Tax treatment of passive investment companies – do they carry on a business?

Earlier this year the ATO Commissioner issued Draft Taxation Ruling TR 2017/D2 (the ruling) which represents the Commissioner’s preliminary view on how to apply the central management and control test of company residency and tax treatment following the outcome of Baywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589.  This will be particularly important for many Australians who use trusts with corporate beneficiaries.

Central Management and Control test of residency

One of the requirements of the central management and control test of residency is that the company carries on business in Australia.  In footnote 3 of the ruling, the Commissioner quotes a number of cases on how the ATO may view a company and their subsequent tax treatment.  Essentially, any company that is maintained to make a profit or gain for its shareholders, even if the company only holds passive investments, and its activities consist of receiving rents or returns on its investments and distributing them to shareholders as likely to be carrying on a business.

Changes to corporate tax rate

In accordance with the Enterprise Tax Plan, from 1 July 2016, companies with an annual turnover of less than $10 million were subject to a headline corporate tax rate of 27.5%.  From 1 July 2017 the turnover threshold increased to $25 million.

The Minister for Revenue and Financial Services, Ms Kelly O’Dwyer MP issued a statement on 4 July 2017 confirming that the policy behind the tax cuts were not meant to apply to passive investment companies.  However the footnote in the ruling does raise the question as to whether this will continue to be the case and whether these companies will incur the same tax treatment.

What happens next?

Following public comment on the ruling and in consultation with tax practitioners, further guidance may be provided by the Australian Taxation Office in August.  This guidance is likely to clarify what circumstances, if any, could constitute a passive investment holding company to take advantage of the lower company tax rate.  This will be particularly important for many Australians who use trusts with corporate beneficiaries.

If you believe you may be affected by this ruling, please consult your tax professional for further advice.