Law Companion Ruling

LCR 2019/5

Base rate entities and base rate entity passive income

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What this Ruling is about

1. This Ruling considers the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018 which amends the law to limit access to the lower corporate tax rate. From the 2017-18 income year a corporate tax entity must be a 'base rate entity' to be taxed at the lower rate. This Act also makes changes to how a corporate tax entity calculates the amount of a franking credit it may attach to a frankable distribution.

2. This Ruling provides advice on:

•

the general scheme of the new law

•

what amounts of assessable income are 'base rate entity passive income' (BREPI)

•

the meaning of rent, interest and when a share of net income of a trust or partnership is referable to an amount of BREPI, and

•

how to calculate a corporate tax entity's corporate tax rate for imputation purposes and work out the maximum amount of the franking credit it may attach to frankable distributions.

3. This Ruling does not provide guidance on terms and concepts where there is existing ATO guidance on their meaning and the context of the law does not suggest a different meaning. This existing advice is summarised in Appendix 1 of this Ruling.

4. All legislative references in this Ruling are to the Income Tax Rates Act 1986 (ITRA 1986) unless otherwise indicated.

Date of effect

5. This Ruling is a public ruling, effective for those who rely on it in good faith from the 2017-18 income year and later income years as set out in the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018.

General scheme

6. Under the new law, a corporate tax entity will be taxed at the lower corporate tax rate if it is a base rate entity. A corporate entity will be a base rate entity if:

•

no more than 80% of its assessable income is BREPI^[1], and

•

its aggregated turnover^[2] is less than the relevant threshold ($25 million in the 2017-18 income year; $50 million from the 2018-19 income year).^[3] A corporate tax entity's aggregated turnover is the sum of their ordinary income and the ordinary income of any entity that is connected with^[4] or an affiliate^[5] of the corporate tax entity, where that ordinary income is derived in the ordinary course of carrying on a business.

7. 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.

8. Eligibility for the lower corporate tax rate depends on an entity's BREPI and aggregated turnover in an income year. A corporate tax entity's tax rate may change if there are fluctuations in either their BREPI, as a percentage of their assessable income, or their aggregated turnover. The Commissioner does not have a discretion to allow an entity to be a base rate entity in an income year, if its BREPI is more than 80% of its assessable income or its aggregated turnover exceeds the applicable threshold in that income year.

Base rate entity passive income

9. The types of assessable income of an entity^[6] that are BREPI are listed in section 23AB. Table 1 of this Ruling summarises the different forms of assessable income that are BREPI and whether they are defined terms.

Interest (or payments in the nature of interest)

10. Interest (or payments in the nature of interest) is BREPI^[21], except in the circumstances outlined in Table 1 of this Ruling.

What is interest?

11. Interest means 'the return, consideration, or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal'.^[22]

Payments in the nature of interest

12. Payments in the nature of interest must have the character of return or profit to the lender for the use of money belonging to, or owed to another.^[23] Whether a payment has this character turns on its substance, no matter how it is calculated.^[24] For example, payments are not in the nature of interest if they are payable under a clause in a contract that requires a borrower to pay a lender's costs and liabilities a lender incurs to establish a loan, or under an indemnification clause to pay amounts of tax payable on interest received.^[25]

Royalties

13. 'Royalties' in paragraph 23AB(1)(d) has the meaning given by subsection 6(1) of the ITAA 1936.^[26] The ATO's views on the meaning of royalty are contained in the advice listed in Appendix 1 of this Ruling.

14. The definition of 'royalties' in subsection 6(1) of the ITAA 1936 extends the ordinary meaning of royalties to include specified payments. For example, the expanded definition of royalties includes the right to use industrial, commercial or scientific equipment.^[27] 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.^[28]

Rent

15. 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.^[29] The Commissioner's view and examples on when consideration paid for the use of land or premises will be rent for the purpose of paragraph 23AB(1)(d) are set out in TD 2006/78. As rent takes its ordinary meaning there are no statutory income tax law exceptions that apply in contrast to the definition for interest (or payments in the nature of interest).

