Now this should be an easy answer. So tell me what you think it is? I understand that it is a bit harder than it was now that there are two rates, being 30% and 27.5% (28.5% in the 2015/16 year). But can you tell me who gets the lower rate?
Don’t worry if you can’t because neither can the Commissioner…
In Practical Compliance Guideline PCG 2018/D5 Enterprise Tax Plan: small business company tax rate change: compliance and administrative approaches for the 2015-16, 2016-17 and 2017-18 income years the Commissioner states:
1. This draft Guideline sets out the ATO’s compliance and administrative approaches for corporate tax entities that have faced practical difficulties in determining their corporate tax rate and corporate tax rate for imputation purposes in the 2015-16, 2016-17 and 2017-18 income years.
2. The Commissioner acknowledges that uncertainty may have arisen as a result of changes to the tax laws, and changes to these laws still before Parliament, that set out eligibility for the reduced corporate tax rate and the subsequent release of Draft Taxation Ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?.
The background in a very quick summary is (the longer summary is in this 9 pager paper I wrote) that from 1 July 2015, corporate entities that were small business entities (less than $2m turnover and carrying on a business) were given the 28.5% tax rate. From 1 July 2016 the rate dropped to 27.5% for these small business entities (but now less than $10m turnover and carrying on a business). For 1 July 2017 the 27.5% rate was available to base rate entities (less than $25m turnover and carrying on a business) and from 1 July 2018 the 27.5% rate was available to base rate entities (less than $50m turnover and carrying on a business).
But what is a business? The Commissioner has some weird understanding of this and even put out a Draft Ruling (Draft Taxation Ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?). For example, For example, these are companies carrying on a business according to the draft Ruling:
- A share investment company; and
- A family company with income consisting only of an unpaid trust entitlement, which it reinvests, even if it is just under a loan agreement back to the trust
It is unlikely that any practitioner has considered these companies to be carrying on a business previously.
Although this draft Ruling has never been finalised due to the Bill introduced on the same day, the draft Ruling shows that the Commissioner is considering a major change in his understanding of what can be carrying on a “business” and this could open the door for many more corporate entities claiming the small business concessions that exist.
The Government did not like the Commissioner handing out the 27.5% rate to almost every company so 3 hours after the Draft Ruling came out the Government released the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017. This Bill (still before the Senate) states that, from 1 July 2017, a company will qualify for the lower corporate tax rate for an income year only if:
- No more than 80% of the company’s assessable income for that income year is base rate entity passive income; and
- The aggregated turnover is less than the aggregated turnover threshold for that income year ($25m for the 2018 year and $50 for all subsequent years).
So where does this leave us… We have the law as it is today, we have a Draft Ruling that massively expands the definition of “carrying on a business”, and we have a Bill that throws out the definition of business altogether and replaces it with a passive income test. If I am completing the Company Tax Return for either of:
- A share investment company; and
- A family company with income consisting only of an unpaid trust entitlement from a business trust, which it reinvests under a loan agreement back to the trust;
for the 2017/18 year, do I:
- Use the 30% tax rate for both like I did in previous years as I don’t believe the Company is carrying on a business based on the Commissioner’s finalised positions?
- Use the 27.5% tax rate for both as I believe the Company is carrying on a business based on the Commissioners draft position in the Draft Ruling positions? Or
- Do I use the 80% passive income rule in the Bill before the Senate which means the share investment company uses the 30% rate and the family company gets the 27.5% rate as we look through the trust distribution and see it comes from a business?
And remember, the lower rate might sound good but what if you want to pay out lots of franked dividends? The higher rate might be better.
The Commissioner gives an answer to this question is in Practical Compliance Guideline PCG 2018/D5 Enterprise Tax Plan: small business company tax rate change: compliance and administrative approaches for the 2015-16, 2016-17 and 2017-18 income years. And the answer is DO WHATEVER YOU WANT AS LONG AS IT IS NO UNREASONABLE OR DODGY. What he actually says is…
This means that the Commissioner will not allocate compliance resources specifically to conduct reviews of whether corporate tax entities have applied the correct rate of tax or franked at the correct rate in the 2015-16 and 2016-17 income years. However, this approach will not apply where:
- the Commissioner becomes aware that a corporate tax entity’s assessment of whether they were carrying on a business in the 2015-16 or 2016-17 income years was plainly unreasonable, or
- the corporate tax entity has entered into
- any artificial or contrived arrangement affecting the characterisation of the company as carrying on a business or not
- a tax avoidance scheme whose outcome depends, in whole or part, on the characterisation of the company as carrying on a business or not, or
- arrangements designed to conceal ultimate beneficial or economic ownership of any connected or affiliated entities.
Choose away! Optional tax rates!