Public advice and guidance compendium

We disagree with this conclusion. In our view, royalty should take its ordinary meaning for the purposes of the BREPI analysis. This view is supported by both the text of the ITRA 1986 and the Explanatory Memorandum to the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2018 (the EM).

Paragraph 18 of Taxation Ruling IT 2660 Income tax: definition of royalties provides that 'payments for the use of...industrial, commercial or scientific equipment...will be royalties. In this context 'equipment' does not have a narrow meaning and includes such things as machinery...'

The final Ruling should include further examples and clarify the types of commercial income streams that it would consider to be included in the definition of royalties, or not to be royalties, for BREPI purposes.

A sentence has been added to paragraph 14 of the final Ruling (paragraph 13 of the draft Ruling) stating

Therefore, a hiring fee for the use of or the right to use industrial, commercial or scientific equipment (including machinery) will be a royalty within the meaning of subsection 6(1) and will be BREPI.

A more detailed discussion of what constitutes a royalty for the purposes of subsection 6(1) of the ITAA 1936 is beyond the scope of this Ruling.

The ATO's views on what is meant by a royalty that apply for the purpose of the BREPI definition are contained in:

•

Taxation Ruling IT 2660 Income tax: definition of royalties

•

Taxation Ruling TR 2008/7 Income tax: royalty withholding tax and the assignment of copyright

•

Taxation Ruling TR 93/12 Income tax: computer software

•

Taxation Ruling TR 95/6 Income tax: primary production and forestry

•

Taxation Ruling TR 2004/17 Income tax: indemnification of royalty withholding tax.

What kinds of payments under a 'licence to occupy' arrangement would be included in definition of rent?

Consistent with the purpose of the amendment, 'rent' in paragraph 23AB(1)(d) means the consideration payable by a tenant to a landlord for the exclusive possession and use of land or premises.

Does a reimbursement of outgoings constitute 'rent' (which is not defined in the ITAA 1936) for the purposes of paragraph 23AB(1)(d)?

See Issue 7 of this Compendium in relation to management fees - a similar approach would be applicable to reimbursements.

A company may have a franking account balance as at 30 June 2017, paying a dividend at 30% but in the 2017-18 year, the company only received interest income and suffered a loss which is 100% passive income. Therefore, the dividend is paid out for the 2018 year at 27.5%, although tax has been paid in the past at 30%.

Does the franking account carry forward at 30%?

In determining the corporate tax rate for imputation purposes for an income year, a corporate tax entity does not apply the aggregated turnover threshold for the previous income year. Rather, it compares its aggregated turnover for the previous income year against the aggregated turnover threshold for the current income year.

If a company derives no assessable income in a year, does it meet the requirement in paragraph 23AA(a) that no more that 80% of its assessable income is BREPI?

What is the franking rate that applies if a company has nil assessable income?

If the company has no assessable income for a particular income year, its BREPI for that year cannot be 80% or more of its assessable income (refer to paragraph 23AA(a)).

If the company was dormant in the previous year, and did not derive any assessable income, it would follow that the franking rate for the current year would be 27.5%.

The BREPI of an entity is (subject to subsection 23AB(2)) assessable income that is any of the amounts listed in paragraphs 23AB(1)(a) to (g). Specifically, an amount included in the assessable income of a beneficiary of a trust estate under Division 6 of the ITAA 1936 is BREPI to the extent the amount is referable to another amount that is BREPI under a preceding paragraph of subsection 23AB(1). Division 6 includes so much of that share of the net income of the trust estate in the assessable income of the beneficiary. In relation to Example 1.1 this amount would be the trust's rental income (net of expenses).

Example 1.1 has been amended in the final Ruling to make it clear that the rental income (net of expenses) is the amount included in the beneficiary's assessable income as a share of the net income of the trust estate. For consistency, a similar change has been made in respect of services income. The following changes have been made in the final Ruling:

•

the reference to 'net rental income' has been changed to 'rental income (net of expenses)'

•

the reference to 'net services income' has been changed to 'services income (net of expenses)', and

•

the following words have been added to paragraphs 25 and 26 of the final Ruling (paragraphs 22 and 23 of the draft Ruling):

Therefore, the amount included in the assessable income of each of the beneficiaries is $500,000 under Division 6 of the ITAA 1936 (as the beneficiary's share of the net income of the trust estate). The $500,000 distributed to Smith Pty Ltd will be BREPI, to the extent that it is referable to another amount that is BREPI.