A net capital gain

16. A net capital gain for an income year is calculated using the method described in subsection 102-5(1) of the ITAA 1997.^[30] Broadly, it is calculated by subtracting the total of capital losses made in the income year and carried forward net capital losses, from the total of capital gains made in an income year. This is then adjusted for any small business concessions to which the taxpayer is entitled.^[31]

Trusts and partnerships

17. If a company is assessed on a share of net income from a trust, or their individual interest in the net income of a partnership, it will have BREPI to the extent that the amount included in its assessable income under Divisions 5 or 6 of Part III of the ITAA 1936 is referable to BREPI of the trust or partnership.^[32]

18. Where there is a chain of trusts or partnerships, the tests must be applied at each level.

Streaming of franked dividends and capital gains by the trustee of a trust

19. Where a trust makes capital gains or receives a franked distribution, the trustee may (where they have an express or implied power under the trust deed) stream these amounts to particular beneficiaries for tax purposes.^[33] This can occur by making a beneficiary specifically entitled to these amounts.

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.^[34]

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.^[35]

22. Other amounts of the net income of a trust (including capital gains and franked distributions to which no beneficiary is specifically entitled) are proportionately shared between beneficiaries based on their present entitlements to trust income.^[36]

Apportionment of expenses

23. In determining each beneficiary's or partner's share of net income, the trustee or partners must allocate expenses in a fair and reasonable way. Generally, expenses that can be clearly attributed to income should be allocated against that income. Indirect expenses that relate to more than one amount such as overheads, must be fairly and reasonably apportioned between different amounts.^[37]

Example 1.1 - apportionment of directly referable trust income

24. John Smith and Smith Pty Ltd are the beneficiaries of the JD Smith Trust. The JD Smith Trust owns a commercial investment property. In the 2017-18 income year, the net income of the JD Smith Trust comprised:

•

$800,000 in rental income (net of expenses), and

•

$200,000 in fees for services (net of expenses).

25. John Smith and Smith Pty Ltd were each presently entitled to half of the distributable income of the JD Smith Trust. Therefore, the amount included in the assessable income of each of the beneficiaries is $500,000 under Division 6 of the ITAA 1936 (as each beneficiary's share of the net income of the trust estate).

26. The $500,000 included in the assessable income of Smith Pty Ltd will be BREPI to the extent that it is referable to another amount that is BREPI. Rental income is BREPI^[38], so the amount of the trust's net income assessed to Smith Pty Ltd that is referable to rental income ($400,000) will be BREPI. The amount referable to fees for services ($100,000) is not BREPI. Assuming Smith Pty Ltd has no other income, its BREPI will be 80% of its assessable income.

Example 1.2 - working out amount of a company's share of net income attributable to BREPI

27. 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 business income (net of expenses)

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$300,000 unfranked dividend (net of expenses), and

•

$200,000 rental income (net of expenses).

28. For trust law purposes, the trustee of Busy Trust resolved to make Company 1 presently entitled to its net business income, Bob presently entitled to the net unfranked dividend and Sub Trust 1 presently entitled to the net rental income.

29. For tax law purposes, as Company 1 was presently entitled to $500,000 of the trust's income available for distribution (that is, $1 million or 50%), it was assessable on 50% of the trust's net income.

30. 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 ITAA 1936 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.

Assuming Company 1 has no other income, its BREPI will be 50% of its assessable income.

Example 1.3 - working out the amount of a company's BREPI where it receives a distribution from an attribution managed investment trust (AMIT)

31. Company 1 is a unit holder in the Alpha Attribution Managed Investment Trust (AMIT). The Alpha AMIT is a beneficiary of the Bega Trust. The net income of the Bega Trust consists of the following amounts:

•

$50,000 interest income

•

$400,000 net capital gains, and

•

$300,000 franked dividends.

32. Alpha AMIT is specifically entitled to the capital gains and franked distributions of the Bega Trust, and so the amounts of $400,000 and $300,000 are included in its assessable income under Subdivision 115-C of the ITAA 1997 and Subdivision 207-B of the ITAA 1997, respectively.

33. The trustee of the Bega Trust resolves to distribute all of the remaining net income of the trust to the Alpha AMIT, with the amount $50,000 (referable to interest derived by the Bega Trust) included in Alpha AMIT's assessable income as a presently entitled beneficiary under Division 6 of the ITAA 1936.^[39]

34. When Company 1 receives its distribution from the Alpha AMIT, for the purposes of determining the effects to Company 1 of including an amount in its assessable income, section 276-80 of the ITAA 1997 treats the amounts distributed as having been derived by Company 1 in its own right, and with the character of each amount flowing through to Company 1.^[40] Therefore, Company 1's share of the following amounts will be BREPI of Company 1:

•

the net capital gain (paragraph 23AB(1)(f))

•

the franked dividend (paragraph 23AB(1)(a), noting that the dividend is not a non-portfolio dividend as it 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)

•

the franking credit on the franked dividend (paragraph 23AB(1)(b)), and

•

the Division 6 of the ITAA 1936 amount (paragraph 23A(1)(g), as the amount that is included in the assessable income of Alpha AMIT under Division 6 is entirely referable (indirectly) to an amount of interest that is BREPI under paragraph 23AB(1)(d)).

