Considerations for accountants around the new corporate tax rate
Accountants will be kept busy in coming months with the recent changes to Australian company tax rates – which came into effect on 1 July 2017. The new company tax rate and tax ruling opens the way for tax refunds for many small investment companies.
The new tax law ensures that a company will not qualify for the lower company tax rate of 27.5 per cent if more than 80 per cent of its assessable income is passive income. However, the amendment only applies prospectively from the 2017/18 income year, which differs to the 1 July 2016 start date in the exposure draft law.
This, combined with a new draft tax ruling, indicates that many small passive investments companies, whether or not its passive income is greater than 80 per cent of its assessable income, will be entitled to the 27.5 per cent tax rate for the 2016/17 income year and 28.5 per cent tax rate for the 2015/16 income year. Where these companies have paid tax at the 30 per cent rate, they may be entitled to claim a refund of the extra tax paid. Where their tax returns for these years have not yet been lodged they should ensure their tax returns show they are small business entities to ensure they are taxed at the lower rates.
Accountants need to use caution as the change in the tax rate for these companies may also affect the franking credits available for dividends that were paid in the 2016/17 income year.
Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017
The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 (new law) was introduced into the House of Representatives on 18 October 2017 and will amend the current tax law to ensure that from 1 July 2017 a company will not qualify for the lower company tax rate of 27.5 per cent if more than 80 per cent of its assessable income is passive income (such as interest, dividends or royalties). This is a ‘bright line’ test that will replace the previous requirement that a company be ‘carrying on a business’.
Small-to-medium sized companies will have to deal with three different sets of rules to determine their eligibility for the lower company tax rate and the rate of franking for dividends over the 2015/16, 2016/17 and 2017/18 income years.
This is a result of the introduction of tax legislation changing the rules for the 27.5 per cent tax rate from 1 July 2017 and the ATO simultaneously releasing a draft ruling on when a company is considered to be carrying on a business.
This means there will be some companies that were previously entitled to the lower tax rates for the 2015/16 and/or the 2016/17 income years but will now not be entitled to the lower tax rates for the 2017/18 year where they qualify as carrying on a business but don’t qualify under the new passive income test.
It may also go the other way for some companies that are not carrying on a business but qualify under the passive income test so they become entitled to the lower company tax rates for 2017/18 but not for the earlier years.
New ‘base rate entity passive income’ definition
The amendments to ensure a corporate tax entity will not qualify for the lower company tax rate if more than 80 per cent of its assessable income is of a specifically defined ‘passive’ nature. This new concept of ‘base rate entity passive income’ (passive income) includes, among other things, portfolio dividends (dividends on shares with less than 10 per cent voting interest), franking credits attached to portfolio dividends, net capital gains, rent, interest, royalties, and certain amounts that flow through a partnership or a trust (to the extent that it is attributable to an amount of passive income).
The definition of “base rate entity passive income” includes dividends from a company other than non-portfolio dividends (within the meaning of section 317 of the ITAA 1936), which is a dividend paid to a company where the company has at least 10 per cent of the voting power in the company paying the dividend. However, there is no tracing through to the type of income received by the dividend paying company so that all non-portfolio dividends will not be treated as passive income even if they are paid out of the passive income of the dividend paying company.
Therefore, where a dividend is received by a trust and then distributed to a company it appears that dividend will not be able to be a “non-portfolio dividend” even if the trustee holds 10 per cent or more of the voting power. This is because the definition requires the dividend to be paid to a company by the dividend paying company. It is not clear whether this is the intention of Parliament because there are comments in the explanatory memorandum to the new law that indicates that a trust can receive a non-portfolio dividend.
Rent and royalties
The definition of passive income in the new law includes interest income, royalties and rent. There are existing provisions that ensure that interest derived by an entity that is from the ‘active conduct of a business’ or banking business or money lending business will not be treated as passive income.
However, it appears that the same exclusion does not apply to rent or royalties that come from the active conduct of a business.
Therefore, under the changes in the new law, rent and royalties will constitute passive income irrespective of the extent of activities that would otherwise point to an active business i.e. companies which are in the business of actively deriving rent and royalties will be considered passive investment companies.
Aggregate turnover hurdle
In determining whether a company is entitled to the 27.5 per cent tax rate, its ‘aggregate turnover’ must be less than the ‘annual aggregate turnover threshold’ ($10 million for 2016/17) which includes the annual turnover of the company and its connected entities.
Following the release of the draft ruling on companies carrying on a business, many companies and their connected entities will now have to recalculate their aggregate turnover to include ‘passive income’ in their business income, which may result in them being over the aggregate turnover threshold. This is an issue for entitlement to the lower company tax rates for all of 2015/16 and 2016/17, 2017/18 and future years.
These companies may also have to reconsider their entitlement to the other small business entity concessions (including the small business CGT concessions and the under $20,000 asset writeoff etc.) for previous, current and future years.
Prospective amendment going forward
The amendments introducing the passive income test for the 27.5 per cent tax rate will apply prospectively from the 2017/18 income year; whereas for the 2015/16 and 2016/17 income years the carrying on a business test is still the relevant test to qualify for the 27.5 per cent tax rate (in addition to the relevant aggregate turnover test for the year).
Given the ATO’s view on companies carrying on a business, there may be some that have lodged their 2015/16 and/or 2016/17 income tax returns that did not lodge as a small business entity because it was considered not to be carrying on a business but can now ask for amended assessments at the lower tax rates for those years. Where companies have not yet lodged their 2016/17 tax return they can now confidently lodge tax returns as small business entities.
Lance Cunningham, national tax director, BDO.