On 31 August 2018 new rules were introduced that change the eligibility requirements for companies applying the lower 27.5% corporate tax rate from the 2017-18 income year. Broadly, the new rules ensure companies with mostly passive investment income cannot access the lower company tax rate.

What has changed?

The definition of a base rate entity has been changed by replacing the ‘carrying on a business’ requirement with a passive income test.

From the 2017-18 income year, a company will be a base rate entity, and eligible for the lower 27.5% company tax rate, if:

  • Less than 80% of the company’s assessable income is Base Rate Entity Passive Income (BREPI); and
  • Aggregated turnover is less than the relevant threshold ($25m for the 2017-18 income year, increasing to $50m for the 2018-19 and later income year).

BREPI includes dividends (other than ‘non-portfolio dividends’), net capital gains, rent, interest, royalties and amounts that are included in partnership or trust distributions to the extent they are attributable to an amount of BREPI of the partnership or trust.

Imputation of dividends

The new rules also affect the rate companies can attach franking credits to dividends.

A company’s corporate tax rate for imputation purposes is worked out using the aggregated turnover, BREPI and assessable income from the previous income year. As a result, a company’s tax rate for an income year may be different to the rate it can frank dividends in that year.

If companies have already issued distribution statements for the 2017-18 financial year using the incorrect rate they should tell their shareholders the correct dividend and franking credit amount as soon as possible. This can be done through an amended distribution statement or through letter or email.

What are the implications?

Since these changes apply retrospectively from the 2017-18 income year, corporate taxpayers should review the following:

  • Company tax calculations and tax returns for the 2017-18 income year to ensure they have applied the correct company tax rate;
  • Franking credits attached to dividends paid from 1 July 2017 to ensure the correct company tax rate has been used for imputation purposes; and
  • Tax effect accounting calculations for the 2017-18 income year to ensure the correct company tax rates have been used to calculate the current year’s tax provision and deferred tax balances.

The types of companies most immediately impacted by these changes are those whose activities predominantly generate passive income, such as Listed Investment Companies or commercial leasing companies. Previously these companies would be eligible to apply the lower 27.5% tax rate (subject to the aggregated turnover test). However, following the introduction of the new rules, they are not eligible and must apply a company tax rate of 30%.

Corporate beneficiaries may also find they are no longer eligible to apply the lower 27.5% tax rate. Under the new rules, assessable income received from trusts must be traced through to determine if it is referable to BREPI.

Looking ahead

Corporate taxpayers should review their tax position for the 2017-18 income year and take corrective action, if necessary. They should also consider the impact of the changes on their income tax and dividend strategy for the 2018-19 and future income years.