As 100% of Company 1's assessable income for the year of income is BREPI, it is taxable at the rate of 30%.

Example 1.4 - how to characterise dividends received by a trust

35. Top Floor Co is wholly owned by the Mezanine Trust, which has two beneficiaries: Freddy and Basement Co. Top Floor Co derives only rental income. Top Floor Co pays a franked dividend to the MezanineTrust.

36. The Mezanine Trust also derives interest from a bank account. The trustee streams the franked dividend to Basement Co for trust law purposes and this is effective for tax purposes under Subdivision 207-B of the ITAA 1997. Basement Co has no other income. The trustee resolved to distribute all of the remaining distributable income of the trust to Freddy (that is, the interest income).

37. Basement Co needs to determine the extent to which its share of the net income of the Mezanine Trust is attributable to another amount that is BREPI. The franked dividend received by Mezanine Trust from Top Floor Co is not a non-portfolio dividend, as it is not paid to a company.^[41] The franked dividend received by Mezanine Trust is BREPI.^[42]

38. Basement Co's share of the net income of the Mezanine Trust is entirely referable to BREPI.^[43]

Example 1.5 - apportionment of indirectly referable trust income

39. Succotash Pty Ltd and Tom Edwards are beneficiaries of the Beta Trust. The Beta Trust is the sole beneficiary of the Central Property Trust.

40. The Central Property Trust owns commercial rental properties which it leases on normal commercial terms. In the 2017-18 income year, the Central Property Trust's net income was $900,000, derived solely from the rental of its commercial properties. All (100%) of its net income is attributable to BREPI.

41. The Beta Trust was entitled to all Central Property Trust's trust income. Beta Trust's net income included $900,000 of BREPI, attributable to the net income from the Central Property Trust.

42. The Beta Trust also earned $100,000 in net trading income by operating a retail business. The net income of the Beta Trust for the 2017-18 income year was $1 million.

43. The $900,000 share of net income of the Central Property Trust is attributable solely to rental income, and so is referable to BREPI. Beta Trust has also included $100,000 in net trading income in its net income. Of Beta Trust's $1 million in assessable income in the 2017-18 income year, 90% is BREPI.

44. Succotash Pty Ltd is presently entitled to 50% of the trust income of the Beta Trust. Half (50%) of the net income of the Beta Trust is included in its assessable income.

45. Succotash Pty Ltd earned no other income in the 2017-18 income year. Its 2017-18 assessable income was $500,000, consisting entirely of the Beta Trust distribution.

46. 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.

Example 1.6 - apportionment of trust expenses

47. Orange Grove Co is the beneficiary of the Orange Trust, which owns and operates a small citrus grove. In the 2017-18 income year, the Orange Trust received:

•

$850,000 from the sale of oranges, and

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$400,000 from renting out parts of the grove.

48. In the 2017-18 income year the Orange Trust paid an accountant to handle the financial affairs to the Trust, which cost $50,000. It also hired labourers to assist in the sale of oranges, which cost $150,000, and staff to manage the renting of the grove, which cost $100,000.

49. In determining its net income, the Orange Trust allocated its expenses against its two sources of income. The cost of $150,000 for hiring labourers was attributed to trading income from the sale of oranges, reducing that amount to $700,000. The cost of $100,000 for hiring staff to manage the renting of the grove was attributed to rental income, reducing that amount to $300,000. The accountant's cost of $50,000 related to both income amounts and needed to be apportioned on a fair and reasonable basis. In these circumstances, an apportionment that reflected the proportions of each income source was considered to be fair and reasonable.

50. The $50,000 spent on an accountant was apportioned in the following way:

•

$35,000 was attributed to the income from selling oranges (that is, $50,000 × $700,000 / ($700,000 + $300,000)), reducing that amount to $665,000, and

•

$15,000 was attributed to the income from renting the grove (that is, $50,000 × $300,000 / ($300,000 + $700,000)), reducing that amount to $285,000.

51. Orange Grove Co was presently entitled to all of the trust income of the Orange Trust in the 2017-18 income year. Its assessable income therefore included all of the net income of the Orange Trust totalling $950,000. Orange Grove Co included no other income in its assessable income. Of the $950,000, the $285,000 referable to rental income was BREPI.^[44] The remaining $665,000 was referable to trading income, which is not BREPI.

