HLB Mann Judd: Welcome clarification on company tax impact for investment companies

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This week’s announcement by the Minister for Revenue and Financial Services provides welcome clarification of how the changes to company tax rate will affect certain investment companies, says Peter Bembrick, tax partner at HLB Mann Judd Sydney.

“The Treasury Exposure Draft released in mid-September raised a number of question marks about how passive investment companies would be treated and whether they would qualify for the lower 27.5 percent tax rate.

“There were also serious concerns about the timing of the start of the new rules, which were originally proposed to apply retrospectively from the 2016/17 financial year.

“In our view this had the potential to cause significant problems for companies that had already finalised their 2017 financial statements and income tax returns, paid dividends, issued dividend statements to shareholders and in some cases amended dividend statements following previous Government announcements.

“In particular, it would have negatively affected small public companies, and we believed it would have been unreasonable to force such companies to make amendments to the various documents, not to mention the impact on shareholders who may have already lodged their own 2017 income tax returns.

“Fortunately the outcome of consultation by Treasury with accounting firms and professional bodies is that the Government has removed this aspect of retrospectivity.  There may still be some impact where companies have declared franked dividends since 1 July 2017, but the situation should be much more manageable than if the changes had been applied to the 2016/17 year.”

Mr Bembrick said that the Bill that was introduced into Parliament this week has retained the most important feature of the Exposure Draft.

“The Bill has replaced the current, potentially subjective “carrying on a business” test with a “bright line” test which is based on the nature of the company’s assessable income.

“That is, if more than 80 percent of the company’s assessable income represents passive investment income then the company will continue to pay tax at 30 percent, and similarly will continue to frank any dividends it pays to shareholders at 30 percent.”

Further examples have also been added to better illustrate how the test will be applied to various situations, including where distributions and dividends flow through chains of trusts, companies and partnerships, and where companies deriving business income also receive investment income.

The “bright line” test will apply prospectively for the 2017/18 year onwards, and the test will be applied each year based on the previous year’s percentage of passive investment income and aggregated turnover.

Mr Bembrick added that two other important aspects of the Minister’s media release are the statements that the ATO is releasing detailed guidance in the form of draft tax ruling TR 2017/D7 as to when a company may be considered to be carrying on a business for the purposes of determining which tax rate applies for the 2016/17 year, and that the ATO will adopt a “facilitative approach” to this question, not selecting companies for audit solely on this question, unless the position taken appears “plainly unreasonable”.

“Businesses that have already lodged their 2017 tax returns, and those with them under preparation, should review these in the light of the ATO’s draft ruling and other available guidance, especially if the existence of a business is not immediately obvious.

“If there are particular concerns on this point, options to consider may include preparing a reasonably arguable position paper, obtaining a private ruling from the ATO, or seeking an opinion from a revenue law barrister.

“Companies that have declared dividends since 1 July 2017 should review the application of the “bright line” test with reference to the Bill and examples in the Explanatory Memorandum.

“All companies should also review the implications of the new rules for the business structure (especially those with multiple layers, including trusts) going forward, and ensure that the implications of future tax and dividends are appropriate.

“They will need to pay particular attention to structures involving businesses but that may still generate large amounts of passive income, such as rent payable by an operating company to a related entity owning the business premises,” Mr Bembrick says.

HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and a member of the HLB Mann Judd Australasian Association.