What rate of tax does my private company pay?

From 1 July 2018, the rules for determining the rate of tax paid by a company changed fundamentally. Now, the company tax rate depends upon whether the company is a ‘base rate entity’.

These changes also affect the rate at which a company can frank its dividends.

There are two tests in determining whether a company is a ‘base rate entity’.

Turnover test

To be a base rate entity, a company’s aggregated turnover must not exceed the ‘base rate entity threshold’ for the year:

A company’s aggregated turnover includes income earned in connected entities, but is restricted to income from business activities only (and not investment activities).

So, if a company’s aggregated turnover in the 2019 year is $57 million, it is not a base rate entity, and is taxed at 30%.

Passive income test

The second test is whether the company’s ‘base rate entity passive income’ or ‘BREPI’ is more than 80% of its assessable income.

If a company’s BREPI for a year is not more than 80% of its assessable income, it is a base rate entity (subject to the turnover test).

BREPI is essentially income from passive investments. Examples of income that are usually BREPI include:

• dividends (including the franking credits attached), unless received by a shareholder that is a company that owns at least 10% of the voting rights in the company paying the dividend
• interest
• royalties
• rent
• net capital gains
• distributions from trusts and partnerships to the extent that the distributions are referrable to the BREPI of that trust or partnership.

Why does it matter?

If a company is a base rate entity, then its income is taxed at the base rate entity rate, and its dividends will be franked to that lower rate as well.

If a company is not a base rate entity, then its income is taxed at 30%, and its dividends can be franked to that 30% rate also.

The rate at which a dividend can be franked reflects the rate of tax payable by the company in the current year (based on whether it was a base rate entity for the previous year) and not necessarily at the rate at which the profits that gave rise to that dividend were taxed. This means that profits from previous years that were taxed at 30% may only give rise to a franking credit at the lower base rate entity rate.

Bucket companies

An example of this is a distribution to a bucket company.

Trading entities in the 2019 year will be (generally) taxed and pay dividends to 27.5%, while investment and bucket companies will continue to be taxed at the higher rate of 30%.

Consider a trading company that qualifies as a base rate entity in the 2019 year. It pays a dividend to a family trust, which distributes it to a bucket company, which only receives these distributions and has no non-passive income.

The dividend from the trading company will be franked to 27.5%, however, the dividend will be assessed in the bucket company at its rate of 30% as it is not a base rate entity. This means the bucket company will have top up tax on the dividend that is distributed through the family trust.

As a result of these rule changes, the common strategy of paying dividends from an active business entity through a family trust to a bucket company could result in top up tax in the bucket company.

Know your tax rate!

It is very important to be aware of the rate of tax each company in a group will pay, and also the rate at which its dividends will be franked, as this is likely to differ from company to company going forward, and even from year to year in the same company.

There can also be a difference between the rate of tax paid in the past (and the rate at which franking credits have arisen), and the rate at which a dividend can be franked in the future.

This will be covered in our upcoming roadshow – click here for details.

If you have any questions about the rate at which your company will pay tax or can frank its dividends, please contact a member of our tax team.