New legislation passed by Parliament has finally brought some certainty to the application of the lower corporate tax rate. However, the new rules also introduce additional complexity.
In August 2018 legislation was passed to change the eligibility criteria for determining whether a corporate taxpayer is a base rate entity. This change was made so companies with mostly passive investment income cannot access the reduced corporate tax rate.
In October 2018 separate legislation was passed by Parliament to accelerate the reduction of the tax rate for base rate entities by five years. As a result, eligible businesses with turnover below $50 million will have a tax rate of 25 percent by the 2021-22 income year, rather than 2026-27 as previously legislated.
Definition of base rate entity
The definition of a base rate entity has been modified by replacing the ‘carrying on a business’ requirement with a new ‘passive income’ test. Under the passive income test, companies will not be eligible for the reduced corporate tax rate if more than 80 percent of their assessable income is Base Rate Entity Passive Income (BREPI).
The aggregated turnover test remains unchanged with the thresholds for the 2017-18 and 2018-19 financial years being $25 million and $50 million respectively.
Taxpayers do not have a choice to opt-in or opt-out of applying the lower corporate tax rate. Application of the reduced corporate tax rate is dependent only on a company meeting the relevant eligibility criteria.
The new definition of a base rate entity applies retrospectively from the 2017-18 financial year.
What is BREPI?
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.
The new passive income test introduces additional complexity when determining a company’s tax rate.
In addition to calculating a company’s aggregated turnover (which is based on ordinary income), companies are now also required to perform an analysis of their assessable income to determine the proportion of BREPI.
Imputation of dividends
The new rules also impact the maximum rate companies can attach franking credits to dividends.
To determine its ‘corporate tax rate for imputation purposes’ for an income year, a company must use its aggregated turnover, assessable income and BREPI 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 distributions for the same year.
If a company didn’t exist in the previous year, its corporate tax rate for imputation purposes is 27.5 percent (irrespective of whether the company was a base rate entity eligible to apply the lower corporate tax rate for that year).
Impact on prior years
Due to previous uncertainty, companies may have issued distribution statements for the 2016-17 or 2017-18 income years using an incorrect corporate tax rate for imputation purposes. The ATO’s proposed administrative approach allows companies to inform their shareholders in writing of the correct franking credits attached to the dividends paid, rather than reissuing distribution statements.
Companies may have also applied the incorrect corporate tax rate for the 2015-16 and 2016-17 income years. However, the ATO advised it will not allocate compliance resources specifically to conduct reviews of whether corporate tax entities have applied the correct corporate tax rate for these income years.
While the Federal Government brought forward the introduction of a lower 25 percent tax rate for base rate entities by five years, it also confirmed it will no longer extend the 25 percent tax rate to companies with aggregated turnover of greater than $50 million. Therefore, it seems a multi-rate corporate tax system is here to stay.
Corporate taxpayers should assess the impact of the lower company tax rate for future years and plan accordingly by considering their level of aggregated turnover, the nature of their assessable income and timing of dividends paid.