Topic 11 Taxation of Companies 2015

Week 10 Taxation of CompaniesTax losses, Dividend Imputation and Franking Account

ReferencesChapter 21

Key ConceptsDefinition of a companyPublic v privateReasons for distinctionDividend Franking AccountFranked UnfrankedImputation creditTreatment of various expensesLoansExcessive Remuneration LossesConsolidation

General ConceptsCompanies lodge a tax return each yearPay tax BAS, PAYG instalments Self assessment no assessment issued 4 years to amend 2 years if SBEFlat rate of tax 30% (on every dollar)

Definition of a Company s 995-1A body corporate; or any other unincorporated association or body of persons; butNot a partnership, or non-entity joint venturePublic company listed on any stock exchange in the worldNon profit companiesLife assurance companiesSemi Government bodiesSubsidiaries of public companiesCo op companiesOtherwise private companyDifferent from Corporations Act 2001 definition of public/private company

Public - Private CompanyImportant differences:Private Company: Loans to shareholders and associates - Div 7A, s 109B -109ZE ITAA 36 - a loan to a shareholder or associate is deemed a dividend unless commercial loan arrangementsPrivate Company: Excessive remuneration - s 109 ITAA 36 - deemed dividend and excess not deductible to companyAbility to claim carry forward losses

Dividend Imputation SystemFranked Dividend paid from profits that have been taxedTherefore carries an imputation creditDividend can be fully or partially frankedUnfranked dividendDividend paid from profits that are not subject to tax (difference between accounting and taxable income)Partly Franked DividendA combination of the aboveImputation CreditsRepresent how much tax was paid by the company in order to pay a franked dividendCompanies maintain a dividend franking account to record how much tax they have paid and therefore how much franked dividends they can pay out.

Imputation CreditKey to system is calculation of Imputation creditIn practice company paying you the dividend will tell shareholder the amount of the franking credit.Example:If a company pays a fully franked dividend of $1,000 what is the imputation creditAs dividend is from after tax income then the imputation credit is calculated as:Cash dividend x Company tax rate/(1-Company Tax rate)=$1,000 x 30%/70% = 429Proof:Company income is $1,000 +$429 = $1,429 x 30% = tax of $429 leaves a dividend of $1,000

Dividend ImputationCompany tax imputed to shareholder - avoids double taxationI July 1987 introduced in AustraliaCompany pays a franked dividend with franking credits from franking accountFranking account - credits for tax paid and debits for dividends paidExcess franking credits refunded, Div 67

Example Old systemCompany Taxable income 100Tax at 34% 34Net after tax profit paid as div 66

Tax in hands of shareholderTaxable income 66Tax at 60% 40

Total tax on $100 $74

Example of new systemCompany level

Taxable income100Less: Company tax 30%30-----Net corporate profit70Franking credit - franking account30

Shareholder levelFully franked dividend70Imputation credit30Gross up included in assessable income100

Example - contShareholder pays tax at 46.5% (income over $180,000)

Tax on 100 x 46.5 = $46.50

Tax payable - $46.50

Less: tax offset $30 - imputation credit

Tax to pay by shareholder - $16.50

Total tax paid on profit = $30 company + $16.5 individual = $46.50

Example of Individual receiving a dividendIndividual shareholder receives a 100% franked dividend of $10,000. The following amount is included in assessable income Dividend - $10,000Plus imputation credit: dividend x 30/70 (gross up) =$4,285Gross dividend included in Assessable income =$14,285Treatment by shareholder is the same whether shareholder is a company, trust, partnership or super fund

Example of Individual receiving a partly franked dividendIndividual shareholder receives a 50% franked dividend of $10,000. The following amount is included in assessable income Dividend - $10,000Plus imputation credit:Dividend x 30/70 (gross up) x 50% = 2,142Gross dividend included in Assessable income =$12,142

Franking RulesCompanies can frank to any percentage benchmark ruleBenchmark Rule - all dividend must be franked to same percentage during income year, but does not apply to public companiesExample:Private company pays a dividend of $140,000. The maximum franking credit is $60,000. If company attaches a franking credit of $30,000, it is franking to 50%. This sets the franking percentage for the rest of the year on any other dividends declared to 50%Penalty for breach - franking percentage differential - to stop companies retaining franking creditsCan not over frank as may be liable for franking deficit tax and franking additional tax

Franking AccountCredits from PAYG instalments and tax payableReceives a fully franked dividend credit for franking attached to dividendDebits Refund of income taxPayment of franked dividendFranking deficit taxObjective is to have nil or credit balance at end of year

Example of movements in the Franking AccountDateActivityDebit($)Credit($) Balance($)1/7/14Opening Balance3,00028/7/14Payment of 4th quarter tax instalment of $6,0006,0009,00030/9/14Fully franked dividend of $21,000 received Credit = 21,000 x 30/70 = 9,0009,00018,00028/10/14 Payment of 1st quartertax instalment of $9,0009,00027,00028/2/15 payment of 2nd quartertax instalment of $9,0009,00036,00022/6/15Payment of fully-frankeddividend of $14,000. Debit = $14,000 x 30/706,00030,00030/6/15Closing balance (openingbalance on 1 July 2015)30,000

Impact on ShareholdersShareholders need to include as part of income the imputation credits and then claim as a tax offset the imputation creditThe gross up of the income for the imputation credit needs to be done for all shareholders.

