Since 2015, there have been many changes to the tax laws, both enacted and proposed, which set out the eligibility for the lower corporate tax rate. Since 2017, there have also been legislative changes, both enacted and proposed, to the rate at which a company franks a distribution made to its members (i.e. shareholders).
- The Tax Laws Amendment (Small Business Measures No. 1) Act 2015 (enacted on 22 June 2015) reduced the corporate tax rate from 30 per cent to 28.5 per cent for the 2015–16 income year for small business entities (SBEs) as defined in s. 328-110 of the ITAA 1997 that were carrying on a business in that year and had an aggregated turnover (as defined in s. 328‑115 and s. 328-120 of the ITAA 1997) in that year or the previous year of less than $2 million.
- The Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 (enacted on 19 May 2017) further reduced the corporate tax rate from 28.5 per cent to 27.5 per cent for the 2016–17 income year for SBEs that were carrying on a business in that year and had an aggregated turnover in that year or the previous year of less than $10 million. This Act also increased the SBE turnover threshold from $2 million to $10 million from 1 July 2016.
- On 18 October 2017, the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 (‘the BRE Bill’) was introduced into Parliament. The BRE Bill proposes to amend the current law by setting a ‘bright line’ test to determine which companies are eligible for the lower tax rate.
This discussion does not consider the measures contained in the Treasury Laws Amendment (Enterprise Tax Plan No. 2) Bill 2017 which proposes to extend the corporate tax cuts to companies with an aggregated turnover of $50 million or more from 1 July 2019. This Bill remains before the Senate.
The Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 (enacted on 19 May 2017) introduced the concept of the Base rate entity (BRE), contained in s. 23AA of the Income Tax Rates Act 1986 (ITR Act).
Under existing s. 23AA of the ITR Act, a company is a BRE for an income year if:
- it carries on a business (within the meaning of the ITAA 1997) in the income year; and
- its aggregated turnover (within the meaning of that Act) for the income year, worked out as at the end of that year, is less than $25 million.
The aggregated turnover threshold for BREs increased to $50 million from 1 July 2018.
The BRE Bill proposes to remove the ‘carrying on a business’ requirement so that, under the proposed changes, a company will be a BRE and eligible for the lower tax rate of 27.5 per cent from the 2017–18 income year only if:
- no more than 80 per cent of its 2017–18 assessable income is base rate entity passive income (as defined in proposed s. 23AB of the ITR Act); and
- its aggregated turnover in 2017–18 is less than $25 million.
The BRE Bill also proposes to change the assumptions that a company makes when determining its corporate tax rate for imputation purposes (i.e. its franking rate).
Until the BRE Bill is passed, a company must meet the criteria under the existing law to be eligible for the lower tax rate of 27.5 per cent in the 2017–18 income year. At the time of writing, the BRE Bill had not yet passed the Senate.
Our Banter blog on the changes to the Base rate entity rules in November 2017, and our most recent blog on How to prepare a 2018 company tax return with unenacted measures detail the measures contained in the BRE Bill.
As we have previously discussed, clarity on these measures continues to elude tax practitioners and there is now increased confusion because the measures in the BRE Bill are proposed to start on 1 July 2017, yet the BRE Bill remains before Parliament unenacted.
Adding to the conversation is draft ruling TR 2017/D7 which was released by the ATO on 18 October 2017, the day the BRE Bill was introduced into Parliament.
The draft ruling provides guidance on when a company carries on a business within the meaning of s. 23AA of the ITR Act. The broad position taken by the Commissioner on when a company ‘carries on a business’ impacts not only on whether the company is eligible under the current law for the lower tax rate but also the maximum rate at which it can frank its distributions.
The Commissioner acknowledges that uncertainty may have arisen as a result of enacted and proposed changes to the tax laws that set out eligibility for the lower tax rate and the maximum franking rate, and the subsequent release of TR 2017/D7.
