit of shareholders when a dividend is paid, reducing the after-tax cash position of a shareholder.

No transitional or consequential amendments to the dividend imputation system have been indicated. By contrast, when New Zealand recently reduced its corporate tax rate, it introduced transitional provisions to allow franking credits generated at the previous corporate tax rate to be distributed at that rate for a period after the corporate tax rate was reduced. The equivalent response in Australia would be an amendment to section 202-60 of the ITAA97.

On an ongoing basis, trapped franking credits may arise as the PPL levy will reduce profits but will not generate franking credits.

Separately, the appropriate treatment of the PPL levy for financial statement purposes should be considered.

In some cases, it is expected that companies could consider special dividends or other capital management strategies, such as share buy-backs, to distribute franking credits prior to 1 July 2015. On the other hand, companies wholly owned by non-residents may consider deferring dividend distributions until after 1 July 2015.

In order to maximise share price, shareholder value and after-tax cash for shareholders, companies will need to monitor current and forecast franking account balances and distributable profits, having regard to profit forecasts, expected tax payments and scheduled distributions.

In the absence of transitional provisions at 30 June 2015, and on an ongoing basis, companies will need to consider how best to manage their franking account balances in the interests of shareholders. 

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