52. As Orange Grove Co has BREPI of 30% and its aggregated turnover is below the relevant threshold of $25 million, it qualifies for the lower corporate tax rate of 27.5% in the 2017-18 income year.

Imputation

53. This section provides guidance on the imputation consequences of the lower corporate tax rate and the distinction between the corporate tax rate and the 'corporate tax rate for imputation purposes'.

54. The franking credit a corporate tax entity may attach to a frankable distribution cannot exceed the maximum franking credit for the distribution.^[45] The maximum franking credit is worked out by reference to the corporate tax entity's corporate tax rate for imputation purposes.^[46]

55. A corporate tax entity's corporate tax rate for imputation purposes is worked out differently to its tax rate. This means a corporate tax entity's tax rate for an income year may be different to the rate it can frank dividends in that year.

56. The Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018 amends the meaning of corporate tax rate for imputation purposes from the 2017-18 income year.^[47] From the 2017-18 income year a corporate tax entity works out its corporate tax rate for imputation purposes by^[48]:

•

assuming that its aggregated turnover, BREPI and assessable income are the same as in the previous income year, and

•

applying the corporate tax rate for the current income year.

57. 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.

58. If the entity did not exist in the previous income year, its corporate tax rate for imputation purposes is 27.5%.^[49]

Example 2.1 - company does not have a previous income year

59. Kookaburra Co was founded on 1 July 2017.

60. As Kookaburra Co did not exist in the prior income year (the 2016-17 income year), its 2017-18 corporate tax rate for imputation purposes is 27.5%.

Example 2.2 - company does not have any assessable income in the previous income year

61. Swan Co has been carrying on a business since 1 July 2014.

62. In the 2016-17 income year, Swan Co was dormant and had no aggregated turnover. Swan Co's 2016-17 assessable income was nil, and so its BREPI was nil.

63. As Swan Co existed in the 2016-17 income year, the corporate tax rate for imputation purposes of Swan Co for the 2017-18 income year is determined as the corporate tax rate for the 2017-18 income year based on the assumption that its aggregated turnover, BREPI and assessable income are the same as the 2016-17 income year.

64. As Swan Co's assessable income and BREPI for the 2016-17 income year are nil, it has no more than 80% of its assessable income as BREPI. As Swan Co has no connected entities or affiliated entities in the 2016-17 income year, Swan Co's aggregated turnover for the 2016-17 income year is nil, its aggregated turnover is less than the relevant threshold for the 2017-18 income year. Therefore, its corporate tax rate for imputation purposes for the 2017-18 income year is 27.5%.

Example 2.3 - corporate tax rate is different to corporate tax rate for imputation purposes because of aggregated turnover change in consecutive income years

65. In the 2016-17 income year, Emu Co had aggregated turnover of $24 million. Emu Co's 2016-17 assessable income was 55% BREPI.

66. In the 2017-18 income year, Emu Co had aggregated turnover of $28 million. Emu Co's 2017-18 assessable income was 62% BREPI. Because Emu Co's 2017-18 aggregated turnover was above the aggregated turnover threshold of $25 million, it is not a base rate entity, and had a 2017-18 corporate tax rate of 30%.

67. 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 income year. As such, it is assumed that, for the purposes of determining the corporate tax rate for imputation purposes for the 2017-18 income year, Emu Co's aggregated turnover is the same as the 2016-17 income year, being $24 million and of that, 55% is BREPI. Accordingly, as its aggregated turnover is below the threshold of $25 million and its BREPI is not more than 80% of its assessable income, its corporate tax rate for imputation purposes is 27.5%.

Example 2.4 - corporate tax rate is different to corporate tax rate for imputation purposes because of a change in the percentage of BREPI in consecutive income years

68. In the 2017-18 income year, Cockatoo Co had an aggregated turnover of $48 million. Cockatoo Co's 2017-18 assessable income was 82% BREPI.

69. In the 2018-19 income year, Cockatoo Co had aggregated turnover of $46 million. Cockatoo Co's 2018-19 assessable income was 75% BREPI. Cockatoo Co's 2018-19 aggregated turnover was below the aggregated turnover threshold of $50 million, and its BREPI was below the 80% threshold. Therefore, it was a base rate entity, with a 2018-19 corporate tax rate of 27.5%.

