Chapter 4 Companies National Core Accounting Publications 1

Chapter 4 Companies © National Core Accounting Publications 1

Overview Definition of a company s. 995(1) defines a company as including “all bodies or associations corporate or unincorporated, but does not include a partnership”. © National Core Accounting Publications 2

Overview Residence Under s. 6(1) ITAA 36, a company is a resident in Australia if: § it is incorporated in Australia, or § it is not incorporated in Australia, it carries on business in Australia and has either its central management and control in Australia, or its voting power is controlled by Australian resident shareholders. © National Core Accounting Publications 3

Overview Taxation of companies A company when it is registered is taxable in its own right. All resident companies whose total income is $1 or more must lodge a Company tax return. Therefore, a company trading at a loss must still lodge a tax return. Companies are taxed at a flat tax rate of 30% in 2014/15. © National Core Accounting Publications 4

Private Companies Certain payments made by private companies may be deemed by the ATO to be dividends and, as such, may be disallowed as deductions. These are: § Payments to associates. § Excessive remuneration. © National Core Accounting Publications 5

Private Companies Payments to associates A loan or advance made by a private company to an "associated person" will be deemed to be a dividend if considered to represent a distribution of profits. "associated person" means a shareholder, director, or their associates (e. g. spouse, other relatives). The deemed dividend becomes assessable income of the recipient and is not franked. © National Core Accounting Publications 6

Private Companies Excessive remuneration Where the ATO considers that remuneration paid by a private company to an associated person is excessive (i. e. beyond what is “reasonable”) the excess is not allowed as a deduction. It is deemed to be an unfranked dividend of the company. © National Core Accounting Publications 7

Calculation of Taxable Income Net Profit compared to Taxable Income § Income Statement - is prepared according to accounting standards. § Taxable income - is calculated according to taxation law. Therefore, net profit/loss will not necessarily equal taxable income. © National Core Accounting Publications 8

Tax Losses To be able to claim a deduction for a carry forward tax loss, a company must satisfy either: § the continuity of ownership test, or § the same business test. © National Core Accounting Publications 9

Tax Losses Continuity of ownership test - requires that shares carrying more than 50% of all voting, dividend and capital rights must be owned at all times during the year of recoupment of the tax loss and during the actual loss year. © National Core Accounting Publications 10

Illustration: Application of ownership test Acme Pty Ltd incurred a tax loss in the 2013/14 income year when its shares were owned as follows: A — 30% B — 21% C — 24% D — 25% In 2014/15 the company’s shares were owned as follows: A — 30% B — 21% E — 49% Required: Determine if Acme Pty Ltd can claim its 2013/14 tax loss as a deduction in the 2014/15 income year. © National Core Accounting Publications 11

Illustration: Application of ownership test Solution: The company satisfies the continuity of ownership as shareholders A and B own 51% of shares in both income years. Therefore Acme Pty Ltd can claim the tax loss as a deduction in the 2014/15 income year. © National Core Accounting Publications 12

Tax Losses Same business test - requires that a company carry on the same business in the recoupment year as it carried on immediately before a change in the beneficial ownership of its shares. If a company fails the continuity of ownership test it may still be able to carry forward past tax losses if it satisfies the same business test. © National Core Accounting Publications 13

Same Business Test What actually constitutes the same business is a question of fact. A company can expand or contract its activities without necessarily ceasing to carry on the same business. However, the company must not: § derive assessable income from a new kind of business or transaction. § start a business or initiate a transaction in order to meet the same business test. © National Core Accounting Publications 14 14

Illustration: Excess Franking Credits GC Investments Pty Ltd had $6, 000 in excess franking credits for the year ended 30 June 2015. Required: Calculate the deemed tax loss. Solution: The deemed tax loss is: 6, 000 ÷ 30% = $20, 000 © National Core Accounting Publications 15

Research & Development (R&D) Companies incurring expenditure on scientific research and development activities may claim a tax offset. Eligible expenditure must be incurred on or after 1 July 2010. © National Core Accounting Publications 16

Research & Development (R&D) Eligibility requirements • Must be a company. • Must spend $20, 000+ on eligible R&D in an income year. • Must be eligible R&D activities. © National Core Accounting Publications 17

