The recently introduced Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 ensures that a company will not qualify for the lower company tax rate if more than 80% of its assessable income is passive income.

The Bill modifies the requirements that must be satisfied for a corporate tax entity to qualify as a "base rate entity" by replacing the "carrying on a business" test with a passive income test. More specifically, the Bill amends the Income Tax Rates Act 1986 to ensure that, from the 2017–2018 income year, a corporate tax entity will qualify for the lower corporate tax rate for an income year if:

  • no more than 80% of the its assessable income for that income year is base rate entity passive income; and
  • the corporate tax entity's aggregated turnover for the income year is less than the aggregated turnover threshold for that income year.

The amendment will apply from the 2017–2018 income year. In the 2016-2017 income year, a company will need to be carrying on a business and have a turnover under $10 million to qualify for the 27.5% tax rate.

Meaning of "passive income"

An amount of assessable income will be considered "base rate entity passive income" if it is:

  • a distribution by a corporate tax entity (other than a non-portfolio dividend);
  • franking credits attached to such a distribution;
  • a non-share dividend;
  • interest;
  • a royalty;
  • rent;
  • a gain on a qualifying security;
  • a net capital gain; or
  • an amount that is included in the assessable income of a partner in a partnership or a beneficiary of a trust estate to the extent that the amount is referable to another base rate entity passive income amount.

An amount that flows through a trust to a corporate tax entity (ie directly from the trust to the corporate tax entity) will retain its character for the purposes of determining whether the amount is base rate entity passive income of the corporate tax entity. That is:

  • if an amount derived by a trust is, for example, a dividend (other than a non-portfolio dividend) which passes directly from the trust to a beneficiary that is a corporate tax entity, then the amount will be base rate entity passive income of the corporate tax entity because the trust distribution is directly referable to the dividend of the trust;
  • if an amount derived by a trust is, for example, trading income which passes directly from the trust to a beneficiary that is a corporate tax entity, then the amount will not be base rate entity passive income of the corporate tax entity because the trust distribution is directly referable to the trading income of the trust.

Imputation changes

The Bill makes consequential amendments to the operation of the dividend imputation system.

Under the imputation system, the amount of franking credits that can be attached to a distribution cannot exceed the "maximum franking credit" for the distribution. The maximum franking credit is worked out with reference to the "corporate tax gross-up rate" and the "corporate tax rate for imputation purposes".

Corporate tax entities usually pay distributions to members for an income year during that income year. However, a corporate tax entity will not know its aggregated turnover, the amount of its base rate entity passive income, or the amount of its assessable income for an income year until after the end of that income year. The Bill therefore provides that a corporate tax entity must assume, for the purposes of working out its corporate tax rate for imputation purposes for an income year, that:

  • its aggregated turnover for the income year is equal to its aggregated turnover for the previous income year;
  • its base rate entity passive income for the income year is equal to its base rate entity passive income for the previous income year; and
  • its assessable income for the income year is equal to its assessable income 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 the lower corporate tax rate of 27.5%.