As many would be aware, further to this year’s Federal Budget, from 1 July 2015 the Government is proposing to:

• reduce the company tax rate from 30% to 28.5%; and
  
• introduce the paid parental leave (PPL) levy on “large” companies.  
  

What may not have been considered to date are the potential impacts of these changes to shareholder value. From a shareholder perspective, a change in tax rate could result in franking credits getting trapped in the company and ultimately result in an increase in the overall taxation paid by shareholders on company profits. To maximize shareholder value it is important that dividend distribution policies and capital management policies be reviewed.

At this stage, there is limited detail available on these proposals, and the Government will need to navigate its way through the new Senate taking its place from 1 July 2014. Notwithstanding those uncertainties, there are a number of matters that should be considered.

Whilst the policy and legislative detail is not settled, if there are no transitional imputation measures, a portion of the franking credit balance as at 30 June 2015, which has been generated at a tax rate of 30%, may be “trapped” in the company’s franking account. As is demonstrated in the below example, from a shareholder’s point of view, this will result in a lower after tax cash dividend.

Assume $100 of pre-tax profits derived prior to 30 June 2015 and subject to 30% tax
Pre-tax profits	$100
Company tax	$30
After tax profits	$70
Franking credits	$30
Individual: top rate	49%
Dividend	$70
	Dividend Paid Prior to 30 June 2015		Dividend Paid After 30 June 2015
Maximum franking credit	= $70 x (30/70) = $30		= $70 x (28.5/71.5) = $27.9
Trapped franking credits	Nil		$2.1
Grossed up assessable dividend	$100		$97.9
Cash (net of tax) after distribution to shareholder	Individual	Super Fund	Individual	Super Fund
	$51	$85	$49.9	$83.2
Effective tax on underlying profits after distribution to shareholder	49%	15%	50.1%	16.8%

  

Based on the above, in respect of a dividend paid after 1 July 2015 from profits arising before that date:

• Approximately 7% of the franking credits (2.1/30) get trapped within the company. Whilst these could be distributed if the company has other “untaxed profits”, this will result in an additional cash cost to the company if paid as a cash dividend
  

• The effective tax rate on the underlying profits rises above the shareholder’s marginal rate, as a result of some of the tax paid credits remaining trapped within the company. The net cash amount in the hands of the shareholders is reduced.
  

In addition, after the commencement of the PPL on 1 July 2015, there may be further trapped franking credits on an annual basis for large companies.

In order to maximise returns to shareholders via dividend payments, companies should actively monitor government policy in this area. Companies should also actively plan ahead to forecast their future franking balances to determine the potential scale of trapped franking credits (as at 30 June 2015), and consider alternative dividend and capital management policies.

Kamlee Coorey Tax Partner Deloitte (02)9840 7030 kcoorey@deloitte.com.au