Eligibility for the lower company tax rate clarified

On 19 September 2017, we considered the Exposure Draft legislation on eligibility for the lower company tax rate that was released on 18 September 2017.

On 18 October 2017, the Government released two documents to clarify eligibility for the lower company tax rate:

Uncertainty had arisen earlier this year as to whether passive investment, including ‘bucket’, companies should be eligible for the lower company tax rate based on the requirement in section 23AA of the Income Tax Rates Act 1986 that they were “carrying on a business.”

The Bill if legislated will amend section 23AA of the Income Tax Rates Act 1986 with a ‘bright line’ test for eligibility for the lower company tax rate with effect from 1 July 2017. The test will ensure that a company that meets the turnover threshold ($25 million in the 2018 income year) will not qualify for the lower company tax rate if more than 80% of its assessable income is passive income (such as interest, rent, dividends, royalties, or net capital gains). From 1 July 2017, unlike in the Exposure Draft and for the 2017 income year, there will not be a “carrying on a business” requirement.

For the 2017 income year, section 23AA of the Income Tax Rates Act 1986 stays unchanged. That is to be eligible for the lower company tax rate the company will need to be “carrying on a business” and have aggregated turnover less than $10 million. Unlike in the Exposure Draft, there is not a restriction on the amount of passive income derived by the company.

To, hopefully, help with determining when a company is “carrying on a business” for the 2017 income year, the ATO released TR 2017/D7 that contains the ATO’s preliminary views on that question together with examples.

Bright line test for the 2018 income year onwards

A company will qualify for the lower company tax rate if no more than 80% of the entity’s assessable income for that income year is “base rate entity passive income” and the aggregated turnover of the entity for that income year is less than the threshold for that year.

Broadly, ‘base rate entity passive income’ means:

  • distributions by corporate tax entities, other than dividends paid to the company by another company where the first company owns a greater than 10% interest;
  • non-share dividends (distributions on instruments classified as equity for tax purposes);
  • franking credits;
  • interest, royalties, and rent;
  • gains on certain debt securities issued at a discount;
  • net capital gains; and
  • partnership or trust distributions to the extent that partnership or trust income is traceable (directly or indirectly) to ‘base rate entity passive income’

The proposed legislation includes some key differences to the Exposure Draft:

  • the start date is 1 July 2017 (rather than 1 July 2016);
  • the removal of the “carrying on a business” requirement;
  • clarification of the definition of base rate entity passive income by:
  • including franking credits;
  • excluding amounts of exempt income or non-assessable non-exempt income (as those amounts do not form part of assessable income); and
  • ‘capital gains’ now being ‘net capital gains’, thereby excluding disregarded capital gains and allowing for capital losses.

If passed and assented as tabled:

  • a ‘bucket company’ in receipt of distributions of active income (or has less than 80% of base rate passive income) will be eligible for the lower company tax rate;
  • a company that actively manages (say) a portfolio of rental properties would not be eligible for the lower tax rate if rental income (and other ‘base rate entity passive income’) is more than 80% of income; and
  • companies that sell a business and make a net capital gain may not be eligible for the lower company tax rate due to the net capital gain being passive income.  

For dividend imputation purposes, the tax rate used in franking calculations will be based on the company tax rate for the income year, but assuming aggregated turnover, passive income, and assessable income are the same as in the prior year. We consider the application of the company tax rate changes and imputation here.

The tracing requirement for companies in receipt of trust and partnership distributions may result in increased compliance costs in terms of accounting fees and having to amend trust deeds and pro forma resolutions.

TR 2017/D7: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?

TR 2017/D7 will only be relevant for the 2017 income year and section 23AA.  TR 2017/D7 only applies to companies (other than companies limited by guarantee) incorporated under the Corporations Act 2001, and excludes companies in their capacity as trustee of a trust, corporate limited partnerships, and public trading trusts.

TR 2017/D7 runs to 25 pages and includes many examples. However, TR 2017/D7 concludes that where a company (or NL company) is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it is likely to be carrying on a business in a general sense and therefore to be carrying on a business within the meaning of the section 23AA.

Comments on TR 2017/D7 are due by 1 December 2017.  

ATO compliance approach

The Media Release by the Hon Kelly O’Dwyer stated that the ATO advised that it will adopt a facilitative approach to compliance in relation to the “carrying on a business” test for the 2017 year. That is, it will not select companies for audit based on their determination of whether they were carrying on a business in the 2017 income year, unless their decision is plainly unreasonable.

For further information or advice, please contact:

Daniel Smedley
Principal | Accredited Specialist in Tax Law
Sladen Legal
M +61 411 319 327 |  T +61 3 9611 0105
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia  
dsmedley@sladen.com.au

Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia  
nbrydges@sladen.com.au

Patricia Martins
Legal Project Manager
Sladen Legal
T +61 3 9611 0138
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia  
pmartins@sladen.com.au

Neil Brydges