By Kim Reynolds and Liam Blundell
What’s all the fuss about?
Changes to the corporate tax rate have been a hot topic over the recent years and it might seem like the rules are ever changing. So, what is all the fuss about and how does a company work out what its tax rate is?
The Government has introduced a decrease in company tax rates from 30% to 27.5%, further decreasing to 26% and then 25% in coming years.
So, my company qualifies for the lower corporate tax rate if the annual turnover is less than $50 million? You beauty!
Unfortunately no, it’s not quite that simple. There are two tests to look at in order to determine if your company qualifies for the lower corporate tax rate.
A base rate entity is a company that both:
- has an aggregated turnover less than the aggregated turnover threshold
- 80% or less of their assessable income is base rate entity passive income
Aggregated Turnover Test
What is aggregated turnover? It’s not as simple as looking at only the company’s turnover.
Aggregated turnover is the company’s annual turnover from carrying on a business plus the annual turnover from carrying on a business of any business or individual “connected with” or affiliated with the company.
Is the company carrying on a business?
The ATO has issued TR 2017/D7, a draft tax ruling on this issue which indicates that whether a company is carrying on a business requires consideration of a number of factors including:
- the nature of the company’s activities, particularly whether they are intended to be profit making
- the company’s intention to carry on a business
- the degree of repetition and regularity of the company’s activities, including whether the activities are carried on in a business-like manner, and
- the size and scale of the company’s operations
Meaning of “connected with” and “affiliate”
Determining entities “connected with” and affiliated with the taxpayer can be a complex exercise. So who is an affiliate and what does “connected with” actually mean?
An affiliate will be a company or individual that carries on a business that will generally act in concert with or in accordance with the directions or wishes of the taxpayer.
Whereas, an entity will be connected with another entity if either entity “controls” the other, or both entities are “controlled” by a common third entity.
“Control” may exist where the taxpayer, its affiliates, or the taxpayer with their affiliates have a right to at least 40% of voting power/distributions of a company, unit trust or partnership. “Control” of a discretionary trust may arise where a beneficiary has received a distribution of at least 40% of the income/capital of a trust in previous 4 years or where the trustee might act in accordance with the directions or wishes of the taxpayer, their affiliates, or the taxpayer together with their affiliates.
Base Rate Entity Passive Income Test
As the name suggests, this test requires companies to calculate what percentage of their assessable income is passive income. Base rate entity passive income (BREPI) includes:
- Dividends other than non-portfolio dividends (a dividend is non-portfolio if paid to a company and the company has a >10% voting interest in the company paying the dividend)
- Franking credits on such dividends
- Non-share dividends
- Interest income (with some exceptions, i.e. an authorised deposit-taking institution is not passive income)
- Royalties and rent
- Gains on qualifying securities
- Net capital gains
- Income from trusts or partnerships, to the extent it is traceable (either directly or indirectly) to an amount that is otherwise base rate entity passive income
If the percentage of the BREPI exceeds 80% of the total assessable income of the company, the lower corporate tax rate will not apply – even if the company has passed the aggregated turnover test as both tests need to be satisfied.
For example, where a company’s assessable income is made up of $85,000 of interest income and $15,000 of business income, the 80% passive income test would be failed as the passive income would be greater than 80% of the assessable income.
Effect of the Changing Tax Rate on Franking Credits
With the recent and ongoing changes to the corporate tax rate, it’s important to make sure any dividends are franked at the correct rate.
To work out the maximum franking rate, the company must apply the current year aggregated turnover threshold to the BREPI, assessable income and aggregated turnover of the previous year.
For example, where a company pays a dividend in 2018–19, its maximum franking rate was limited to 27.5 per cent where both of the following conditions are satisfied:
- the company’s aggregated turnover in 2017–18 was less than $50 million (being the turnover threshold for the 2018–19 income year); and
- the company’s BREPI for the 2017–18 income year is no more than 80 per cent of its assessable income for the 2017–18 income year.
Can a company choose its tax rate?
No, there is no scope in the legislation for a company to choose its tax rate. Therefore, the complex issues outlined above must be carefully considered.
An Important Message
While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents. Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.