INSIGHT: Cutting the Cuts—The Australian Corporate Tax Rate Saga Continues

Among the trend of countries lowering their corporate tax rates, Australia is increasingly becoming an outlier.

Based on the Organization for Economic Co-operation and Development (“OECD”) website, the average corporate tax rate across the OECD has dropped from 32.5 percent in 2000 to 23.9 percent in 2018. For example, the U.S. has cut its national corporate tax rate to 21 percent.

However, Australia has settled for a 30 percent general corporate tax rate and a slightly lower 27.5 percent rate for “base rate entities,” to be progressively lowered to 25 percent by the 2026–27 income year.

The reduced Australian corporate tax rate (as at September 24, 2018) is as shown in the Table.

The merit of lowering or maintaining the corporate tax rate is beyond the scope of this article, being a job better left to the economists. Instead, this article will explore these two key issues:

• When does the lower corporate tax rate apply?
• Where is the legislative trend heading towards in Australia?

When Does the Lower Corporate Tax Rate Apply?

The Australian corporate tax rates are set out in the Income Tax Rates Act 1986 (Cth) (the “Rates Act”).

Relevantly, section 23(2) provides that:

"(2) The rate of tax in respect of the taxable income of a company is:
(a) if the company is a base rate entity for a year of income—27.5%; or
(b) otherwise—30%
if subsections (3) to (5) and section 23A do not apply to the company.”

Subsections (3) to (5) and section 23A provide for the income tax rates applicable to specific categories of company (e.g. retirement savings account providers, pooled development funds and life insurance companies), all of which are beyond the general scope of this article.

This means that a company should be able to access the lower tax rate of 27.5 percent if it is a “base rate entity” for a year of income.

Before August 31, 2018, an entity was a “base rate entity” for the purposes of section 23AA of the Rates Act if it satisfied two conditions:

• it carries on a business in the year of income (the carries on a business condition) (now repealed and replaced by the base rate entity passive income threshold—see below); and
• its aggregated turnover for the year of income, worked out as at the end of that year, is less than AU$50 million ($36,230 million) (the turnover condition).

Carries on a Business Condition (Now Repealed)

“Carries on a business” carries its meaning from the Income Tax Assessment Act 1997 (Cth) over into the Rates Act. In this regard, the Commissioner of Taxation (the “Commissioner”) released “Draft Taxation Ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?” (“TR 2017/D7”).

At paragraph 10 of TR 2017/D7, the Commissioner provides that:

"[t]he case law highlights that it is not possible to definitively state whether a person is carrying on a business. Whether the activities of a person constitute the carrying on of a business is a question of fact, and must be answered based on a wide survey and the overall impression of the activities of the person and having regard to the indicia of carrying on a business as a whole.”

These indicia are outlined in TR 2017/D7 and include, among other things, considerations of the nature of the activities, particularly whether they have a profit-making purpose and whether the person intends to carry on a business.

Turnover Condition

The turnover condition currently requires the company’s “aggregated turnover” for the year of income (worked out as at the end of that year) to be less than AU$50 million (the turnover threshold was AU$25 million for the 2017–18 income year). At a high level, a company’s aggregated turnover is the sum of its “annual turnover,” the annual turnover of any connected entity and any entity that is an affiliate (exclusions may apply).

Generally, a company’s “annual turnover” is the total ordinary income that it derives in the income year in the ordinary course of carrying on a business.

Base Rate Entity Passive Income Threshold

On August 31, 2018, the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018 (Cth) received assent.

Generally, these amendments ensure that a company will only qualify as a base rate entity (and therefore qualify for the lower corporate tax rate for an income year) if no more than 80 percent of the company’s assessable income for that income year is “base rate entity passive income,” and the turnover condition is met.

These amendments commence immediately after the commencement of the Treasury Laws Amendment (Enterprise Tax Plan) Act 2017 (Cth) (which commenced July 1, 2017). This means that the “carries on a business” condition has effectively been repealed (retrospectively) and replaced by the base rate entity passive income threshold from the 2017–18 income year.

“Base rate entity passive income” includes, for example, a dividend (including the attached franking credit), a non-share dividend, interest or a payment in the nature of interest (subject to certain exceptions, e.g. for financial institutions), royalties and rent.

The turnover condition still applies.

Where is the Legislative Trend Heading in Australia?

The Treasury Laws Amendment (Enterprise Tax Plan No. 2) Bill 2017 (Cth) was introduced into Parliament on May 11, 2017.

If passed, this Bill would have increased the aggregated turnover that applies for a company to qualify for the lower corporate tax rate annually until it reached AU$1 billion in the 2022–23 income year.

In the 2023–24 income year, the corporate tax rate would have been 27.5 percent for all companies.

The corporate tax rate would have then been progressively lowered in stages until it reached 25 percent for the 2026–27 income year and for subsequent income years for all companies.

This Bill received a lot of attention in Parliament and from the public, and was ultimately defeated in the Senate on August 22, 2018.

At this stage, the government appears to have ruled out reviving tax cuts for the big end of town but may accelerate the cuts for small business. However, at the time of writing, the opposition is ahead in the polls. The opposition has indicated that it would, if elected, maintain the default corporate tax rate at 30 percent and reduced corporate tax rate at 27.5 percent. Given the defeat in the Senate and the recent change in leadership of the country, direction on this point is not yet settled.

Australia may have resisted the trend to lower corporate tax rates for now, but for how long can Australia resist the winds of change?

Planning Points

In light of the above, taxpayers should take steps to:

• Identify any connected entities and entities that are affiliates for the purposes of section 328-115 of the Income Tax Assessment Act 1997 (Cth);
• Ensure procedures are in place to account for the total ordinary income derived by the taxpayer and by any connected entity and any entity that is an affiliate for the purposes of section 328-115 of the Income Tax Assessment Act 1997 (Cth) in the income year in the ordinary course of carrying on a business. These procedures should also be set up to exclude certain dealings such as, at a high level, dealings with or between the taxpayer’s connected entities and entities that are affiliates; and
• Ensure accounting systems are set up to separately identify “base rate entity passive income” which is included in the taxpayer’s assessable income for the income year.

Miles Hurst is a Partner and Struan Davidson is an Associate with Baker McKenzie Australia.