Chapter+2+The+Tax+environment

Topic1

Chapter 2

The Tax Environment

Objectives

Describe the key elements of the Australian taxation system

and explain the significance of dividend imputation.

Why are taxes relevant?

• Taxation is usually a mandatory cash outflow

• The real-world wealth of business owners is always after-tax wealth

• Taxation affects the amount of the firm’s cash flows available to its owners

Introduction to income taxation

Depends on:

• Type of taxpayer

• Taxable income

• Tax rate

• Company

• Individual

• Partnership

Assessableincome

minus

Allowable deductions

Marginal (individuals) vs

Flat (companies)

Profit

Taxable

income

Introduction to income taxation

NetProfit

Tax1:Determine net profit before tax

2: Calculate taxable income (likely to be different to profit)

5: Pay tax to government (cash outflow)

3: Multiply taxable income by tax rate to compute tax

4: Determine net profit after tax

Our 2012-2013 Individual Progressive Tax regime

Taxable income Tax payable

Up to $18,200 Nil

$18,201 - $37,000 19% on amounts over $18,200

$37,001 - $80,000 $3,572 + 32.5% on amounts over $37,000

$80,001 - $180,000 $17,547 + 37% on amounts over $80,000

Over $180,000 $54,547 + 45% on amounts over $180,000

Example 1: Taxable income: individual (p. 30)

• Jane Piper has been working as an apprentice plumber for J & S Plumbing.

• For the financial year just ended on 30 June she received gross wages of $45 000.

• During the year she purchased protective clothing and boots costing $250 and she spent $250 on replacing some of her plumbing tools that had been damaged.

• She can claim both of these expenditures as allowable deductions.

• Calculate her taxable income

Example 1: Taxable income: individual (p.30)

Calculation of tax payable for Jane Piper

Example 2: Taxable income: business (p.30)

• During the financial year just ended on 30 June, J & S Plumbing earned from the provision of plumbing services a gross income of $600 000.

• The cost of materials purchased during the year totalled $230 000 and other operating expenses were $100 000 (the break-down of these costs is shown below).

• The business has $125 000 in debt outstanding, at a 16% per annum interest rate, which resulted in $20 000 interest expense for the year

(i.e. $125 000 × 0.16 = $20 000).

• Calculate the taxable income of J & S Plumbing

Example 2: Taxable income: business (p.30)

Tax payable: company

Calculation of tax payable for J & S Plumbing

Australian company tax rate: 30%

Taxable income:$250,000

Tax payable: = 0.30 x $250,000

= $175,000

Tax payable: Example 3 other structuresPartnership:

• Taxation of The J&S Plumbing Partnership

• Assumptions:

Partners: Sue – entitled to 10% of income

John – entitled to 90% of income

• Both receive no other income

• Both have no allowable deductions

• Calculation process:

• Sue includes 10% x $150,000 income in her individual tax return. i.e. she pays $1,350 tax

• John includes 90% x $150,000 income in his return and pays $47,000 tax

Example 2.4: Tax rate: other structures (p.32)

Partnership:

• Taxation of The J&S Plumbing Partnership

Sue John Total

Partnership share10% 90% 100%

Taxable income $25,000 $225,000 $250,000

Tax payable $2,850 $74,800 $77,650

Net income $22,150 $150,200 $172,350

Tax payable: summary

• Compare the tax position of each structure:

J&S Plumbing J&S Plumbing Partnership

Ltd Sue John Total

Taxable income $250,000 $25,000 $225,000 $250,000

Tax payable ($75,000) ($2,850) ($74,800) ($77,650)

Net income $175,000 $22,150 $150,200 $172,350

Dividend imputation

• A classical tax system has one major drawback:

DOUBLE TAXATION

• Occurs when profits are taxed at both source, and on receipt

Example 2.6: Dividend imputation (p.35)

• Example:J & S Plumbing Ltd

Before Tax 250 000Company tax paid 75,000After tax income 175,000

The partners pay $47,950 tax on their shares of the net income in addition to the $75,000 paid by the company

Dividend imputation

• The solution: Dividend Imputation

• Introduced in 1987

• Ensures that company net income paid to shareholders as dividends is taxed only once, at the shareholders’ marginal personal income tax rates

Dividend imputation: mechanics

• Tax paid by the company is “imputed” to the shareholders

• Allowed as a credit in the shareholders’ tax payable computation (+)

• Calculate Tax payable (-)

• Add both credit and tax payable

Dividend imputation: mechanics (cont’d)

• Dividends can be fully franked, partially franked, or not franked at all

• Franking percentage is dependent on company’s available franking credits

• Franking credits are dependent upon tax paid by the company

Dividend imputation: franking credits

• Calculation of personal tax payable on fully franked dividends

• J&S Plumbing Ltd is owned by John (90%) and Sue (10%)

• J&S Plumbing Ltd had taxable income of $250,000

Franked and unfranked income/Dividend

Fully franked dividend is dividend that a company pays out

of income where tax has been paid.

If company has not paid tax of an income from which

dividend is declared, the dividend is called unfranked

dividend.

Franking Credits calculation

Tax paid by company $ 75 000

Credit allowed to shareholders $ 75 000

John (90%) of $ 75 000 $ 67 500

Sue (10%) of $ 75 000 $ 7 500

Example 2.7: Dividend imputation: franking credits (p.39)

Calculate as if it is personal income 172 350

Example 2.8: Dividend imputation: unfranked dividend (p.40)

Example 2.9: Dividend imputation: unfranked dividend (p.41) (cont’d)