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Changes to Company Tax Rules

Changes to Company Tax Rules

  • Thursday, 04 January 2018 01:08

The company tax rate rules for the 2017 income year are different to the rules that will apply for the 2018 income year onwards.

Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 limits access to the 27.5% company tax rate by replacing the ‘carrying on a business test’ with a ‘passive income test’. Under the new rules, to access the reduced company tax rate, 80% or less of the company’s assessable income must be passive in nature.

The good news is that, unlike the Exposure Draft, the amending legislation is not retrospective and will apply from the 2018 income year. This removes the possibility of retrospective changes to a company’s tax rate and maximum franking percentage rate for the 2017 income year. And, removing the carrying on a business test reduces the uncertainty. 

However, there will be an extra test that will add a layer of complexity when determining what company tax rate should apply. This is not just a gross turnover test but a test that requires you to analyse the components of that turnover.

Where a company is receiving income from trusts or partnerships, you need to trace through to determine the nature of the income that was derived by that trust or partnership, and this might need to be done on multiple levels. For example, Trust 1 might distribute income to Trust 2, which then distributes income to a company. Whether dividends are treated as passive income will depend on the shareholding percentage involved.

These changes mean that companies that only hold rental properties will not qualify for the lower tax rate, even if the rental activities amount to a business under general principles. However, a company that receives distributions from a related trust could still qualify for the lower rate if 20% or more of its income is attributable to trading profits (directly or indirectly through the trust).

Under the proposed new rules, it will no longer be necessary to determine whether the company carries on a business in its own right under ordinary principles to determine its tax rate. The removal of the ‘carrying on a business test’ should eliminate some of the uncertainty that is currently faced when trying to determine the tax rate that applies to many private companies.

However, this would still be relevant in determining whether a company can access other concessions that are available to small business entities. The ATO has released a draft ruling (TR 2017/D7) which explores this concept in the context of companies. The ATO indicates that it would generally be easier to show that a company carries on business when compared with a trust or individual taxpayer.

Changes will also be made to the maximum franking percentage rules. In determining a company’s maximum franking rate for a particular income year, you need to look at the tax rate that would apply in the current year if certain assumptions are made, which are based on prior year results.

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