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Changes to reduced Company Tax Rate

Changes to reduced Company Tax Rate

Brent Murphy and Craig Marston discuss the recently released Treasury Exposure Draft that seeks to clarify how small businesses qualify for the reduced company tax rate.

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Companies seeking to qualify for the reduced small business tax rate of 27.5 percent must, in addition to not breaching the turnover test (currently $25 million), be “carrying on a business”. This requirement has created uncertainty for companies carrying on passive investment activities, particularly following draft ruling TR 2017/D2 in which a comment was made that passive investment companies may be regarded as carrying on a business (see Qualifying for the small business tax rate where this issue was discussed).

As a consequence, Treasury has released an Exposure Draft (ED) intended to clarify that companies with predominantly passive income cannot access the lower company tax rate before the 2024 income year. If enacted this Bill will amend the law for companies for the 2017 and later income years. It appears that companies that claimed the 28.5 percent rate in their 2016 tax returns will not be impacted. 

The new rules impose an additional condition to the turnover and business tests. To qualify for the lower rate, 80 percent or more of a company’s income cannot be passive. Passive income is defined to include amongst other things portfolio dividends, interest, royalties, rent, capital gains and trust and partnership distributions sourced from such income. 

This may encourage taxpayers to structure their affairs in order to earn more non-passive income and will potentially lead to a change in the investment decisions that those companies make as they seek out non-passive income sources. 

It may also lead to an increase in compliance costs for small businesses, that may have a number of new issues to grapple with including:

  • monitoring their turnover across all related entities to determine if they have breached the turnover threshold 
  • monitoring the mix of different income streams each year to determine if they have breached the 80 percent passive income threshold 
  • tracing trust distributions through one or more trusts back to their original source to determine the character of income. 

Based on the ED some significant active businesses that would otherwise be entitled to the lower tax rate may miss out, even though their business activities would not typically be regarded as passive. For example companies with significant property portfolios that principally derive rent may not qualify. This is hard to reconcile from a policy perspective.

The ED does not address the issue that companies that qualify for the reduced tax rate can only frank dividends at 27.5 percent, notwithstanding that they may have paid tax on their retained profits at 30 percent. Some companies may therefore prefer to stay outside the reduced tax rate regime in order to be able to pass on greater franking credits.

So, there will potentially be winners and losers from the proposed changes. Affected taxpayers will need to consider their position carefully to ensure both the tax rate and franking credit implications are understood. 

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