Reduced corporate income tax rate
As you may be aware, the income tax rate for companies under specific turnover thresholds has been reduced to 27.5% with further reductions scheduled to ultimately reduce the company income tax rate for these companies to 25%.
Accessing the lower tax rate has the downside of also reducing the franking credits that can be attached to dividends, even though a company may have a store of 30% franking credits, if the company is subject to the lower company income tax rate. In broad terms, companies eligible for the 27.5% income tax rate can only frank dividends at the lower rate thereby denying shareholders the value of 30% franking credits.
There has been a lot of confusion and contradictory statements from the Government and the Australian Tax Office (ATO) as to how to determine eligibility to the 27.5% income tax rate.
Passive companies, carrying forward 30% franking credits, have inadvertently been caught in the crossfire.
The rules for eligibility for the lower company income tax rate have now been clarified in recent changes to tax legislation.
What are the changes?
As a part of the Coalition Government’s Enterprise Tax Plan legislation, there is now a new way to determine when a company is eligible for the reduced corporate income tax rate of 27.5% (as opposed to the historical 30% income tax rate). The Base Rate Entity Passive Income Test Bill received Royal Assent on 31 August 2018 and applies for the 2017/2018 financial year and onwards.
Companies will be eligible for the reduced corporate tax rate where:
- Not more than 80% of their assessable income is base rate entity passive income; and
- Its aggregate turnover for the year is less than $25 million for 2017/2018. ($50 million for 2018/2019).
Base rate entity passive income is defined to include (but not limited to):
- Franked dividends (excluding non-portfolio dividends)
- Interest, royalties and rent
- Net capital gains
- Partnership and trust distributions of the above.
What does this mean?
Unfortunately, the new legislation means the process of determining if a company is eligible for the reduced corporate tax rate (known as the base rate) just became a whole lot more complicated.
In order to determine the correct tax rate is for a company, the following questions are just some of those that need to be considered:
- Is the company carrying on a business?
- What entities, that are also carrying on a business, are connected entities or affiliate entities of the company?
- What is the total turnover of those entities, from carrying on a business?
- What portion of the company’s assessable income for the year is base rate entity passive income (including tracing through trust distributions to determine the ‘source’ of the distributions)?
What about the franking credits when paying out a dividend?
All the same rules above apply to determine the rate of franking for a dividend declared by the company, with a minor and very important difference.
Rather than looking at the current year’s aggregate turnover, assessable income and percentage of base rate entity passive income, it is the prior financial year figures that are used.
That is, the prior year financial figures are referred to except for the turnover threshold, which is still the current year amount being $25 million for 2017/2018 and $50 million for 2018/2019.
Doesn’t that mean there might be different rates in the same year?
Unfortunately, it does mean that the company income tax rate for the year may be different to the rate it can frank dividends paid during the year.
Can I just choose to pay tax at 30%?
No, this is not an elective system, similar to the small business tax concessions. All companies that fall within the rules must apply them regardless of the outcome.
What do I need to do now?
There is now additional analysis required to determine what is the correct company income tax rate for a financial year.
Separately, analysis will also be required to determine the correct franking rate for any dividends declared or proposed to be declared.
As a result, this analysis will need to be considered when conducting annual tax planning as well as when setting up new structures.
When considering any of the above, it is important to talk with your Blaze Acumen advisor to determine your company’s correct income tax rate and franking treatment.