Government legislates to close wealthy tax loophole

Advertisement

By Leith van Onselen

Back in July it was revealed that a draft tax ruling issued by the Australian Taxation Office (ATO) in March 2017 could allow “passive” family investment companies to claim tax refunds and deductions, opening the door for wealthy families to claim back hundreds of millions of dollars.

This draft ruling overturned the generally-accepted view that such family investment companies – which do not actively carry on a business – would not be eligible for the reduction in the company tax rate for small businesses from 30% to 27.5% over recent years.

Financial Services Minister, Kelly O’Dwyer, subsequently advised the ATO that the Federal Government’s tax cuts for small businesses were not meant to apply to passive family investment companies.

Yesterday, the Turnbull Government introduced legislation to clarify whether a company qualifies for the 27.5% tax rate for small businesses in a bid to end uncertainty over the application of the lower tax rate to passive investment companies. The amendments state that a company will not qualify for the lower tax rate if it derives more than 80% of its income from passive sources, which include interest and dividends. The new test for a passive investment company will apply from the start of the current financial year. From The AFR:

Advertisement

[Kelly O’Dwyer] introduced further legislative amendments on Wednesday that will bring in a single eligibility test from 1 July, 2017.

Companies will not qualify if “more than 80 per cent of its assessable income is passive income such as interest, dividends or royalties”.

In other words, companies will only have to derive 20 per cent of their income from active sources to qualify.

The new test will supersede an earlier one based on whether an entity was “carrying on a business”.

“The bill will provide certainly about eligibility for the lower company tax rate by excluding passive investment companies,” Ms O’Dwyer said in a statement…

The new legislation applies only from 1 July of this year. For the 2016 and 2017 years, the old law and ATO’s low bar continue to apply.

BDO tax partner Tony Sloan said… “many passive investment companies will go and get refunds for the 2016 and 2017 years”…

“I would have thought it would be worth hundreds of millions of dollars”…

Mr Sloan said passive investment companies would try to meet the 20 per cent active income threshold in coming years. “For example, if some active activities were pooled with passive activities, the 20 per cent test may be easily met,” he said.

“The logical way to fix all of these problems is to align the company tax rate with marginal rates, and that was always Paul Keating’s goal. The fact there is a big discrepancy creates an incentive to set up investment companies.”

While it’s good to see the Turnbull Government legislate on this issue, the 80% threshold and the two-year amnesty does look overly generous and will allow wealthy (largely) passive family investment companies to continue to avoid paying tax.

The last point from Sloan is also important. By lowering the company tax rate to 27.5% for ‘small’ businesses, the Turnbull Government has increased incentives for wealthy individuals to structure their tax affairs to avoid paying tax.

Advertisement

[email protected]

About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.