2019 Federal Election – Is small business just collateral damage?

By Chris Burnett

The Australian Federal Election is just a few days away and the idea of a change of Government is seeming almost as certain as death and taxes themselves.  The Australian Labor Party has an ambitious tax and superannuation reform agenda that will see a $446 billion tax hit to a range of taxpayers including retirees and small business owners. 

The three most contentious policies that Labor are going to the polls with are changes to negative gearing, franking credits and trust income – which may impact on how your investment and/or business income is taxed moving forward.

These three tax reform policies have been discussed in a bit more detail below. Please note that the exact details and timing on some of these policy proposals are limited so we caution clients about making decisions before specific policies are ironed out and legislated by a formed Government.

TAX REFORM 1: NEGATIVE GEARING

Currently investors are able to offset losses on their investments (including rental properties) against other taxable income reducing the tax they otherwise pay on that income – this is known as negative gearing.  Labor have proposed to remove negative gearing and the ability to offset losses generated from assets acquired after 1 January 2020 against other taxable income.  All existing negatively geared investments will likely be grandfathered and an exception available for newly constructed properties.

TAX REFORM 2: FRANKING CREDITS

Currently if you receive a franked dividend and your highest marginal tax rate is below that of the company which paid you the dividend, you are entitled to a refund of the tax differential.  For example, if your highest marginal tax rate is only 21% (including Medicare levy) and you receive a franked dividend with franking credits attached of 30% (representing your share of tax the company has already paid on your behalf as a shareholder) – you receive a franking credit refund of 9% when you lodge your tax return.  The imputation system works so that you only pay tax at a rate equal to your personal marginal tax rate.  Labor intends to amend the dividend franking system so that any excess franking credit is deemed non-refundable.

It seems that small business have been made collateral damage under this Labor policy.  For example, if you operate your small business as a company and you make a profit of $50,000 in one year, your company pays tax of $13,750 (or a flat 27.5%) on that income.  If you however received the same amount of income as a sole trader you would only pay tax of $8,797 (or an average rate of 17.6%).  Under Labor’s proposal the small business owner would be almost $5,000 worse off simply because they operated their small business within a company structure.

TAX REFORM 3: DISCRETIONARY TRUSTS

Currently income from a discretionary trust is taxed at the beneficiaries’ individual marginal tax rate.  If their income is less than $37,000 then this will be at the rate of either 0% and/or 19% depending on their income level.  Labor are proposing a minimum tax rate of 30% on Discretionary Trust distributions to individuals irrespective of their income level or marginal tax rate.

Again, small business owners and investors can find themselves in a disadvantaged situation simply by how their business or investments are owned and structured.  For example, if a husband and wife run a small family business together via a discretionary trust and their business makes a profit of $100,000 in a year – which is normally distributed between them ($50,000 each).  Currently they will pay tax of $8,797 each on that income – the same amount a normal $50,000 wage earner would pay also.  Under Labor’s proposal, they would be required to pay tax of $15,000 each – collectively making them $12,406 worse off under the proposed changes.

FINAL COMMENT – DON’T PANIC JUST YET!

If implemented, the proposed changes would mean the biggest change to tax reform since the introduction of GST almost two decades ago.  However, should Labor form Government, the proposed policies would need to pass through the Senate before they can be enacted and introduced as law.  The makeup of the Senate may mean that these policies are heavily scrutinised and debated leading to changes in their scope and application.  If you would like to discuss in detail how the proposals will specifically affect you and some strategic considerations then please get in contact with me.