Reduced Company Tax Rate and Franking Rate Confusion
For the 2016–17 income year, the company tax rate for small businesses decreased to 27.5%. Companies with turnover less than $10 million are eligible for this rate. The reduced company tax rate of 27.5% will progressively apply to companies with turnover less than $25 million for 2017/2018, and $50 million by the 2018–19 income year. From 2024–25, the rate will reduce each year until it is 25% by 2026–27.
The maximum franking credit that can be allocated to a frankable distribution has also been reduced to 27.5% for these companies – in line with the company tax rate - but is based on the current year small business threshold and last year’ s turnover.
Tax rate and franking rate issues can therefore arise for companies that hover around the current tax years low rate threshold, and with the threshold progressively increasing over the next few years, some companies are paying tax at one rate on the prior year income but can only frank at the lower current year rate for dividends paid in the current year.
There is also confusion about what activities can benefit from the lower business rate, with an ATO interpretation meaning that the tax rate cuts could apply to unintended passive investment companies.
To help with determining when a company is “carrying on a business” for the 2017 income year, the ATO has released TR 2017/D7 that contains the ATO’s preliminary views on that question together with examples.
The Commissioner has taken a broader view than expected of what constitutes a business will much more readily be found to be carrying on a business than an individual or a trust, if their activities are commercial and intended to earn a profit.
The draft Ruling confirms however that it is not possible to definitively state whether a company is carrying on a business and each case will need to be considered individually. However, it does provide some examples of when it is considered activities would or would not amount to a business.
2017-2018 year onwards
The Government has introduced new laws that change the way company tax rates are determined from with the 2017 -2018 year onwards.
The requirement to carry on a business has been replaced by a passive income test.
From 2017-2018 onwards a company will only qualify for the lower company 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 company’s aggregated turnover for the income year is less than the aggregated turnover threshold for that income year.
For the 2017-18 income year, the threshold is $25 million. The turnover threshold will reduce progressively to $50 million by 2026-207 with a company tax rate of 25%.
‘Base rate entity passive income’ includes items such as dividend income (other than non-portfolio dividends), franking credits attached to dividends, interest income, royalty income, rent and net capital gains.
A company that is seeking to apply the lower company tax rate should carefully consider the circumstances in which it operates and whether the reduced rate can apply and what the franking rate for dividends is. The franking rate issue though remains unchanged.
If you are still uncertain, talk to one of our tax specialists.