Clarification regarding Tax cuts for Passive Investors

Things to Consider When Reviewing Your Estate and Succession Plan
24
Oct

Clarification regarding Tax cuts for Passive Investors

24.10.17

As previously foreshadowed, the Government has released  Exposure Draft legislation proposing to ensure that corporate tax entities with predominantly passive income (such as rent, dividends, interest and capital gains) cannot access the lower corporate tax rate of 27.5%.

The proposed legislation answers the question surrounding eligibility, by ensuring that a company will only be able to access the lower tax rate if it is a "base rate entity" (or for 2016-17 a "small business entity").  To qualify for the lower tax rate of 27.5% for a year:

  • the entity's "base rate entity passive income" (see below) is less than 80% of its assessable income;
  • the entity "carries on a business" in the year; and
  • meets the aggregated turnover threshold (e.g. $10m for 2016-17; $25m for 2017-18).

Items classified as "base rate entity passive income" include but are not limited to:

  • distributions (e.g. dividends) other than non-portfolio dividends which meet certain requirements;
  • non-share dividends;
  • rent, interest income, royalties; and
  • capital gains.

When determining the maximum franking credit to attach to a dividend the company can assume that its aggregated turnover, base rate passive income and assessable income is equal to the amount for the previous income year. 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 deemed to be the lower corporate tax rate of 27.5%. By way of an example, assume Company A is carrying on a business and, in the 2016-17 income year, has:

  • aggregated turnover of $8m with base rate passive income of $7.5m; and
  • assessable income of $8m.

For 2016/17, 92.59% of Company A’s assessable income is base rate entity passive income and therefore the corporate tax rate is 30% (even though its aggregated turnover is only $8m). In the following year Company A proposes to pay a dividend and therefore when working out its corporate tax rate for imputation, Company A must assume that its profile is the same as for the prior year (i.e. that it doesn’t meet the 80% threshold and therefore has a 30% tax rate and gross up rate).

The amendments as drafted will broadly commence on 1 July 2016 and apply to the 2016-17 income year and later years of income but are anticipated to cease from the 2023-24 income year when the corporate tax rate is proposed to be 27.5% for all corporate tax entities.

Should you have any questions regarding how the tax cuts could affect you, please contact your ESV engagement partner.