The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2018 received royal assent on the 31 August 2018. These new laws further restrict which companies will be able to apply the lower tax rate of 27.5%.
Old Law
Under the previous rules a company would use the lower rate of tax if it is carrying on a business and had an aggregated turnover of less than:
- $25 million for the 2017/2018 year
- $50 million for the 2018/2019 year
The ATO released TR2017/D7 which set out their views as to when a company will be carrying on business for the purposes of the Income Tax Rates Act 1986. The ATO’s interpretation under this ruling was surprisingly broad in regards to what constituted carrying on a business for companies. The ruling concluded that where
"A 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 section 23”.
An example, from the ruling of a company carrying on a business as a family company which only receives income from a trust. The company enters into a written loan agreement on commercial terms with the trust, under which the distribution is loaned back to the trust in return for a commercial rate of interest. The company is concluded to be carrying on a business as it is investing the assets in a business-like manner with a purpose and prospect of profit.
New Law
The new laws, replace the carrying on a business test with a base rate entity passive income (BREPI) test. This will mean companies with mainly passive income will be ineligible for the lower rates of tax. A company will pass the BREPI test if no more than 80% of the entity’s assessable income for the year is BREPI.
Base rate entity passive income (BREPI) for the purposes of the lower tax rate is:
- Dividends (other than Non – Portfolio Dividends which is where the company has more than 10% of the voting shares)
- Public Trading Trust Distributions
- Franking credits attached to such a distribution
- A non-share dividend (the company holds a non-share equity interest)
- Interest (or a payment in the nature of interest)
- A royalty
- Rent
- A gain on a certain qualifying security
- A net capital gain
- An amount that is included in the assessable income of a partner in a partnership or a beneficiary of a trust estate to the extent that the amount is referable (either directly or indirectly through one or more interposed partnerships or trust estates) to another amount that is passive income.
The ATO has released the Law Companion Ruling 2018/D7 which works through the BREPI categories.
Below is an example of how to work out the corporate tax rate, taking into account the aggregated turnover threshold and the BREPI test.
Example 1.3 from the The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2018 revised explanatory memorandum.
Jane and Dave Smith are the sole shareholders and directors of Smith Pty Ltd. Smith Pty Ltd holds a diversified portfolio of shares from which it earns dividend income as well as several term deposits from which it earns interest. It is also the beneficiary of a trust which owns a commercial investment property. All rental income earned by the trust is distributed to Smith Pty Ltd.
Smith Pty Ltd also earns a small amount of fee for service income. This is derived from the consulting services Jane Smith, a retired business woman, provides to a number of independent businesses year.
In the 2017-18 income year, Smith Pty Ltd had an aggregated turnover that is under the $25 million aggregated turnover threshold. The amount of its assessable income was $900,000, comprising:
- Dividends, rent and interest income of $620,000
- Net capital gains of $180,000 and
- Consulting income of $100,000.
Smith Pty Ltd is a passive investment company as 89 per cent of its assessable income is base rate entity passive income.
Consequently, for the 2017-18 income year, Smith Pty Ltd’s corporate tax rate is 30 per cent.
These new rules will be applied from the 2017-2018 financial year; therefore they may have an impact on tax returns that have been completed before the royal assent had been received.
Imputation Credits
The corporate tax rate for imputation purpose is worked out differently to that tax rate applicable for that year. In order to work out the corporate tax rate for imputation purposes for the year the entity must assume that:
- Its aggregated turnover for the income year is equal to its aggregated turnover for the previous income year
- Its base rate entity passive income for the income year is equal to its base rate entity passive income for the previous income year; and
- Its assessable income for the income year is equal to its assessable income for the previous income year.
If the entity did not exist in the previous year the tax rate for imputation purposes will be 27.5%
Below are examples from the LCR 2018/D7 on how to work out the corporate tax rate for imputation purposes.
Example 2.2 – Corporate tax rate is different to corporate tax rate for imputation purposes because of aggregated turnover change in consecutive income years.
- In the 2016-17 income year, Emu Co had aggregated turnover of $24 million. Emu Co's 2016-17 assessable income was 55% BREPI.
- In the 2017-18 income year, Emu Co had aggregated turnover of $28 million. Emu Co's 2017-18 assessable income was 62% BREPI. Because Emu Co's 2017-18 aggregated turnover was above the aggregated turnover threshold of $25 million, it is not a base rate entity, and had a 2017-18 corporate tax rate of 30%.
- Emu Co had a 2017-18 corporate tax rate for imputation purposes of 27.5%. This is because its aggregated turnover and base rate passive income, to calculate its corporate tax rate for imputation purposes in the 2017-18 income year, is below the $25 million dollar threshold, and less than 80%.
Example 2.3 - corporate tax rate is different to corporate tax rate for imputation purposes because of a change in the percentage of BREPI in consecutive income years.
- In the 2017-18 income year, Cockatoo Co had an aggregated turnover of $48 million. Cockatoo Co's 2017-18 assessable income was 82% BREPI.
- In the 2018-19 income year, Cockatoo Co had aggregated turnover of $46 million. Cockatoo Co's 2018-19 assessable income was 75% BREPI. Cockatoo Co's 2018-19 aggregated turnover was below the aggregated turnover threshold of $50 million, and its BREPI was below the 80% threshold. Therefore, it was a base rate entity, with a 2018-19 corporate tax rate of 27.5%.
- Cockatoo Co has a 2018-19 corporate tax rate for imputation purposes of 30%. This is because its BREPI for the purpose of determining its corporate tax rate for imputation purposes is above the 80% threshold.
Whilst this is an overview of the new legislation, the workings of each aspect has the potential to be complicated and time consuming. This will be especially relevant when there are interposed entities in which income will need to be characterised as either passive or not and then followed through to the final company taxpayer.
Please be sure to contact an Ulton Adviser if your wish to discuss these matters further by calling, 07 4154 0400.
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