ExampleIndividualCash Dividend $700Imputation Credit $300

Tax rate 0% 19% 32.5% 37% 45%Cash Dividend 700 700 700 700 700Imputation credit 300 300 300 300 300Taxable Income 1,000 1,000 1,000 1,000 1,000

Tax payable 0 190 325 370 450Less Imputation 300 300 300 300 300 creditTax (refund)/payable (300) (110) 25 70 150

Example of Company as a shareholderTaxable Income

Business income 20,000Franked DividendCash 7,000Imputation Credit 3,000

Taxable Income 30,000

Tax Payable at 30% 9,000Less Imputation Credit 3,000

Net tax payable 6,000

Example of Company as a shareholder calculating how much loss it can claimAssume that the company has carry forward losses of $35,000Taxable Income

Business income 20,000Franked DividendCash 7,000Imputation Credit 3,000

Taxable Income 30,000

Less losses of 35,000Taxable income (5,000)

Tax Payable at 30% 0Less Imputation Credit 3,000

Net tax payable nilNet benefit of imputation credits lost therefore can only claim loss of $20,000 and still no tax payable

Example continuedIf only claim loss equal to income other than franked dividends thenAs in example aboveTaxable income is $30,000

Less loss of $20,000

Taxable income $10,000Tax at 30% $3,000Less Imputation credit $3,000No tax payable

Loss to carry forward of $15,000

Anti -Avoidance MeasuresPart IVA ITAA 36 - tax avoidanceCannot trade franking credits or stream dividends45 day holding period - must hold shares at risk for more than 45 days in order to claim franking credits and 90 days for Preference sharesDe minimis rule 45 day (90 day) only applies if more than $5,000 value of tax offset claimed using franking credits

Distribution - DividendsCompany - return to shareholder dividend, s 44Loan or benefit to shareholders/associates - deemed dividends Div 7ASection 109 excess payments by private companies to associates to be dividends and are assessable to recipient and non deductible to company

Loans Division 7APayments by company to shareholder/associatePayment includes transfer of property, crediting of accountLoans not repaid by the end of the current year and loan made on basis of being a shareholderForgiveness of debt

Brookton Co-Operative Society v FCTWhen is a dividend paid when it is declared by the Directors or distributed to the shareholders?The dividend is only paid and treated as income in the hands of the shareholder when actually paid and not just declared by the Directors. The Directors can rescind that decision at any time.

Company Loss TestsTest introduced to prevent tax avoidance through tax loss company tradingownership can be traced back through a group of companiessame business test requires no income to be generated from any other type of businessGrouping of losses - 100% subsidiary, now consolidation from 1 July 2003Net exempt income can reduce losses offset or carry forward

First Test Continuity of Ownership TestDivision 36 and Division 165, ITAA 97Section 165-13 and deduction under s 36-17.Conditions:Same persons own the same shares that gave them more than 50% of the Voting power,Rights to dividends,Rights to capital distributionOwnership test must be met from the time the loss was incurred all the way through to when the loss is utilised (covers intervening income years)Can trace through company shareholding (alternative test)

Example 1In the loss year the shares of Company X were owned by:A 12%B 40%C 48%In year 3 , Company X has taxable income and wants to use up the losses. Since the loss year the share holding has changed to:A 64%B 23%C 13%As the same shareholders owned more than 50% of the shares in the loss year and the income year as well as the intervening year Company X can deduct the prior year loss.

Example 2Assume the same shareholding as in Example 1 but that in year 3 the shareholding is:A 40%BD Pty Ltd 60%B and D own 50% each of the companyWhere there is an interposed company the alternative test applies which is:Is it reasonable to assume that there are people that are able to:Control the voting power,Get more than 50% of the dividend andGet more than 50% of the capitalIf satisfied then meet the Continuity of Ownership Test

Second Test Same Business Testif not same owners, must have carried on same business, no new or additional businessTest is that The company carries on the same business as it did immediately before the change in majority ownership occurred at all times in the income year where there are prior losses and at all times in the year where there are current lossesThe company must not derive income from a new kind of business or transaction,Start a business or initiate a transaction to meet the same business testIf income is greater than $100m then does not need to meet the same business testSame business test is set out in TR 1999/9

Examples of the Same Business TestA company carried on the business as a dealer in motor parts and accessories. After the change in ownership it did the same business but under another name, at a different place with different directors and employees with different stock and plant in conjunction with a dealer having a different franchise Did not meet the SBT (Avondale Motors case)

Avondale Motors (Parts) v FCTWhat is required in order to satisfy the continuity of business test to claim carry forward losses?Ownership very easy, but continuity of business requires the same business, an identical business. High Court must be identical business and not a similar business. Company was bought because of the losses. The new business changed the name of the company but the business activities were not identical.

Examples of SBTA company carried on the business of distributing and installing swimming pools was not the same as a business of manufacturing , selling and installing the pools

Company lossesCompany can determine the amount of the tax losses they can in an income year to avoid losing imputation creditsCapital losses - same tests applyForeign losses - cannot be used to offset Australian income, carried forward to offset foreign profitBad debts - must satisfy loss tests.Deductible under s 25-35, ITAA 97

ConsolidationEffective from 1/7/02Group companies can elect to be treated as one company for tax purposesHolding company must elect to consolidateBenefit is one tax return and subs treated as divisions of the holding company