Research & Development (R&D) Eligible R&D activities Are systematic, investigative or experimental activities which involve innovation or high levels of technical risk carried on for the purpose of: § Acquiring new knowledge. § Creating improved materials, products, services, devices or processes. © National Core Accounting Publications 18

Research & Development (R&D) Eligible R&D expenditure Examples are: • • Salary and Wages Overheads Operating costs Production costs during trialling Consultants and contractors Payments to research agencies and laboratories Decline in Value Plant leasing © National Core Accounting Publications 19

Research & Development (R&D) R&D tax offset Smaller companies A 43. 5% refundable tax offset is available to small companies with an annual aggregate turnover of less than $20 million. These companies can receive an uncapped fully refundable offset if they are in tax loss. © National Core Accounting Publications 20

Illustration: R&D tax offset – smaller company Bio Laboratories Pty Ltd incurred an accounting net loss of $50, 000 for the year ended 30 June 2015. This comprised income $500, 000, eligible R&D expenses of $100, 000 and other expenses $450, 000. Required: Calculate taxable income and tax payable. © National Core Accounting Publications 21

Illustration: R&D tax offset – smaller company Solution: Accounting net loss add: R&D expenditure subject to the tax offset Taxable Income $ (50, 000) 100, 000 50, 000 Tax Payable is: Tax on $50, 000 @ 30% less R&D tax offset (100, 000 x 43. 5%) Refund Due $ 15, 000. 00 43, 500. 00 28, 500. 00 © National Core Accounting Publications 22

Research & Development (R&D) R&D tax offset Larger companies A 38. 5% non-refundable tax offset is available to companies with an annual aggregate turnover of $20 million or more and less than $20 billion in the 2014/15 income year. Very Large companies Very large companies with turnover of $20 billion or more are not eligible for the R&D tax offset. Instead, these companies must claim their R&D expenditure under general tax law provisions as deductions. © National Core Accounting Publications 23

Illustration: R&D tax offset – large company Aus Resources Ltd had an annual aggregate turnover of $30 million, and it incurred an accounting net loss of $200, 000 in the 2014/15 income year. This comprised income $30, 000, eligible R&D expenses of $1, 000 and other expenses $29, 200, 000. Required: Calculate taxable income and tax payable. © National Core Accounting Publications 24

Illustration: R&D tax offset – large company Solution: Accounting net loss add: R&D expenditure subject to the tax offset Taxable Income Tax Payable is: Tax on $800, 000 @ 30% less R&D tax offset (1, 000 x 38. 5%) limited to: © National Core Accounting Publications $ (200, 000) 1, 000 800, 000 $ 240, 000. 00 Nil 25

Capital Gains and Losses The CGT Discount method does not apply to companies. Capital losses are subject to the continuity of ownership and same business test provisions. A company may transfer current year net capital losses to another resident company in a wholly owned group but only if both companies were part of the same owned group at all times. © National Core Accounting Publications 26 26

Reconciliation A company’s net profit/loss normally will not correspond to its taxable income due to a variety of factors such as: § § § expenses not allowed as deductions franking credits capital gains increases and decreases in provisions grossing up of foreign income Therefore, must reconcile net profit/loss to taxable income. © National Core Accounting Publications 27

Imputation System Franking account A company that pays franked dividends must keep a franking account for tax purposes. A franking account is an account maintained to keep track of the income tax credits that a company can pass on to its members. Franking accounts are basically a running total of all franking credits and franking debits. © National Core Accounting Publications 28

Imputation System Franking account § If franking debits > franking credits franking deficit (i. e. debit balance). § If franking debits < franking credits franking surplus (i. e. credit balance). © National Core Accounting Publications 29

Imputation System Franking credits A franking credit arises when a company: § makes a payment of a PAYG instalment or income tax; § receives a franked distribution from another company, or § incurs a liability for franking deficit tax. © National Core Accounting Publications 30

Imputation System Franking debits A franking debit arises when a company: § receives a refund of income tax. § makes a franked distribution. § underfranks a distribution (i. e. the corporate tax entity makes a distribution with a franking percentage that is less than the entity's benchmark franking percentage for the franking period). © National Core Accounting Publications 31

