Tax Tip 295: Company Paid Tax is not the final Tax paid on its Income

If a company earns income it is taxed. Generally the tax rate is 30% or 27.5% for companies that are base rate entities. It is a flat rate so no matter how much or little the company earns the rate remains the same.


Companies can pay their profits out as dividends to shareholders. Dividends are income to the shareholders as well.

In order for this income to be not taxed twice there is a system called the imputation system which allows the recipient of a dividend paid by the company to get a credit for any tax paid by the company on the income that comes out as a dividend. This means that there could be more tax payable by the dividend recipient, or no further tax or even a tax refund.

Example

Lisa is on an income of $500,000 per year and her dad set up a company many years ago with her and her brother as the sole shareholder with this company paying out $20,000 in grossed up dividends to each of them each year.

Bart is still living at home and has no income yet.

They will each get $14,000 in fully franked dividends with $6,000 in franking credits.

Lisa will have an extra taxable income of $20,000 so she would have to pay 47% tax on this which is $9,400. But she has a $6,000 franking credit so this means she only has to pay top up tax of $3,400.

Bart on the other hand has no income, so his taxable income for the year would be just this $20,000 and the tax payable on $20,000 for a resident adult is nil. So Bart would not have to pay any tax and would get $20,000 back.


Net result is

Lisa receives $14,000 in dividends but pays $3,400 extra tax so Lisa ends up with $10,600 in her hands.

Bart receives $14,000 in dividends but pays no tax, so he gets back $6,000 in tax that the company paid and overall has $20,000 in his hands at the end.


2 people receiving the exact same income can have totally different results.

 

Care must be taken that the imputation (franking) is not compromised or tainted or lost.

Lets assume Fred Pty Ltd has paid tax on its $1m profits at 27.5% and its Director has at some point used $500K of company money for private purposes. The Director, Fred doesnt consider or comply (or want to comply) with the tax advice he sought. The ATO detect that he borrowed funds and doesnt have a complying Div 7A loan and therefore they consider that iat the time Fred drew the money it was income. The ATO assess Bill on the $500,000 he borrowed 2 years ago. No franking credit is allowed.

Between Bill and the company $372,500 tax has been paid on the $500K. Thats an avg rate of 74.5%. Many tax penalties surrounding company profits and franking can see the credits lost

 

Hi Terry - Good example - but maths again - Bart would get $6,000 in imputation credits (tax) back, he would correctly end up with $20k in his pocket as outlined correctly further in your example.