Advisers with clients that own small businesses can be a valuable source of advice for those that operate through a company structure and, if the Labor party wins the next federal election, for those that have a family discretionary trust.

In my last column I detailed the problem that had been created by the coalition, through its so-called assistance to small business owners, reducing the company tax rate down to 27.5 per cent.

By not allowing company dividends to be frank at different imputation rates, which reflected the higher company tax rates of 30 per cent and 28.5 per cent and franking all dividends at 27.5 per cent for the 2017 and later financial year’s, shareholders face the risk of losing the benefit accumulated franking credits.

When the ATO was asked if unused franking credits could be attached to untaxed income in a company an ATO spokesman said, “Surplus franking credits in a company’s franking account are available to frank dividends that might relate to tax preferred income of the company.  Examples of tax preferred income that may arise for companies are:

  • Income that is not assessable to the company,
  • Income that has been sheltered from a timing difference on account of different depreciation rates for tax and accounting purposes, and
  • Income that has been sheltered from timing differences resulting from special tax incentives such as the $20,000 instant asset write-off, or R&D incentives.

One area where advisers can add value for clients with small businesses operated through a company, which find themselves with a large balance of unused franking credits due to the reduction in the franking rate, is how the excess credits can be attached to the un-taxed profit made on the sale of a business.

Previously there was no tax benefit by a company claiming the 50 per cent active asset discount on the sale of the business. This is because when an untaxed accumulated profit is distributed to shareholders it was classed as an unfranked dividend and tax is paid at the shareholders applicable marginal rate.

By attaching unused franking credits to profits not taxed in the company’s hands, means the company can claim an amount of the 50 per cent of active asset discount that results in a fully franked dividend.

If the Labor party wins the next federal election it has stated that it will introduce a new tax on distributions from discretionary family trusts. The way that the new tax will be levied on beneficiaries is similar to the way that non-residents are taxed. Beneficiaries of family trusts will pay a minimum tax rate of 30 per cent on income distributed to them.

This means an individual that receives only trust income will not get the benefit of the $18,200 tax-free threshold or the lower 19 per cent marginal tax rate. Instead they will pay 30 per cent on all trust distributions up to $37,000. Income above this level will be taxed at normal marginal tax rates.

This would mean for a small business operated through a family discretionary trust, which distributes income to a spouse also involved in the business that has no other income, tax of $11,100 would be paid on $37,000 distributed to them, rather than the $3572 that is currently payable.

Advisers will not only add value for their clients by letting them know how this new tax will affect them, if they have a family trust that either operates a business or earns investment income, but by looking at strategies that will result in beneficiaries having other taxable income in addition to the distribution from the family trust.

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