Imputation System Franking debits § ceases to be a franking entity (to eliminate any franking surplus in the franking account). § issues tax-exempt bonus shares (instead of making a distribution). § streams imputation benefits to members most able to benefit from them. § buys back a share on-market. © National Core Accounting Publications 32

Illustration: Franking Account Singha Ltd had the following transactions for the year ended 30 June 2015: 1 July Opening balance $3, 000 credit 1 Sept Fully franked dividend received - $15, 000 28 Oct PAYG tax instalment paid - $5, 000 10 Feb Unfranked dividend received - $2, 000 22 March Payment of fully franked dividends - $30, 000 15 May Balance of 2013/14 company tax paid - $20, 000 Required: Prepare the Franking Account for the year ended 30 June 2015. © National Core Accounting Publications 33

Illustration: Franking Account Date Transaction Debit Credit Balance 1 July Opening balance 3, 000 cr 1 Sept Fully Franked Dividend received 15, 000 x 30/70 6, 429 9, 429 cr 28 Oct PAYG tax instalment 5, 000 14, 429 cr 22 March Frankable Distribution 30, 000 x 30/ 70 15 May Balance of Company tax paid 12, 857 © National Core Accounting Publications 1, 572 cr 20, 000 21, 572 cr 34

Imputation System Benchmark rule - requires that a private company must frank all frankable dividends made during a franking period at the “benchmark franking percentage”. The benchmark franking percentage is the same as the franking percentage for the first frankable distribution made by the entity within the franking period. © National Core Accounting Publications 35

Imputation System Benchmark rule Over-franking tax § If the actual franking percentage of a frankable distribution exceeds the benchmark franking percentage over-franking tax arises. § The formula to calculate over-franking tax is: Franking % differential x Amount of franked distribution x © National Core Accounting Publications 30/ 70 36

Illustration: Over-franking a Distribution Maroons Pty Ltd has a benchmark franking percentage of 75%. The company made a fully franked distribution of $6, 000 (i. e. franked at 100%). Required: Calculate the over-franking penalty tax. Solution: The over-franking penalty tax is: (100% - 75%) x $6, 000 x 30/ 70 © National Core Accounting Publications = $ 642. 86 37

Imputation System Benchmark rule Under-Franking debit If the actual franking percentage of a frankable distribution is less than the benchmark franking percentage an under-franking debit entry arises. The amount of under-franking tax is calculated on the same basis as over-franking tax. © National Core Accounting Publications 38

Illustration: Under-franking a Distribution Blues Pty Ltd has a benchmark franking percentage of 90%. The company made a franked distribution of $7, 000 franked at 70%. Required: Calculate the under-franking penalty tax. Solution: The under-franking penalty tax is: (90% - 70%) x $7, 000 x 30/ 70 = $600 This will appear as a debit entry in the Franking account. © National Core Accounting Publications 39

Imputation System Franking Deficit Tax (FDT) Franking deficit tax will arise only where the company has a franking deficit at the end of the year (i. e. a debit balance which means that franking debits > franking credits). The FDT amount is the same as the deficit balance of the franking account. © National Core Accounting Publications 40

Illustration: Excessive over-franking penalty Blue Dragon Pty Ltd had a Franking account deficit (debit balance) of $1, 000 at 30 June 2015. During the income year, $8, 000 of franking credits arose in the franking account. Required: Calculate the FDT offset and the penalty for excessive over-franking. © National Core Accounting Publications 41

Illustration: Excessive over-franking penalty Solution: FDT of $1, 000 is payable. As the FDT is greater than 10% of the total franking account credit entries for the year (i. e. $1, 000 > 10% x 8, 000), Blue Dragon Pty Ltd’s FDT offset entitlement is reduced by 30%. Therefore, the FDT offset is: $1, 000 less 30% = $700 The reduction of $300 (i. e. 30% of $1, 000) effectively acts as a penalty. © National Core Accounting Publications 42

Payment of Tax Companies pay their tax under the PAYG system either in a single lump sum or in quarterly instalments. Under the PAYG instalments system tax payments are made throughout the year of income to which they relate. Such payments will be made in conjunction with the lodgement of a Business Activity Statement (BAS). © National Core Accounting Publications 43