Topic1 Chapter 2 The Tax Environment

Objectives
Describe the key elements of the Australian taxation system and explain the significance of dividend imputation.

Why are taxes relevant? Taxation is usually a mandatory cash outflow The real-world wealth of business owners is always
after-tax wealth

Taxation affects the amount of the firms cash flows

available to its owners

Introduction to income taxation

Depends on: Type of taxpayer
Company Individual Partnership Assessable income minus Allowable deductions

Taxable income Tax rate

Marginal (individuals) vs Flat (companies)

Introduction to income taxation

1:Determine net profit before tax 2: Calculate taxable income (likely to be different to profit) 3: Multiply taxable income by tax rate to compute tax 4: Determine net profit after tax 5: Pay tax to government (cash outflow)

Tax
Taxable income

Profit Net

Profit

Our 2012-2013 Individual Progressive Tax regime

Taxable income
Up to $18,200 $18,201 - $37,000 $37,001 - $80,000

Tax payable
Nil 19% on amounts over $18,200 $3,572 + 32.5% on amounts over $37,000 $17,547 + 37% on amounts over $80,000 $54,547 + 45% on amounts over $180,000

$80,001 - $180,000

Over $180,000

Example 1: Taxable income: individual (p. 30) Jane Piper has been working as an apprentice
plumber for J & S Plumbing. For the financial year just ended on 30 June she received gross wages of $45 000. During the year she purchased protective clothing and boots costing $250 and she spent $250 on replacing some of her plumbing tools that had been damaged. She can claim both of these expenditures as allowable deductions.

Calculate her taxable income

Example 1: Taxable income: individual (p.30)

Calculation of tax payable for Jane Piper

Example 2: Taxable income: business (p.30) During the financial year just ended on 30 June, J & S
Plumbing earned from the provision of plumbing services a gross income of $600 000. The cost of materials purchased during the year totalled $230 000 and other operating expenses were $100 000 (the break-down of these costs is shown below). The business has $125 000 in debt outstanding, at a 16% per annum interest rate, which resulted in $20 000 interest expense for the year (i.e. $125 000 0.16 = $20 000).

Calculate the taxable income of J & S Plumbing

Example 2: Taxable income: business (p.30)

Tax payable: company

Calculation of tax payable for J & S Plumbing
Australian company tax rate: 30% Taxable income:$250,000 Tax payable: = 0.30 x $250,000 = $175,000

Tax payable: Example 3 other structures

Partnership: Taxation of The J&S Plumbing Partnership Assumptions: Partners: Sue entitled to 10% of income John entitled to 90% of income Both receive no other income Both have no allowable deductions Calculation process: Sue includes 10% x $150,000 income in her individual tax return. i.e. she pays $1,350 tax John includes 90% x $150,000 income in his return and pays $47,000 tax

Example 2.4: Tax rate: other structures (p.32)

Partnership:

Taxation of The J&S Plumbing Partnership

Sue Partnership share 10% Taxable income Tax payable Net income $25,000 $2,850 $22,150 90% $225,000 $74,800 $150,200 100% $250,000 $77,650 $172,350 John Total

Tax payable: summary

Compare the tax position of each structure:

J&S Plumbing Ltd J&S Plumbing Partnership Sue $25,000 ($2,850) $22,150 John $225,000 ($74,800) $150,200 Total $250,000 ($77,650) $172,350

Taxable income $250,000 Tax payable Net income ($75,000) $175,000

Dividend imputation

A classical tax system has one major drawback:

DOUBLE TAXATION
Occurs when profits are taxed at both source, and on receipt

Example 2.6: Dividend imputation (p.35) Example:

J & S Plumbing Ltd Before Tax Company tax paid After tax income 250 000 75,000 175,000

The partners pay $47,950 tax on their shares of the net income in addition to the $75,000 paid by the company

Dividend imputation

The solution: Dividend Imputation Introduced in 1987 Ensures that company net income paid to
shareholders as dividends is taxed only once, at the shareholders marginal personal income tax rates

Dividend imputation: mechanics

Tax paid by the company is imputed to the

shareholders

Allowed as a credit in the shareholders tax

payable computation (+)

Calculate Tax payable (-) Add both credit and tax payable

Dividend imputation: mechanics (contd)

Dividends can be fully franked, partially

franked, or not franked at all

Franking percentage is dependent on

companys available franking credits

Franking credits are dependent upon tax paid

by the company

Dividend imputation: franking credits

Calculation of personal tax payable on fully

franked dividends

J&S Plumbing Ltd is owned by John (90%)

and Sue (10%)

J&S Plumbing Ltd had taxable income of

$250,000

Franked and unfranked income/Dividend

Fully franked dividend is dividend that a company pays out of income where tax has been paid. If company has not paid tax of an income from which dividend is declared, the dividend is called unfranked dividend.

Franking Credits calculation

Tax paid by company Credit allowed to shareholders John (90%) of $ 75 000 Sue (10%) of $ 75 000 $ 75 000 $ 75 000 $ 67 500 $ 7 500

Example 2.7: Dividend imputation: franking credits (p.39)

Calculate as if it is personal income

172 350

Example 2.8: Dividend imputation: unfranked dividend (p.40)

Example 2.9: Dividend imputation: unfranked dividend (p.41) (contd)