Eligibility for lower company tax rate

On 18 September 2017, the Government released for public consultation exposure draft legislation to amend the Income Tax Rates Act 1986 to confirm that companies that earn predominantly passive income will not be eligible for the lower company tax rate.

The company tax rate for small companies was lowered to 27.5% with effect from 1 July 2017. The turnover threshold that applies for a company to qualify for the lower tax rate was $10 million in the 2017 income year increasing annually to $50 million in the 2019 income year. The government proposes that the threshold will increase to $1 billion in the 2023 income year before being removed in 2024.

Under the proposed amendments, companies that are generating predominantly passive income will not be eligible for the lower company tax rate. To be eligible for the lower company tax rates:

  • the company must carry on a business (undefined) in the income year;
  • the aggregated turnover of the company must be less than the relevant threshold for the income year; and
  • the company does not have ‘base rate entity passive income’ for that year of 80% or more of its assessable income for that year.

‘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);
  • interest, royalties, and rent;
  • gains on certain debt securities issued at a discount;
  • capital gains; and
  • partnership or trust income to the extent that partnership or trust income is attributable to ‘base rate entity passive income’.

It appears that the draft legislation is both broader and narrower than some commentators had speculated. For example:

  • a company that actively manages 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
  • a bucket company in receipt of trust distributions may be eligible for the lower tax rate if the income distributed is not ‘base rate entity passive income’ (such as interest, dividends, rent, and capital gains).

However, the bucket company in receipt of such distributions would still need to satisfy that it ‘carries on a business’ although the Australian Taxation Office (ATO) states in another context in Draft Taxation Ruling TR 2017/D2 that “where a company is established or maintained to make profit or gain for its shareholders it is likely to carry on business”. The use of the word “likely” means that a bucket company relying on the statement in TR 2017/D2 to avail of the lower tax rate would ‘likely’ face ATO scrutiny.

Consultation closes on 29 September 2017.

For further information or advice, please contact:

Daniel Smedley
Principal
T: 03 9611 0105
E: dsmedley@sladen.com.au

or

Neil Brydges
Special Counsel
T: 03 9611 0176
E: nbrydges@sladen.com.au

 

Neil Brydges