- The ATO has released final guidance LCR 2019/5 for accessing the lower company tax rate for small businesses
- LCR 2019/5 provides guidance on base rate entity and what is base rate entity passive income
- LCR 2019/5 highlights there is ‘devil in the detail’ when it comes to determining whether a company is in fact a base rate entity
Australia's lower company tax rate is dependent on a corporate tax entity qualifying as a 'base rate entity' (BRE). That is:
- it has an 'aggregated turnover' that is less than $50 million in the 2018-19 income year and future years (note: the threshold was less than $25 million in the 2017-18 income year), and
- No more than 80% of its assessable income is 'base rate entity passive income' (BREPI).
Further, the maximum franking credits that can be attached to dividends are to be determined by:
- assuming the 'aggregate turnover', 'BREPI' and 'assessable income' in the current year is the same as the previous year; and,
- applying the relevant corporate tax rate for the current year, given these assumptions.
The ATO has released Law Companion Ruling LCR 2019/5 on what is a BRE and what is BREPI. It will be read with keen interest by small to medium corporates and their advisors. This guidance had previously been released as draft LCR 2018/D7 in August 2018 and CA ANZ lodged a submission the draft on 4 October 2018.
This article provides our brief observations on the ATO's final guidance.
What has changed from the ATO's draft guidance?
- Additional examples have been included and some of the pre-existing examples refined.
- The LCR 2019/5 more explicitly states the ATO's position on some key components of BREPI.
- Whilst the LCR 2019/5 is still focussed on the newer test (i.e. 'no more than 80% BREPI'), brief comments have been added on the pre-existing aggregated turnover test.
- Accompanying the release of the LCR 2019/5, the ATO has published a Compendium of Comments, summarising issues raised by industry on the draft LCR and the ATO's response.
The key observations from the final LCR are as follows:
- Non-portfolio dividend definition
The ATO's view is that franked dividends flowing through a trust cannot be 'non-portfolio dividends' in the hands of any ultimate corporate beneficiary and thus will be BREPI. A different outcome might arise if the non-portfolio shareholding was held directly by the corporate receiving the dividends, albeit the shares must carry the requisite voting interests of at least 10% to qualify.
- Rent and royalty definitions
The ATO's position is that rent for BREPI purposes will be limited to consideration received by a landlord for exclusive possession and use of land or premises.
On the other hand, the meaning of royalties takes on the wider definition of royalties in section 6(1) of the Income Tax Assessment Act 1936. One consequence of this wider royalty definition is equipment hiring fees will not be 'rent' but will most likely be 'royalties' and accordingly will be BREPI.
It is also apparent this royalty definition has potentially wider ramifications for the income earned by businesses in the software and technology sectors.
- Partnership and trust income
The dissection of partnership and trust net assessable income into their BREPI and non-BREPI components will have several tax compliance difficulties due to factors such as:
- potential differences between trust law and tax law BREPI entitlements
- the impacts of trust streaming rules for tax
- the need for a reasonable apportionment of expenses at the partnership and trust level, and
- the need for tracing of BREPI components through a chain of partnerships and trusts.
- Interest definition:
Notwithstanding the limited commentary in LCR 2019/5 on this definition, what is interest or in the nature of interest and what are the statutory exceptions thereto, will be an important matter for some corporates, particularly in the financial services sector.
- Imputation consequences
The examples in LCR 2019/5, explaining what franking credits are to be attached to dividends, highlight several tricks and traps that now arise in paying franked dividends. Take for example the new Example 2.2 which discusses the maximum franking credits that can be attached to a dividend paid by a dormant company. In this case, the mechanics of the BRE provisions result in an outcome whereby the maximum franking credits are limited to the lower company tax rate, notwithstanding the dividend paying company is inactive;
- Aggregated turnover test impacts
As noted above, brief comments have been added on the other limb of the BRE definition (i.e. the aggregated turnover test). However, LCR 2019/5 does not go on to include any worked examples that might highlight some of the practical complexities of the aggregated turnover test. Certainly, a number of consultation issues raised in the Compendium of Comments centre on the aggregated turnover test and highlight further tricks and traps in trying to navigate through the BRE definition.
LCR 2019/5 highlights there is 'devil in the detail' when it comes to determining whether a company is in fact a BRE.
Some smaller corporates may need assistance in matters such as:
- revisiting 2018 and 2019 tax rate positions in light of the final LCR
- creating new forecasting and tax return reporting for BREPI and non-BREPI
- assessing the tax rate impacts for 2020 and future years on a more proactive basis (e.g. not wait until tax return lodgement time)
- understanding the new franking rules and their consequences for past and future dividend payments.