$950,000 is the assessable income of the company, being the net distribution received from the trust but the aggregated turnover should be $850,000, being the ordinary income derived in the ordinary course of business, and excluding the $400,000 of rent as rent is not derived in the ordinary course of business.

Clarify whether rent, in Example 1.5 of the draft Ruling, is ordinary income derived in the ordinary course of business.

The draft Ruling implies the ATO has formed a view under section 328-120 of the ITAA 1997 that passive rental income distributed to Succotash Pty Ltd is 'ordinary income' derived by the company 'in the ordinary course of carrying on a business' and that the amount is included in the annual turnover of the company. Whether this is the correct conclusion is queried.

A detailed discussion of the meaning of the terms 'aggregated turnover', 'carrying on a business' and 'in the ordinary course of carrying on a business' is beyond the scope of this Ruling.

Of the $500,000 share of net income of the Beta Trust on which Succotash Pty Ltd is assessed, 90% is referable to BREPI. Consequently, Succotash Pty Ltd was not a base rate entity and did not qualify for the lower corporate tax rate of 27.5% in the 2017-18 income year. It is taxable at the 30% rate.

There is a mismatch between corporate tax rates and imputation rates across two consecutive years, similar to Example 2.2 of the draft Ruling. The example requires clarification as to how the corporate tax rate for imputation purposes is calculated.

Suggested edits:

Emu Co has a 2017-18 corporate tax rate for imputation purposes of 27.5%. This is because it is assumed its aggregated turnover, BREPI and assessable income are the same as the previous year, being $24 million assessable income for the 2016-17 income year of which 55% was BREPI, in order to calculate its corporate tax rate for imputation purposes in the 2017-18 income year. This is below the $25 million dollar threshold, and less than 80%.

The corporate tax rate that applies in Example 2.3 of the final Ruling (Example 2.2 of the draft Ruling) is 30%, as stated in paragraph 66 of the final Ruling. The corporate tax rate for imputation purposes in this Example is 27.5%, as stated in paragraph 67 of the final Ruling.

The question of whether a company carries on a business is outside the scope of this Ruling.

New paragraph 7 states that:

Unlike the aggregated turnover test, a corporate tax entity does not include the BREPI or assessable income of any connected entity or affiliate when determining whether it meets the 80% BREPI test. In other words, it is only the BREPI and assessable income of the corporate tax entity that is relevant when determining whether 80% or more of its assessable income is BREPI. The BREPI and assessable income of any connected entity or affiliate is not relevant for this purpose.

Note however that whether an amount is ordinary income derived in the course of carrying on a particular business for the purpose of the aggregated turnover rules is beyond the scope of this Ruling.

...of any entity that is connected with or an affiliate of the corporate tax entity...

In finalising the Ruling, the ATO should consider including an example which illustrates how Example 1.2 of the draft Ruling would be if a beneficiary is specifically entitled to a type of income (for example, a franked distribution).

20. Where a franked dividend paid to a trustee of a trust is streamed to a beneficiary that is a corporate tax entity, it is not a non-portfolio dividend of the corporate tax entity, as the dividend is not paid to a company that has a voting interest of at least 10% of the voting power in the company paying the dividend.

21. The amount of a franked dividend streamed to a beneficiary of a trust is treated as being included in the beneficiary's assessable income under Division 6 of the ITAA 1936 for the purposes of applying the BREPI test in section 23AB.

Example 1.4 - how to characterise dividends received by a trust

Company 1, Sub Trust 1 and Bob are beneficiaries of the Busy Trust. The net income of Busy Trust consisted of the following amounts:

•

$500,000 net business income;

•

$100,000 net franked dividend income;

•

$300,000 net unfranked dividend, and

•

$200,000 net rental income.

Pursuant to the terms of the trust deed, the trustee of Busy Trust resolved to make Company 1 presently entitled to its net business income and specifically entitled to the net franked dividend income, Bob presently entitled to the net unfranked dividend, and Sub Trust 1 presently entitled to the net rental income.

For tax law purposes, as Company 1 was presently entitled to $500,000, it was presently entitled to 50% of the net income of the trust.

Although Company 1's share of net income is $500,000, that amount is not referable solely to business income. The effect of Division 6 of the 1936 Act is that Company 1's share of net income is attributable to:

•

$250,000 of business income, which is not BREPI

•

$150,000 of unfranked dividend income, which is BREPI, and

•

$100,000 of rental income, which is BREPI.

Company 1 is also specifically entitled to $100,000 of franked dividend income, which is BREPI.

Company 1 had no other income apart from the Busy Trust. Of the $600,000 of income from the Busy Trust to which Company 1 was presently or specifically entitled, 58% is referable to BREPI and Company 1 qualifies for the lower corporate tax rate.