70. Cockatoo Co has a 2018-19 corporate tax rate for imputation purposes of 30%. This is because it is assumed its aggregated turnover, BREPI and assessable income are the same as the previous income year. As such it is assumed that, for the purposes of determining the corporate tax rate for imputation for the 2018-19 income year, Cockatoo Co's aggregated turnover is the same as the 2017-18 income year, being $48 million, of which 82% is BREPI. Although the aggregated turnover is below the threshold of $50 million, its BREPI is above the 80% threshold. Accordingly, its corporate tax rate for imputation purposes is 30%.

Commissioner of Taxation
13 December 2019

Appendix 1 - Related ATO rulings and guidance

71. The first column of the below table lists amounts of assessable income that are base rate entity passive income. The second column lists other guidance material relevant to those amounts.

© AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA

You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).

Previously released in draft format as LCR 2018/D7

References

ATO references:
NO 1-CYTCVCC

Business Line:  IND

Related Rulings/Determinations:

IT 2660
TD 2006/78
TD 2008/24
TD 2008/25
TR 93/12
TR 95/6
TR 96/3
TR 96/14
TR 2002/4
TR 2002/14
TR 2004/17
TR 2008/7
TR 2012/D1
TR 2012/5

Legislative References:
ITRA 1986 4
ITRA 1986 23AA(a)
ITRA 1986 23AA(b)
ITRA 1986 23AB
ITRA 1986 23AB(1)(a)
ITRA 1986 23AB(1)(b)
ITRA 1986 23AB(1)(c)
ITRA 1986 23AB(1)(d)
ITRA 1986 23AB(1)(e)
ITRA 1986 23AB(1)(f)
ITRA 1986 23AB(1)(g)
ITRA 1986 23AB(2)(a)(i)
ITRA 1986 23AB(2)(a)(ii)
ITRA 1986 23AB(2)(a)(iii)
ITRA 1986 23AB(2)(b)
ITAA 1936 Div 5 Pt III
ITAA 1936 Div 6 Pt III
ITAA 1936 Div 16E Pt III
ITAA 1936 6(1)
ITAA 1936 95AAB(2)
ITAA 1936 95AAD
ITAA 1936 202A
ITAA 1936 317
ITAA 1997 Subdiv 86-A
ITAA 1997 102-5
ITAA 1997 102-5(1)
ITAA 1997 Subdiv 115-C
ITAA 1997 152-35
ITAA 1997 152-40(4)(e)
ITAA 1997 165-111
ITAA 1997 202-60
ITAA 1997 205-15
ITAA 1997 Subdiv 207-B
ITAA 1997 276-80
ITAA 1997 328-115
ITAA 1997 328-125
ITAA 1997 328-130
ITAA 1997 960-115
ITAA 1997 960-120
ITAA 1997 Subdiv 974-C
ITAA 1997 974-120
ITAA 1997 995-1(1)
FSCDA 2001 5(3)
FSCDA 2001 32(1)
NCCPA 2009 35(1)
NCCPA 2009 64(2)
NCCPA 2009 65(2)
Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Act 2018
Acts Interpretation Act 1901 15AA
Corporations Act 2001 254T
Corporations Act 2001 761A

Case References:
C H Bailey Ltd v Memorial Enterprises Ltd
[1974] 1 All ER 1003

The Commissioner of Taxation v Century Yuasa Batteries Pty Ltd
[1998] FCA 269
82 FCR 288
98 ATC 4381
38 ATR 442
Federal Wharf Company Limited v Deputy Federal Commissioner of Taxation
[1930] HCA 30
44 CLR 24
(1930) 4 ALJ 200
(1930) 1 ATD 70
(1930) 36 ALR 349
Commissioner of Taxation v Greenhatch
[2012] FCAFC 84
203 FCR 134
2012 ATC 20-322
(2012) 88 ATR 560
Radaich v Smith
[1959] HCA 45
(1959) 101 CLR 209
[1959] ALR 1253
(1959) 33 ALJR 214
(1959) 69 WN (NSW) 97
Ronpibon Tin NL v Commissioner of Taxation (Cth)
[1949] HCA 15
78 CLR 47
8 ATD 431
[1949] ALR 785
United Scientific Holdings Ltd v Burnley Borough Council
[1977] 2 All ER 62
[1978] AC 904
[1977] 2 WLR 806
(1977) 75 LGR (Eng) 407

Other References:
Revised Explanatory Memorandum to Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2018
Halsbury's Laws of England, 4th Edition Reissue, Butterworths, London 1994, vol 27(1), paragraph 212, 'Landlord and Tenant', The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne