The governments Enterprise Tax Plan legislation which was passed in May 2017 and lowered the tax rate for companies over the next ten years.

Corporate Tax Rate Reduction Chart -

 

Corporate Tax Rate

Turnover <$10M

Turnover <$25M

Turnover <$50M

2016-17

27.5%

30%

30%

2017-18

27.5%

27.5%

30%

2018-24

27.5%

27.5%

27.5%

2024-25

27%

27%

27%

2025-26

26%

26%

26%

2026-27

25%

25%

25%

 

The legislation was initially directed to companies who actively carried on a business but as those with a legal background will know, it is a well-established principle that generally a company will always be considered to be carrying on a business.

Passive income Restrictions

Not surprisingly , this created some confusion as to when a company would not satisfy the business test and caused somewhat of an image problem for the government with the concept of wealthy individuals receiving a reduction in their tax rates by holding passive income assets in companies.

To clear the fog a little, the government introduced additional legislation which changes focus for eligibility from "carrying on a business" to how much "passive income" the company earns.

On 18th October 2017, the Enterprise Tax Plan Base Rate Entities Bill was introduced to parliament.

The new legislation will deny the corporate tax rate reduction to entities who have more than 80% of their income derived from "Base Rate Passive Income".

Base Rate Passive Income is defined to be:

-          A corporate distribution (dividends) other than non-portfolio dividends (own more than 10% of shares of a company)

-          Interest income

-          Royalties

-          Rent

-          Net Capital Gains

-          A trust or partnership distribution referrable to the above.

In respect of trust distributions, where a distribution is received from a trust and that trust has been actively carrying on a business then it will not be considered passive income in the hands of the company and the lower tax rate will apply.

Therefore, most "bucket companies" in a small business family group will be considered to have received active income from a trust and will be taxed at the lower tax rate.

It is also worthwhile noting that the lower tax rate is compulsory if all conditions are met.

 
New legislation restricts access to the reduced company tax rate

Legislation restricting access to the small business company tax rate reduction entered Parliament last month. The changes specifically preclude companies with passive investments such as rental property income from qualifying for the small business entity tax rate of 27.5%.

For the 2017 income year a company could access the reduced company tax rate if it was carrying on a business and it had an aggregated turnover of less than $10 million. The changes replace the 'carrying on a business test' with a 'passive income test' from the 2018 income year onwards. Under the new rules, to access the reduced company tax rate, 80% or less of the entity's assessable income must be passive in nature.

The passive income test is not simple. Where a company is receiving income from trusts or partnerships, you need to trace through to determine the nature of the income that was derived by that trust or partnership, and this might need to be done on multiple levels. For example, Trust 1 might distribute income to Trust 2, which then distributes income to a company. Whether dividends are treated as passive income will depend on the shareholding percentage involved.

These changes mean that companies that only hold rental properties will not qualify for the lower tax rate, even if the rental activities amount to a business under general principles. However, a company that receives distributions from a related trust could still qualify for the lower rate if 20% or more of its income is attributable to trading profits (directly or indirectly through the trust).

Under the proposed new rules, it will no longer be necessary to determine whether the company carries on a business in its own right under ordinary principles to determine its tax rate. The removal of the 'carrying on a business test' should eliminate some of the uncertainty that is currently faced when trying to determine the tax rate that applies to many private companies. However, this would still be relevant in determining whether a company can access other concessions that are available to small business entities.

Changes will also be made to the maximum franking percentage rules. In determining a company's maximum franking rate for a particular income year, you need to look at the tax rate that would apply in the current year if the following assumptions are made: 

·       The company's aggregated turnover in the current year is the same as in the previous year;

·       The company's assessable income in the current year is the same as in the previous year; and

·       The company's passive income in the current year is the same as in the previous year.

There have been a lot of changes to the company tax rules and who and what they apply to. This development should finally provide some much needed certainty around which companies can qualify for the lower corporate tax rate and the flow-on impact that this has on franking rates for dividends paid by companies.