80% or less of the entity’s assessable income must be passive in nature to access the reduced company tax rate.
The good news is that, unlike the Exposure Draft, the amending legislation is not retrospective. It will apply from the 2018 income year. This removes the possibility of retrospective changes to a company’s tax rate and maximum franking percentage rate for the 2017 income year. And, removing the carrying on a business test reduces the uncertainty. But, this is another change for practitioners to get across.
However, there will be an extra test that will add a layer of complexity when practitioners are determining what company tax rate should apply. This is not just a gross turnover test. It requires you to analyse the components of that turnover.
Where a company receives income from trusts or partnerships, you need to trace through to determine the nature of the income derived by that trust or partnership. For example, Trust 1 might distribute income to Trust 2, which then distributes income to a company. The treatment of the dividends will depend on the shareholding percentage involved.
These changes mean that companies that only hold rental properties will not qualify for the lower tax rate. This is even if the rental activities amount to a business under general principles. However, a company that receives distributions from a related trust could still qualify for the lower rate if 20% or more of its income is attributable to trading profits (directly or indirectly through the trust).
Under the proposed new rules, it will no longer be necessary determining whether the company carries on a business in its own right under ordinary principles to determine its tax rate. The removal of ‘carrying on a business test’ should eliminate the uncertainty currently being faced when determining private companies’ tax rates.
However, this would still be relevant in determining whether a company can access other concessions available to small business entities. The ATO has actually released a draft ruling today (TR 2017/D7) which explores this concept in the context of companies. It would generally be easier to show that a company carries on business compared with a trust or individual taxpayer.
Maximum franking percentage rules will also change. To determine a company’s maximum franking rate, one has to look at the tax rate applicable in the current year. See if the following assumptions are made:
- The company’s aggregated turnover in the current year is the same as in the previous year;
- The company’s assessable income in the current year is the same as in the previous year; and
- The company’s passive income in the current year is the same as in the previous year.