Avoid losing valuable franking credits


Avoid losing valuable franking credits

As you no doubt know by now, the corporate tax rate for small business entities has been reduced to 27.5% from the standard corporate rate of 30%, effective from the 2016-17 financial year.  Find out how this poses a real risk of excess franking credits being wasted. 

The corporate tax rate reduction to 27.5% applies to small business entities.  A small business entity is one that carries on business in an income year and has aggregated turnover in that year of less than $10 million.

The problem that arises from this change is that the bench marking rate for a company that is a small business entity drops form 30% to 27.50%.  As dividends can now only be franked at a maximum of the applicable corporate tax rate, any accumulated earnings can only be franked at a maximum of 27.50%.  This could potentially result in excess franking credits being wasted.

To give an example, say ABC Company Pty Ltd has been trading at around $8 million turnover for a number of years and has made $100,000 taxable income for the past five years, but has not paid a dividend.  In June 2017 it wants to consider paying out shareholders and finalising the company.

At June 2017 its franking account looks like this:

If the company continues to trade and the small business entity tax rate stays at 27.50% (or lower as is planned) then those excess franking credits can never be used.  In addition, shareholders may have to fund the shortfall between the imputation credit and their own marginal rate of tax, particularly in relation to years where the 30% rate applied.

One solution is to liquidate the company and pay distributions to shareholders in a later year, i.e. when the company has ceased to trade.  If a company ceases to carry on a business, it is no longer defined as a small business entity, and therefore reverts to the corporate tax rate of 30%.  All distributions can then be franked at a maximum rate of 30%, or to the extent of franking credits available.

For companies nearing the end of their useful lives, it will be worth planning the eventual liquidation and deregistration around the franking credits available.  A members’ voluntary liquidation is a good way to potentially unlock these franking credits.

It would be worthwhile considering whether to delay all distributions until the liquidation of the company has started, and ensuring that the maximum corporate tax rate can be used as much as possible, especially to avoid leakage or wastage of franking credits.

If you want to consider how this can best be planned for your individual circumstances, speak to one of the team at dVT Group today on 02 9633 3333.