Technical Update:

Federal Government to clarify ‘carrying on a business’ for companies

07 August 2017

The Government has announced a legislative solution to the current confusion regarding which small companies will be entitled to the 27.5 per cent small business company tax rate.

In an article in the Australian Financial Review on Friday 4 August, the Minister for Revenue and Financial Services, Kelly O’Dwyer stated that the Government will introduce legislation to clarify which companies should be entitled to the reduced company tax rate. In the article, she indicated a legislative amendment would be introduced to remove any uncertainty, stating that only active trading companies should qualify for the lower tax rate.

BACKGROUND

From 1 July 2015, companies that were carrying on a business and which had an aggregated turnover up to $2 million during that income tax year were to be liable to an income tax rate of 28.5 per cent. From 1 July 2016 the turnover threshold increased to $10 million and the tax rate reduced to 27.5 per cent. Then from 1 July 2017, the turnover threshold increased to $25 million.

It appears that the Government’s intention in providing these concession was to encourage small businesses to reinvest the tax savings in their business, providing employment and investment growth.

The issue became confused when the Tax Office issued a draft Taxation Ruling in which the Tax Office stated that, in its opinion, companies that were engaged in passive investments in shares and property could be seen to be carrying on a business. The ATO subsequently confirmed this view in the context of the small business company tax cuts on the ATO website here, which says companies will be eligible for the lower 27.5 per cent rate even if their activities are ‘relatively passive’.

The Tax Office’s view seemed to extend the availability of the small business tax cuts to companies that were carrying on passive investment activities. It was also argued that the Tax Office’s view could extend the tax cut to private companies that were beneficiaries of private family trusts.

This view seems to be contrary to the Government’s policy for the tax cuts as the Minister for Revenue and Financial Services indicated in a media release here noting that “it is up to the ATO to determine how the law applies and in this case whether a company is carrying on business or not” and “the policy decision made by the Government to cut the tax rate for small companies was not meant to apply to passive investment companies”.

Presumably the amendment proposed by the Federal Government, as mentioned in the Australian Financial Review article, will provide a definition of ‘active trading business’ that is consistent with the Government’s intentions.

The article also makes the comment that “companies holding passive investments, such as those linked to family trusts” will not be eligible for the lower rate. However, this statement was not directly attributed to Ms O’Dwyer.

BDO COMMENT

It is hoped that the definition produced in the amending legislation provides the clarity companies have been demanding. Hopefully, there will also be sufficient detail provided in the Explanatory Memorandum (EM) accompanying the amending legislation and that the EM will provide detailed examples to clearly establish which passive companies will not qualify for the reduced company tax rate.

The Australian Financial Review article also quoted BDO Australia’s National Tax Director, Lance Cunningham suggesting possible solutions to the current confusion, including legislative amendments to either exclude passive investment companies from the lower tax rate or keep the current definition and allow all small business companies the choice of which tax rate they wish to apply. The article also refers to the still unresolved issue of companies on the 27.5 per cent tax rate having trapped franking credits and an overall increase in tax payable for the lower tax paying companies and their shareholders.

BDO issued a Technical Update on 29 June 2017, available here, which explored the implications for taxpayers paying franked dividends and included a detailed example illustrating the issues. Perhaps the suggestion to allow companies to choose which tax rate they wish to apply may provide a solution to both the franking issue and the carrying on a business issue. However, the comments attributed to the Minister would indicate it is more likely that the legislative amendment will exclude passive investment companies from the lower tax rate. BDO will keep you informed on the progress of these changes.