Finally, we have some certainty about the corporate tax rates. Parliament recently passed legislation and the fate of other proposed changes has also been settled. This means that there are two categories of companies when it comes to the tax rate, these are determined by turnover and business activity. Read our summary of what these are and how they apply to businesses.
Two corporate tax rates
The rate of 27.5% applies to corporate tax entities known as “base rate entities”, that is a company which carries on a business and has an aggregated turnover of less than $50 million. This is up from $25 million in the last financial year (ie 2017-18), but will stay at $50 million until 2023-24. The ALP has confirmed that it will not change the rules for base rate entities if elected – so there we have our first certainty. Namely, that the rate for base rate entities is locked in at 27.5% until 2023-24.
The tax rate for all other companies remains at 30%, ie the “standard corporate tax rate”. This will not change.
There had been legislation before Parliament that proposed to progressively extend the 27.5% corporate tax rate to all companies, regardless of turnover, by 2023-24. The rate would then have been cut – for all companies – down to 25% (progressively, over 3 years). However, the legislation did not make it through the Senate and the Government has since announced that it would not proceed with this proposal. This provides us with our second certainty – there will be no changes to the standard corporate tax rate.
The tax rate for base rate entities is scheduled to reduce after 2023-24, as this has already been legislated. It will decrease to 27% in 2024-25, to 26% for 2025-26 and finally to 25% for 2026-27 and following. It is reasonable to state this as the third certainty – that the tax rate for base rate entities will decline progressively to 25%.
Passive income ineligible for a lower rate
Now, this is all perfectly straightforward for a company carrying on what may be termed a trading business, eg providing services, buying and selling trading stock, importing/exporting etc. But if the activities of the company wholly or partly consist of receiving returns on investments, ie “passive income”, such as rent, interest and dividends – then it can get a bit tricky.
The Government never intended that companies receiving passive income should benefit from the lower tax rate. It recently changed the rules to ensure this does not happen. A corporate tax entity that carries on a business will only qualify for the lower 27.5% rate for a particular year if its passive income is less than 80% of its assessable income (and of course its aggregated turnover is less than $50m). Put the other way, companies that receive more than 80% of their income in passive forms will pay tax at the standard corporate tax rate, regardless of turnover.
The passive income is termed “base rate entity passive income” in the amending legislation. And what qualifies? Well, dividends and the associated franking credits to start with. Interest (or a payment in the nature of interest) also qualifies – but not if the entity is a financier – as well as royalties and rent. Another key area that qualifies as base rate entity passive income is net capital gains. This could be important for smaller companies – in that the sale of a substantial asset could shake the income mix and possibly put access to the lower rate at risk.
An amount that flows through a trust to a company retains its character for the purposes of determining whether the amount is base rate entity passive income of the company. For example, if an amount derived by a trust is trading income which passes directly from the trust to a corporate beneficiary, that amount is not base rate entity passive income of the beneficiary – because the trust distribution is directly referable to the trading income of the trust.
The implications of the new corporate tax rate rules might cause confusion for clients. Two scenarios worth raising with them are – businesses operating via a company might find it worthwhile using CGT rollover provisions to transfer assets into a separate entity, to ensure that the 80% rule is not breached. Additionally, they might be impacted by the split 27.5%/30% rate’s implications for the imputation system and franking credits.
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