New ‘bright line’ test will deny some the corporate rate reduction

Last week, legislation was introduced that will exclude some businesses from the reduction of the company tax rate for small and medium corporations to 27.5%.

The Enterprise Tax Plan will eventually deliver a rate of 25% by the 2026-27 income year, introduced progressively, but with an increase in the qualifying aggregated turnover threshold. This was $2 million in 2015-16, $10 million for 2016-17, $25 million for 2017-18 and will be $50 million for 2018-19, where it will remain.

However the government intends to limit the eligibility for these rate reductions through what it has dubbed a “bright line” test, which is to replace the requirement that a company should be “carrying on a business”.

The amended legislation (read it here) limits the rate reduction to corporates that have no more than 80% of “passive” income. A company will therefore not qualify for the lower rate if more than 80% of assessable income is from sources such as interest, dividends or royalties. Passive investment companies are therefore locked out of the lower rate.

The measure will apply prospectively from the 2017-18 income year. According to the ATO, passive income includes:

  • dividends other than non-portfolio dividends
  • franking credits on such dividends
  • non-share dividends
  • interest income, royalties and rent
  • gains on qualifying securities
  • net capital gains
  • income from trusts or partnerships, to the extent it is referable (either directly or indirectly) to an amount that is otherwise base rate entity passive income.

The ATO says that as there are no proposed changes to the law for the 2016-17 income year, companies are encouraged to lodge their tax returns under the existing law. To qualify for the lower 27.5% tax rate in 2016-17 a company must meet the small business entity definition, which requires them to:

  • have an aggregated turnover of less than $10 million, and
  • be carrying on a business.

As far as the requirement to be carrying on a business (see TR 2017/D7), the ATO states that it is aware of some uncertainty among taxpayers about this test, and says it will adopt a “facilitative” approach to compliance for this for the 2016-17 income year. That is, it 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.

Some aspects of the “bright line” test however may need polishing. Among these is how one-off CGT events will be treated if a company is near the 80% threshold. There may also be “corporate veil” issues where for example a trust channels income to an entity.

New ‘bright line’ test will deny some the corporate rate reduction New ‘bright line’ test will deny some the corporate rate reduction New ‘bright line’ test will deny some the corporate rate reduction New ‘bright line’ test will deny some the corporate rate reduction New ‘bright line’ test will deny some the corporate rate reduction New ‘bright line’ test will deny some the corporate rate reduction