When is a tax cut not a tax cut – when it’s part of the new small business entity (SBE) tax cuts.

Whilst the topic of tax may lead to boredom for many of us, we all tend to get excited when the government tells us we are getting a tax cut.

Unfortunately, depending on the ‘fine print’ what might seem like a tax cut may well turn out to be something quite different…and that is certainly the case with the new Small Business Entity (SBE) company tax cuts.

To try and explain it, when a company pays tax, it is really a payment made to the Government by the company on behalf of its shareholders.

The Government takes this money and holds it in what is commonly termed a “franking account”. When the shareholders subsequently take their profits (called dividends), the franking account is used to ‘match’ the tax already paid against the dividends so that, all things being equal, the shareholders receive their dividends without further taxing.

This is a fundamental concept and is designed to prevent profits from being double taxed. Unfortunately the new SBE measures have cleverly and, arguably, inequitably, forgotten about the concept of double taxation and there are literally thousands of small business owners and their shareholders who will pay MORE tax as a result of these measures.

The Government has offered a carrot of a reduction in company tax by 2.5% but at the same time, has taken an axe to our franking account balances and reduced them, not proportionately, but exponentially.

As a simple example, let’s take a small business company who has earned $10,000 profit each year for the last 6 years and who has diligently paid their 30% tax each year. Let’s also assume the owners/shareholders now seek to take the “after tax” profit they would receive those funds without further tax.

Under the new SBE measures, the shareholders in this example will be subject to an additional personal tax of $1,457 because the Government has diluted the value of the shareholders’ franking accounts.

The company has paid 30% tax in years 1-5 then 27.5% tax in year 6. However, when you add the $1,457 shortfall, the REAL tax rate over the entire 6 years is 32%…Now that is when a tax cut is really not a tax cut.