The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 was introduced in the House of Reps on Wednesday 18 October 2017.
This Bill is designed to substitute a ‘bright line’ test for companies that are to be taxed at the lower 27.5%, instead of the ‘carrying on business’ test that has applied since the reduced rate first applied, in the 2016-17 financial year.
One might have supposed that taxpayers would be interested in the lower tax rate category being wider (rather than narrower). But this was not so. The problem was that, along with the lower 27.5% tax rate, the franking credit rate reduced to 27.5% also. The problem here was that companies that held shares in 30% tax rate companies, and received 30% franking credits, would then have the missing 2.5% of those franking credits trapped in the investor company – theoretically for ever, unless it earned untaxed profits, which could then be franked, when distributed as a dividend (or as a ‘non-share distribution’). This regime of reducing company tax rates over 10 years was introduced in the Treasury Laws Amendment (Enterprise Tax Plan) Act 2017, assented to on 19.5.17).
Finally, the Government listened to these complaints and introduced this Bill, which was to substitute a test (for being taxed at the lower 278.5% rate) of not having more than 80% of its gross income as ‘passive income’ (in lieu of the less certain ‘carrying on a business’ test). The provisions kept the relevant turnover threshold test – which was $10m in the 2016-17 year, will be $25m for the 2017-18 year, and will be $50m for the 2018-19 year. This change is to be done by an amendment to s23AA and inserting s23AB of the Income Tax Rates Act 1986. This change will commence from the 2017-18 year.
What I’ve colloquially called ‘passive income’ will be defined in s23AB as follows.
23AB Meaning of base rate entity passive income
Base rate entity passive income is assessable income that is any of the following:
(a) a distribution (within the meaning of the Income Tax Assessment Act 1997) by a corporate tax entity (within the meaning of that Act), other than a non-portfolio dividend (within the meaning of section 317 of the Assessment Act);
(b) an amount of a franking credit (within the meaning of the Income Tax Assessment Act 1997) on such a distribution;
(c) a non-share dividend (within the meaning of the Income Tax Assessment Act 1997) by a company;
(d) interest income (within the meaning of the Assessment Act), royalties and rent;
(e) a gain on a qualifying security (within the meaning of Division 16E of Part III of the Assessment Act);
(f) a net capital gain (within the meaning of the Income Tax Assessment Act 1997);
(g) an amount included in the assessable income of a partner in a partnership or of a beneficiary of a trust estate under Division 5 or 6 of Part III of the Assessment Act, to the extent that the amount is referable (either directly or indirectly through one or more interposed partnerships or trust estates) to another amount that is base rate entity passive income under a preceding paragraph of this definition.
In the 2016-17 income year, however, the old test still applies, namely that a company will need to be ‘carrying on a business‘ to be able to taxed at the lower rate (and not carrying on a business to maintain the higher 30% rate). For these purposes, the ATO released a draft ruling on this subject: TR 2017/D7, which is contentious about whether companies with investments in shares relevantly ‘carry on business’ – concluding they often do (see related TM article). The tax profession is ‘consulting’ with the Commissioner, about the correctness of this draft ruling, also.
The Commissioner has an article, about the whole staged reduction in company tax rates, on his website, which also mentions this anticipated ‘bright line’ test, coming in from 1 July 2017, and the difference between this and the ‘carrying on business’ test in the prior year. Many will not agree with the Commissioner’s ruling about the breadth of ‘carrying on a business’ and to accommodate those persons (who might have anticipated a result like the proposed statutory ‘bright line’ passive income test), he says he will adopt a ‘facilitative approach’ in relation to compliance, meaning he will not select companies, for audit, based on their determination of whether they were carrying on a business in the 2016-17 income year, “unless their decision is plainly unreasonable”.
The Revenue Minister issued a media release covering much of the above.
[APH website: Bills Digest, Bill, Explanatory Memorandum; Minister’s media release; ATO website: stepped reduction in company rates (and ‘facilitative approach’), TR 2017/D7; Related TM Article; FJM; LTN 199, 18/10/17; TM Oct 2017]