To provide some certainty, on 25 July 2018, the Commissioner released draft practical compliance guideline PCG 2018/D5 (‘the draft PCG’) which sets out the ATO’s compliance and administrative approaches for companies that have faced practical difficulties in determining their tax rate and franking rate in the 2015–16 to 2017–18 income years.
The timing of the passage of the amending Acts, the unenacted amendments in the BRE Bill and the timing of the release of TR 2017/D7 may have resulted in some companies making decisions about their eligibility for the lower tax rate without knowledge of, or in anticipation of, the subsequent operation of the law and the ATO’s view of when a company ‘carries on a business’.
This may have led to some companies:
- lodging their 2016 and 2017 tax returns without being certain of the correct position; and/or
- issuing distribution statements to members in 2016–17 and 2017–18 based on a franking rate that is incorrect.
The title of the draft PCG — Enterprise Tax Plan: small business company tax rate change: compliance and administrative approaches for the 2015–16, 2016–17 and 2017–18 income years — is a little misleading. It may not be apparent from a first read of the draft PCG, but the Commissioner’s compliance and administrative approach regarding a company’s:
- tax rate is confined to the 2015–16 and 2016–17 income years. The tax rate for 2017–18 is not covered by the PCG, perhaps because the BRE Bill remains before Parliament and also because not many 2018 company tax returns will have been lodged by the release date of the draft PCG (i.e. 25 July 2018). The ATO has previously advised (QC 48880) taxpayers to apply the existing law on BREs when preparing 2018 returns, but amendments may be necessary if the BRE Bill is passed.
- franking rate is confined to the 2016–17 and 2017–18 income years. The franking rate for 2015–16 is not covered by the PCG because in that year the maximum franking rate was a flat 30 per cent for all companies regardless of whether their tax rate was 28.5 per cent or 30 per cent.
This may be confusing as the PCG covers three income years, but the ATO’s two compliance and administrative approaches each cover only two income years and not the same two years. The reason why there may be uncertainty in relation to the tax rate and the franking rate is set out in the table below.
|Commissioner’s compliance and administrative approach||Reason for uncertainty|
|Tax rate for the 2015-16 and 2016-17 income years only||There may be uncertainty because of the broad view taken by the Commissioner in TR 2017/D7 as to when a company ‘carries on a business’ within the meaning of s. 23AA.
Some companies may not have regarded themselves as carrying on a business and would have lodged their 2016 and 2017 tax returns on the basis that they were not an SBE in the 2015–16 and 2016–17 income years. They would have applied therefore the 30 per cent tax rate.
However, according to TR 2017/D7 (see Examples 3 and 4, and Example 5 Possibility B), some of these companies were carrying on a business which means they were SBEs for those years and were eligible for the lower tax rate of 27.5 per cent.
|Franking rate for the 2016-17 and 2017-18 income years only||There may be uncertainty because of:
ATO’s two compliance and administrative approaches
In light of this uncertainty, the Commissioner will apply two approaches to assist affected companies:
- A facilitative compliance approach will apply to the ‘carrying on a business’ test for tax rate purposes in transition to the new eligibility rules for the lower rate.
- A practical administrative approach will apply that allows companies to choose a simplified method to inform members of the correct franking credit to which they are entitled.
Given the uncertainty around what constitutes ‘carrying on a business’ prior to the release of TR 2017/D7, the Commissioner will not allocate compliance resources specifically to conduct reviews of whether companies have applied the correct tax rate or franking rate in the 2015–16 and 2016–17 income years.
Circumstances in which the ATO’s compliance approach will not apply
The ATO’s facilitative compliance approach in relation to the tax rate will not apply where:
- the Commissioner becomes aware that a company’s assessment of whether they were carrying on a business in the 2015–16 or 2016–17 income years was plainly unreasonable; or
- the company has entered into:
– an artificial or contrived arrangement that affects the characterisation of the company as carrying on a business or not;
– a tax avoidance scheme whose outcome depends, in whole or part, on the characterisation of the company as carrying on a business or not; or
– arrangements designed to conceal ultimate beneficial or economic ownership of any connected or affiliated entities (which may affect whether the company satisfies the aggregated turnover test).
