Unpaid Trust Distributions: ATO's Rulings vs. Recent AAT Decision and What It Means for 2023
It has long been the ATO’s practice to treat a trust’s unpaid present entitlements (“UPE”) to a company as a loan for th...
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%.
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:
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.
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:
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:
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.
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:
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.
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.
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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