© National Core Accounting Publications Chapter 18 Companies © National Core Accounting Publications

© National Core Accounting Publications 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

© National Core Accounting Publications Overview Residence Under s.6(1) ITAA36, 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

© National Core Accounting Publications 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% © National Core Accounting Publications

© National Core Accounting Publications 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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

Illustration: Application of ownership test Acme Pty Ltd incurred a tax loss in 2012 when its shares were owned as follows: A — 30% B — 21% C — 24% D — 25%   In 2013 the company’s shares were owned as follows: A — 30% B — 21% E — 49% Required: Determine if Acme Pty Ltd can claim its 2012 tax loss as a deduction in the 2013 income year. © National Core Accounting Publications

Illustration: Application of ownership test Solution: The company satisfies the continuity of ownership as shareholders A and B own 51% of shares in both 2012 and 2013. Therefore Acme Pty Ltd can claim the tax loss as a deduction in the 2013 income year. © National Core Accounting Publications

© National Core Accounting Publications 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

© National Core Accounting Publications 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

Tax Loss Carry-back Scheme Commencing the 2012/13 income year, companies are able to carry-back tax losses to offset previous year profits so as to provide a refund of tax previously paid. Essentially, this measure will provide: A one year loss carry-back in 2012/13 (i.e. a tax loss incurred in 2012/13 can be carried back and offset against tax paid in 2011/12. For 2013/14 and later income years, a tax loss can be carried back and offset against tax paid up to 2 years earlier. Tax loss of up to $1 million can be carried back for each year, providing a cash benefit of up to $300,000 (the quantitative cap). © National Core Accounting Publications 15 15

Tax Loss Carry-back Scheme Neptune Pty Ltd has been operating for a number of years and paid tax of $75,000 in the 2011/12 income year based on $250,000 taxable income. The company had no carry forward losses at the end of the 2011/12 year.  In the 2012/13 income year the company made a tax loss of $200,000 due to weaker trading conditions. The company has a franking account balance of $400,000.   Required: Calculate the tax refund under the carry-back loss provisions. © National Core Accounting Publications 16 16

Tax Loss Carry-back Scheme Solution: The company’s refund under the carry-back loss rules is limited to the lesser of the following amounts: The tax value of the current loss (i.e. $200,000 x 30% = $60,000) The tax value of the statutory cap (i.e. $1 million x 30% = $300,000) The franking account balance (i.e. $400,000), and The tax paid in the carry-back period (i.e. $75,000) In this case the company can carry-back its full tax loss for the 2012/13 year against the tax paid in the prior year. It will receive a cash refund of $60,000. This brings forward the cash flow benefit of the loss rather than having to wait until the company makes taxable profits in future years. © National Core Accounting Publications 17 17

© National Core Accounting Publications Transfer of losses A company which incurs a tax loss has the right to transfer that loss to another resident company in the same group, provided there is 100% common ownership of the two companies Group loss transfers are only available provided either the loss company or income company is an Australian branch of a foreign bank or non-bank foreign financial entity © National Core Accounting Publications

© National Core Accounting Publications Company bad debts A company is allowed a deduction only for bad debts actually written off, provided it satisfies the continuity of ownership test or the same business test © National Core Accounting Publications

Companies as shareholders A company that receives a franked dividend is required to include in its assessable income the franking credit attached to the franked dividend The company is entitled to a franking tax offset for the amount of the franking credit © National Core Accounting Publications

Illustration: Excess Franking Credits GC Investments Pty Ltd had $6,000 in excess franking credits for the year ended 30 June 2013.   Required: Calculate the deemed tax loss. Solution: The deemed tax loss is: 6,000 ÷ 30% = $20,000 © National Core Accounting Publications

Research & Development 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

Research & Development 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

Research & Development Eligibility 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

Research & Development Eligible R&D expenditure Examples are: Salary & Wages Overheads Operating costs Production costs during trialling Consultants and contractors Decline in Value © National Core Accounting Publications

Research & Development R&D tax offset Smaller companies A 45% refundable tax offset is available to small companies with an annual aggregate turnover of less than $20 million Other companies A 40% non-refundable tax offset is to be available to companies with an annual aggregate turnover of $20 million or more © National Core Accounting Publications

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 2013. 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

Illustration: R&D tax offset – smaller company Solution: Accounting net loss $ (50,000) add: R&D expenditure subject to the tax offset 100,000 Taxable Income 50,000 Tax Payable is: Tax on $50,000 @ 30% $ 15,000.00 less R&D tax offset (100,000 x 45%) 45,000.00 Refund Due 30,000.00 © National Core Accounting Publications

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 2013 income year. This comprised income $30,000,000, eligible R&D expenses of $1,000,000 and other expenses $29,200,000.   Required: Calculate taxable income and tax payable. © National Core Accounting Publications

Illustration: R&D tax offset – large company Solution: Accounting net loss $ (200,000) add: R&D expenditure subject to the tax offset 1,000,000 Taxable Income 800,000   Tax Payable is: Tax on $800,000 @ 30% $ 240,000.00 less R&D tax offset (1,000,000 x 40%) limited to: 240,000.00 Nil © National Core Accounting Publications

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 31 31

© National Core Accounting Publications 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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

© National Core Accounting Publications 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

Illustration: Franking Account Singha Ltd had the following transactions for the year ended 30 June 2013: 1 July Opening balance $3,000 credit 1 October Fully franked dividend received - $15,000 15 December 2010/11 Balance of company tax paid - $20,000 10 February Unfranked dividend received - $2,000 27 March Payment of fully franked dividends - $30,000 Required: Prepare the Franking Account for the year ended 30 June 2013 © National Core Accounting Publications

Illustration: Franking Account Date Transaction Debit Credit Balance 1 July Opening balance 3,000cr 1 October Fully Franked Dividend received 15,000 x 30/70 6,429 9,429cr 15 December Company Tax Paid 20,000 29,429cr 27 March Frankable Distribution 30,000 x 30/70 12,857 16,572cr © National Core Accounting Publications

© National Core Accounting Publications 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

© National Core Accounting Publications 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 30/70 © National Core Accounting Publications

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 = $ 642.86 © National Core Accounting Publications

© National Core Accounting Publications 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

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

© National Core Accounting Publications Imputation system Franking Deficit Tax 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 franking deficit tax amount is the same as the deficit balance of the franking account © National Core Accounting Publications

Illustration: Excessive Over-franking penalty Blue Dragon Pty Ltd had a Franking account deficit (debit balance) of $1,000 at 30 June 2013. 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

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

© National Core Accounting Publications 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