Tax Bites: 30% tax rate or 27.5% tax rate?

As a result of some confusion, the Federal Government has introduced legislation to confirm when a company is eligible to be classified as a Small Business Entity and be taxed at the 27.5% tax rate.

The proposed new legislation is contained in Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017.

The proposed new legislation states that in order to be classified as a Small Business Entity, the company (i) needs to have aggregated turnover of less than $25M for the 2018 financial year; and (ii) must derive no more than 80% of its overall assessable income from a passive income source.

The proposed new legislation states that income derived by the company will be from a passive source if the income represents:

  • Dividend income and related franking credits (other than a non-portfolio dividend);
  • Interest income;
  • Royalty income;
  • Rent;
  • A net capital gain;
  • A distribution from a partnership or trust if the distribution is referrable to a passive source.

Importantly, paragraph 1.4 of the Explanatory Memorandum to the proposed legislation states:

“These amendments will modify 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.  Under the passive income test, companies that are generating predominantly passive income will not be eligible for the lower corporate tax rate”.

Paragraph 1.13 of the Explanatory Memorandum then confirms that where a company (say a corporate beneficiary) receives a distribution of income from a trust or through a chain of trusts, the status of the assessable income derived by the corporate beneficiary is determined by the nature of the income from the original trust that originally derived the income.

Having regard to the above and in accordance with the proposed legislation, where a business is operated in a trust and the net business income of the trust is distributed to a corporate beneficiary, the corporate beneficiary should be eligible to be taxed on the income at the lower 27.5% tax rate notwithstanding that the corporate beneficiary itself, does not conduct its own business operation.  This is a key change from the current position where the corporate beneficiary would not be eligible for the lower 27.5% tax rate on the basis that it does not conduct a business.

The proposed new legislation will apply from 1 July 2017.

If you have any further questions, please do not hesitate to contact Tim Olynyk at t.olynyk@banksgroup.com.au or on (03) 9810 0700.

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