How to Pay Tax, Lose It and Then Have to Pay It Again

Jamie Tulloch

Managing director of e3 Businness Accountants

Believe it or not, but this happens quite often.

Probably the biggest and most common tax mistake made is losing imputation credits i.e. the benefit a shareholder gets from tax already paid by the company.

What is imputation?

It is a mechanism that a company can use to pass on credits for tax it has paid on its profits, to its shareholders when it pays them dividends. These credits offset the amount of tax that a resident shareholder would otherwise be liable to pay on those dividends so they don’t have to pay “double tax”.

As an example – let’s say your company made $100,000 profit and paid tax at the company tax rate of 28 percent, which of course would be $28,000.

This after-tax profit of $72,000 can be treated in three ways: (i) either kept in the company and used as working capital, (ii) paid out to shareholders as a dividend or, (iii) a combination of both.

If the after-tax profit stays in the company, there is no more tax to pay. However, if a dividend is declared and all the profit goes out to a shareholder, then the dividend is taxed at 33 percent; regardless of the income and tax rate of the shareholder.

In dollar terms, this is an extra $3,900 of tax.

However, if the shareholder is on a lower marginal tax rate, they will receive either a refund or a credit if they pay provisional tax when they file their tax return.

How do you lose imputation credits?

Quite simply (and we see it often) it’s all to do with the continuity of shareholders from one year to the next.

Because it’s so easy to file a company’s annual return online, or do a shared transfer online, many shareholders unwittingly lose (destroy is a better word) the imputation credit of 28 percent that they worked so hard to gain and then pay.

The immutable rule is that companies must maintain a minimum of 66 percent of the same shareholding from one year to the next.

If there is a change in continuity of shareholding of 34 percent or greater in any one-year period, starting from when the income tax is paid until the dividend is paid, then the most likely scenario is that the tax credits will be lost. For ever! And that’s painful.

What’s the takeaway here?

Before you make any changes to a company’s shareholding, check with your tax accountant.