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What is the Company Tax Rate? Last answer I promise…

I don’t feel like a pathetic tax advisor any more. You see, for the past 10 months I have not been able to answer the question “What is the company tax rate?”

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I know I find the answer in the Tax Rates Act. And I know the Tax Rates Act tells me 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).
  • From 1 July 2017 the rate stayed at 27.5% but was now available to “base rate entities” and the turnover threshold for a base rate entity was $25 million.
  • From 1 July 2018 the rate stayed at 27.5% but was now available to “base rate entities” and the turnover threshold for a base rate entity was $50 million.

This all sounds very easy, except to work out the rate for the 2015/16 year and the 2016/17 year I need to know if the company is carrying on a business. And for the 2017/18 and following years I need to know what is a “base rate entity”. And on top of this I need to not just know what the company tax rate is, but I also need to know how to work out the imputation rate for each of these years.

So, let’s work through each on these questions…

Question #1: Company Tax Rate for 2015/16 and 2016/17 – Am I carrying on a business?

Last year the Commissioner released 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?). In this Draft Ruling the Commissioner states he believes that most companies will be carrying on a business. He states that 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.

This is much broader than any of us would have thought. So, what do we do regarding whether companies are carrying on a business and therefore might get the 28.5% or the 27.5% rate.

The Commissioner has answered this question in Practical Compliance Guideline PCG 2018/D5. In this Guideline the, Commissioner states he 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 unless he 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.

What does this mean? It appears that a company under the turnover threshold in the 2015/16 and 2016/17 year can use either company tax rates as long as it is not unreasonable to do so.

Lesson #1: If a company has a turnover of less than $2 million in the 2015/16 year or less than $10 million in the 2016/17 year you can almost choose which company tax rate.

Question #2: For the 2017/18 and following years, what is a base rate entity?

The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018 amends the Rates Act to ensure that, from 1 July 2017, a corporate tax entity will not qualify for the lower corporate tax rate of 27.5% if more than 80% of its assessable income is “base rate passive income”.

Base rate entity passive income is defined as:

  • A distribution or dividend by a corporate tax entity, other than a non-portfolio dividend (10% holding). Dividends derived by a holding company which are made by a wholly-owned subsidiary company will not be base rate entity passive income of the holding company;
  • Franking credits attached to such a distribution;
  • A non-share dividend made by a company;
  • Interest or a payment in the nature of interest;
  • A royalty;
  • Rent;
  • A gain on a qualifying security;
  • A net capital gain;
  • An amount that is included in the assessable income of a partner in a partnership or a beneficiary of a trust estate to the extent that the amount is referable to another amount that is base rate entity passive income. Therefore, an amount that flows through a trust to a corporate tax entity will retain its character for the purposes of determining whether or not the amount is base rate entity passive income of the corporate tax entity.

Lesson #2: If a company has a turnover of less than $25 million in the 2017/18 year or less than $50 million in the 2018/19 year, to work out what tax rate that applies you need to consider the percentage of the income of the company that is base rate passive income. Less than 80% and the company tax rate is 27.5%, more than 80% and the company tax rate is 30%.

Question #3: How does this all work for imputation?

There are three answers to this question.

Lesson #3: For the 2015/16 the imputation rate was always 30%. It did not matter whether the company tax rate for the year for a company was 28.5%, they could still frank dividends at 30%.

Easy.

Lesson #4: For the 2016/17 year the rule was that whatever your company tax rate was, was your imputation rate. If the company tax rate was 27.5% the imputation rate was 27.5%. If the company tax rate was 30% the imputation rate was 30%.

There are new rules that apply from 1 July 2017 that were in the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018.

Under these rules, as a company will not know its aggregated turnover, the amount of its base rate entity passive income, or the amount of its assessable income for an income year until after the end of that income year, it will not know its company tax rate when it pays a dividend during the year.

Therefore, to calculate the imputation rate, the company must assume that:

  • Its aggregated turnover for the income year is equal to its aggregated turnover for the previous income year;
  • Its base rate entity passive income for the income year is equal to its base rate entity passive income for the previous income year; and
  • Its assessable income for the income year is equal to its assessable income for the previous income year.

Also, if the corporate tax entity did not exist in the previous income year, its corporate tax rate for imputation purposes for an income year will be the lower corporate tax rate of 27.5%.

Lesson #5: From 1 July 2017, to work out the imputation rate the company needs to look at last year’s turnover and the percentage of base rate passive income in the previous year. If the percentage is less than 80% and the turnover is under the threshold the dividend can be franked at 27.5%. Otherwise, it is taxed at 30%.

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Work and Travel Deductions

Given that I have criticised for my recent comments on tax agent prepared returns making inappropriate claims for work related deductions, I decided to put a paper together on the work related deduction rules to help tax agents.

I hope this paper is informative and helpful.

Work and travel deductions

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Tax Agents Turning a Blind Eye…

We know that the Commissioner has released some pretty crazy findings that Tax Agent prepared returns are more likely to incorrectly claim work related deductions than self prepared returns.

From the Commissioner’s review of the tax gap for individuals not in business he found the following:

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Tax agents get it wrong 78% of the time and self preparers only 57% of the time. By the way, the results show that when tax agents get it wrong, they get it “more wrong”… 85% of the value of mistakes are in tax agent prepared returns…

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But what I find most interesting is why these mistakes were made. Have a look at this chart:

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51% of all the adjustments were due to, at least in part, substantiation issues.

Immediately the lobbyist for the Tax Agents roll out the excuse that this is not the Tax Agents fault. Poor Tax Agents can only rely on the representations of their clients, they say.

But they would only say that if they did not understand the tax law… Have a look at what section 900-15 of the ITAA97 says:

To deduct a *work expense:

(a) it must qualify as a deduction under some provision of this Act outside this Division; and

(b) you need to substantiate it by getting written evidence.

And for completeness sake the definition of a work expenses is “a loss or outgoing you incur in producing your salary or wages.”

Section 900-15 states that even if there is another provision in any tax act that lets you claim a work expense as a deduction, you still don’t get to claim it until you have the correct documentation. It is not that you can claim a deduction but you need the evidence to prove it, but rather it is if you don’t have the correct documentation THERE IS NO DEDUCTION AT ALL!

So when a client walks into the office of a tax agent and wants to claim a deduction for a work expense, the tax agent should say “but if you don’t have a receipt you can’t claim it and so I won’t include it in your return.”

And when I say “receipt”, I mean “receipt”. Division 900 makes it clear that a credit card or bank statement will generally not be enough… but rather than quote the ITAA97, let me quote the Commissioner…

Myth: I don’t need a receipt, I can just use my bank or credit card statement

Fact: To claim a tax deduction you need to be able to show that you spent the money, what you spent it on, who the supplier was, and when the purchase occurred. Bank or credit card statements usually won’t contain this information. The only time you don’t need these details is if record-keeping exceptions apply.

If you want to claim more than $300 of work expenses as a deduction for your client in a return, you should at least confirm there is and, if you have any professionally at all, sight a receipt.

But how is it then that 78% of tax agent prepared tax returns are wrong and the main reason they are wrong is that when they are audited (within two years as that is the amendment period) 51% of the returns with mistakes don’t have the “substantiation” required – put simply, the receipts that are required!

Its because Tax Agents say… “teacher client, did you buy any sunglasses this year and how much did you buy them for?” without asking “teacher client, do you have a receipt for any sunglasses you bought this year”. They say it this way to “get their client the highest refund” but they are doing this by ignoring the fact that section 900-15 states they are not eligible for the refund at all.

I can get anyone a higher refund if I can just ignore the law and put clients at risk…