While the legislation is transitioning, some have been left confused about the application of reduced corporate tax rates and the details of eligibility criteria during this state of limbo. To provide some clarity, we take a closer look.
The intent of the highly anticipated draft Practical Compliance Guideline (PCG) 2018/D5 was to replace and extend the application of draft PCG 2017/D7.
This is where semantics are important.
In this case, the meaning of “extend” appears to literally mean an extension to the application period of the original draft PCG. Why? The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 (Bill) has still not passed the Senate.
So what does this mean for corporate tax entities in the meantime?
Under the proposed legislation, a corporate tax entity will be eligible for the reduced corporate tax rate from the 2017-18 year, if:
i. No more than 80% of its assessable income is base rate entity passive income; and
ii. Its aggregated turnover is less than $25 million.
While corporate tax entities wait for the legislation to change, the eligibility criteria to access the reduced corporate tax rate of 27.5% will be subject to existing law (Treasury Laws Amendment [Enterprise Tax Plan] Act, 2017).
The criteria (which will continue to apply for the 2017-18 year until the Bill is passed) are that the corporate tax entity:
i. Carries on a business; and
ii. Has an aggregated turnover of less than $25 million.
Let’s take a closer look at criterion (i) ‘Carries on a business’.
During the transition to the new criteria, the Commissioner will take a “facilitative compliance approach” to testing for this criterion. This means 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 or 2016-17, unless of course the assessment is plainly unreasonable, or the taxpayer was involved in artificial or contrived arrangements.
Corporate tax entities should continue to rely on the guidance of TR 2017/D7 as to what constitutes (i) ‘Carries on a business’.
While the ATO does not provide a definitive view in TR 2017/D7, it does reference case law indicating that “any gainful use to which a company puts its assets will, on its face, amount to carrying on a business”.
The ruling provides some guidance on accessing the reduced tax rate, however, relies heavily on the taxpayer to make their own assessment.
It requires corporate tax entities to consider the indicia of carrying on a business when assessing eligibility to access the reduced corporate tax rate in the 2015/16, 2016/17, and 2017/18 financial years. These include:
- The nature of the activities, particularly whether they have a profit-making purpose;
- Whether the person intends to carry on a business;
- Whether the activities are:
- Repeated and regular;
- Organised in a business-like manner, including the keeping of books, records and the use of a system;
- The amount of capital employed in those activities; and
- Whether the activity is better described as a hobby, or recreation.
The ruling also notes a single act or transaction can amount to carrying on a business if it is intended to be repeated, or it can be shown that the transaction was the first step in the carrying on of a business.
The ruling offers examples, which include cases where the courts deem a company to be ‘carrying on a business’ in the following scenarios:
- Letting the company premises out for rent;
- Leasing plant to subsidiaries for no fee;
- Providing management and secretarial services to a subsidiary that carries on a business;
- Holding shares in a subsidiary company which are engaged in trading;
- Receiving interest and royalties.
Pass or fail - which is it?
Where the draft PCG lacks guidance and clarity is in the case of corporate tax entities which may pass the carrying on a business test for the 2015/16, 2016/17 and 2017/18 years, but fail the “passive income” test once the Bill passes.
As dangerous as it may be, one is left to make assumptions.
First assumption. A corporate tax entity which, as an example, made a profit solely from interest earned on funds lent to an associated entity (e.g. loan made to an associated under a Division 7A loan agreement or sub-trust arrangement) would be eligible to apply the reduced rate for these years. However, once the Bill has passed the same corporate tax entity will be unable to pass the passive income requirement and as such required to revert to a 30% base tax rate.
Let’s make another. We assume that as the Bill has application from 1 July 2017, once passed, corporate tax entities who applied the reduced corporate tax rate on the basis they were carrying on a business – then found they were ineligible under the passive income test – would be required to amend their 2018 income tax return and adjust for any franking credits applied to dividends at the lower rate.
The draft PCG further extends the Commissioner’s administrative approach to incorrect franking. This will be done by enabling corporate tax entities to inform members of any incorrect franking by providing a written notice, rather than being required to amend a previously issued distribution statement.
The administrative approach applies to the 2016/17 and 2017/18 years and the details of what is required in a written notice can be found in the draft PCG.
Of some relief is that penalties will not be imposed on any amendments.
For more information
How do the proposed changes to the corporate tax rate impact on you? Let us help, please contact your local RSM office.