The approach will also not apply where a company has attracted ATO compliance activity for reasons unrelated to whether the correct tax rate has been applied by the company.
As is always the case, the Commissioner may undertake review activity to ensure compliance, particularly where there is reason to believe a taxpayer’s self-assessment, or the information provided, is incorrect.
Administrative approach: incorrect franking in 2016–17 and 2017–18
Written notification informing members
A company that makes a frankable distribution to its members must give them a distribution statement that includes the amount of the franking credit on the distribution (see s. 202-75 of the ITAA 1997).
A company may have issued an incorrect distribution statement for a frankable distribution in the 2016–17 or 2017–18 income years due to:
- the proposed amendments in the BRE Bill; or
- the passage of the amending Acts (referred to in Background above) subsequent to the distribution being made and the release of TR 2017/D7.
Ordinarily, where a company has issued an incorrect distribution statement to its members, it would need to apply to the Commissioner for permission to amend and reissue the distribution statement (see s. 202-85 of the ITAA 1997).
Given the uncertainty around what franking rate a company should apply, the Commissioner will allow a company to inform its members of the correct franking credit to which they are entitled under the revised corporate tax rate in writing without reissuing the distribution statement.
This administrative approach applies to affected frankable distributions made by companies in the 2016–17 and 2017–18 income years only (see table above).
The Commissioner will not impose penalties on the company for giving a member an incorrect distribution statement provided it gives written notice to each of its members clearly showing the correct amount of the franking credit. The notice should be provided in the same way as the distribution statement was provided (which may be electronically by email). The company can provide this notice to their members without seeking an exercise of the Commissioner’s discretion to allow the distribution statement to be amended.
Notice of correct franking credit
The notice should indicate that the distribution statement previously provided was incorrect and should contain the following details, such that the member has enough information to meet their tax obligations for the distribution:
- name of the company making the distribution;
- date on which the distribution was made;
- amount of the distribution;
- revised amount of franking credit allocated to the distribution, rounded to the nearest cent;
- franking percentage for the distribution, worked out to two decimal places;
- amount of any withholding tax deducted from the distribution; and
- name of the member.
The company must also adjust its franking account to reflect the fact that the franking debit to the account should be calculated by reference to the correct franking rate.
|Example from PCG 2018/D5|
|ABC Co pays a fully franked distribution to a member of $100. The distribution was made on 31 December 2016 before the Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 became law. Applying the 30% tax rate that applied at that time to ABC Co, the company calculated the franking credit to be allocated to the distribution to be:
$100 × 0.30 / (1 – 0.30) = $42.86
ABC Co provides a distribution statement to the member that states that the franking credit on the distribution is $42.86.
Subsequently, the Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 was passed which reduced the corporate tax rate for small businesses with an aggregated turnover of less than $10 million to 27.5% for their 2016–17 income year. ABC Co meets the criteria for the lower corporate tax rate and maximum franking credit for distributions in the 2016–17 income year becomes based on this lower 27.5% corporate tax rate. The result is the initial franking credits allocated to the distribution exceed the maximum franking credit for the distribution and the distribution statement is incorrect.
Instead of seeking an exercise of the Commissioner’s discretion to allow an amended distribution statement, ABC Co sends a letter to each of its members containing the details set out in para. 21 of the draft PCG, explaining that the original distribution statement was incorrect.
When members lodge or amend their tax return, they will be able to use the information in this letter to determine the maximum franking credit on the distribution based on the 27.5% tax rate. Using s. 202-65 of the ITAA 1997, this would be calculated as:
$100 × 0.275 / (1 – 0.275) = $37.93
No penalty is imposed by the ATO.
Amended distribution statement
Alternatively, the company may apply to the Commissioner for permission to amend the distribution statement under s. 202-85 of the ITAA 1997. If the Commissioner grants permission, the company would then be able to provide the member with a new distribution statement and no penalty would be imposed for the initial incorrect statement.