When applying the BREPI test, the company's assessable income is $400,000. What is the company's BREPI? Nil or ($300,000)? If ($300,000), could this loss be applied against other BREPI received by the company?

The trustee resolved to distribute all of the remaining distributable income of the trust to Freddy (that is, the interest income)'.

Paragraph 22 of the final Ruling (paragraph 19 of the draft Ruling) has also been expanded to clarify that amounts of the net income of a trust are proportionately shared between beneficiaries based on their present entitlements to trust income, absent any specific statutory rules that lead to a different result (such as the case for franked distributions and capital gains).

We will consider whether to cover this in further guidance (such as a practical compliance guideline).

•

Does it mean that those distributions cannot satisfy the non-portfolio definition?

•

Appendix 1 should highlight where additional guidance can be sought on the definition, including the 10% voting test.

Refer also to related Issue 38 of this Compendium.

We will consider whether further guidance is required on this issue.

Paragraph 1.16 of the EM seems to suggest that the dividend may retain its non-portfolio characteristic as it passes through the trust.

In Example 1.3 of the draft Ruling, the franked dividend received by the Mezanine Trust that is distributed to Mezanine Co should not be BREPI because it is a non-portfolio dividend.

Taxation Determination TD 2008/25 Income tax: can section 23AJ of the Income Tax Assessment Act 1936 apply to a dividend paid by a company (not being a Part X Australian resident) to the trustee of a trust, even where the trustee then pays an amount attributable to the dividend to an Australian resident company beneficiary? deals with the issue of whether a dividend paid to a trustee can be a non-portfolio dividend within the meaning of section 317 of the ITAA 1936.

In the hands of the trust it is not a non-portfolio dividend and is BREPI. The tracing rule in paragraph 23AB(1)(g) indicates that it is not a non-portfolio dividend in the hands of the recipient company and also BREPI when passed through.

It would therefore be BREPI in the hands of the ultimate recipient.

The corporate beneficiary is denied the lower rate as it hasn't received a non-portfolio dividend.

Paragraph 1.4 of the EM provides that 'Under the passive income test, companies that are generating predominantly passive income will not be eligible for the lower corporate tax rate'.

Paragraphs 1.16 and 1.17 of the EM indicate that it is only a dividend (and not a non-portfolio dividend) that can be traced through a trust in applying paragraph 23AB(1)(g). This is consistent with the test for BREPI applying at each entity, and the law does not provide for 'looking through' any dividend paid from a company to an entity further up the chain. The test for a distribution by a corporate tax entity is provided for in paragraph 23AB(1)(a) to include such distribution in BREPI of the entity, except if the distribution is a non-portfolio dividend. This is consistent with the EM.

Paragraphs 20 and 21 have been added to the final Ruling to provide further explanation (see Issue 30 of this Compendium).

It is unreasonable if Top Floor Co carries on an active business and does not derive any BREPI.

•

The effect of the increase in the aggregated turnover threshold - from $25 million to $50 million from the 2018-19 income year - when working out if a company has satisfied the second condition to be a BRE and a company's corporate tax rate for imputation purposes.

•

How a company determines its BREPI when receiving distributions from one or more trusts in a chain of trusts, where one or more of those trusts has applied prior year revenue losses. The final Ruling should explain, in addition to expenses, how prior year revenue losses applied by trusts before distributing trust income to a company should be apportioned when working out the company's BREPI.

•

How a non-portfolio dividend paid from one company to another is not BREPI (for example, holding company and subsidiary company).

•

How a dividend that is not a non-portfolio dividend paid from one company to another is BREPI (for example, where a private company holds less than a 10% voting interest in a public company).

•

How different types of licence fees may or may not constitute royalties, which affects whether income from licence fees is included in BREPI.

•

That the treatment of rent as BREPI does not turn on whether the rent is derived from a commercial, industrial or residential property, the property is used in the course of carrying on a business or the property is an active asset and that the meaning of 'rent' excludes hire of equipment, motor vehicles, temporary fencing as well as the primary income derived by hotels/ motels.

Once the net amount (net of deductions) is removed from company's taxable income, the only taxable income remaining in the company is passive, but because 23AA(a) tests the assessable income of the company then the 27.5% rate applies. Is this consistent with the policy intent?

A reference to Subdivision 86-A of the ITAA 1997 has been included in footnote 6 of paragraph 9 of the final Ruling.

The Ruling has been amended to add new Example 1.3 - working out the amount of a company's BREPI where it receives a distribution from an AMIT.