The Government has released exposure draft legislation to deny access to the lower corporate tax rate of 27.5% for companies with predominantly passive income. The draft legislation would amend the Income Tax Rates Act 1986 to ensure that a "base rate entity" will qualify for the lower tax rate only if:

  • its "base rate entity passive income" is less than 80% of its assessable income for the year;
  • it "carries on a business" in the year of income; and
  • its aggregated turnover for the income year is less than the aggregated turnover threshold for the year (ie $10 million for 2016–2017; $25 million for 2017–2018; and $50 million for 2018–2019 and later years).

Meaning of "passive income"

Each of the following will be "passive income" of a base rate entity:

  • distributions (eg dividends), excluding non-portfolio dividends;
  • non-share dividends;
  • rent;
  • interest income;
  • royalties;
  • gains on qualifying securities under Div 16E of the Income Tax Assessment Act 1936;
  • capital gains; and
  • amounts included in assessable partnership or trust income, to the extent that they are attributable to base rate entity passive income as listed above.

Corporate tax rate for imputation purposes

In terms of working out the maximum franking credit for a distribution by reference to the "corporate tax gross-up rate", the definition of the "corporate tax rate for imputation purposes" will be amended so that the entity can assume that its aggregated turnover, base rate passive income and assessable income are equal to the amounts for the previous income year. If the corporate tax entity did not exist in the previous income year, its corporate tax rate for imputation purposes for an income year will be deemed the lower corporate tax rate of 27.5%.

Example

Aco is carrying on a business. In the 2016–2017 income year, it has:

  • aggregated turnover of $8 million;
  • base rate passive income of $7.5 million; and
  • assessable income of $8 million.

For the 2016–2017 income year, 92.59% of Aco's assessable income is base rate entity passive income. This means that the applicable corporate tax rate is 30%, even though the company's aggregated turnover is only $8 million (ie under the $10 million aggregated turnover threshold for 2016–2017).

Aco wants to pay a dividend to its shareholders in the 2017–2018 income year. To work out its corporate tax rate for imputation purposes for the 2017–2018 income year, it must assume that its aggregated turnover, base rate passive income and assessable income are the same as for the 2016–2017 income year.

Aco's corporate tax rate for imputation purposes is 30%.

Therefore, its corporate tax gross-up rate for that income year will be: (100% – 30%) / 30% = 2.33.

Aco makes a fully franked distribution of $100 per share in the 2017–2018 income year. The maximum franking credit that can be attached to that distribution is $42.91 (ie $100/2.33). Aco makes the dividend payment on 31 March 2018.

Amy holds 50 shares in Aco and receives a dividend of $5,000. Franking credits of $2,145 are attached to the dividend. For the 2017–2018 income year, Amy includes $7,145 (ie $5,000 plus franking credits of $2,145) in her assessable income in relation to the dividend.

Amy is entitled to a refundable tax offset equal to the amount of the franking credits. Amy's total assessable income for the 2017–2018 income year is $30,000, so her marginal tax rate is 19%.

Therefore, Medicare levy aside, Amy's tax payable on the franked dividend is $1,357.55. The excess franking credits (ie $787.45) will be:

  • applied to reduce Amy's other tax liabilities; or
  • if she has no other tax liabilities, refunded to Amy.

Emma also holds 50 shares in Aco and receives a dividend of $5,000 (and franking credits of $2,145). For the 2017–2018 income year, Emma includes $7,145 in her assessable income in relation to the dividend.

Emma is entitled to a refundable tax offset equal to the amount of the franking credits. Emma's total assessable income for the 2017–2018 income year is $120,000, so her marginal tax rate is 37%. Therefore, Medicare levy aside, the tax payable by Emma on the franked dividend is $2,643.65. This means Emma will need to pay additional tax of $498.65 on the franked dividend