Companies: The Tax Framework

A company is a separate legal and tax entity. That simple proposition changes almost every step of the analysis: the company derives its own income, claims its own deductions, owns its assets, pays company tax and then faces a second set of rules when value moves from the company to shareholders.

1. Separate taxpayer

Income earned by a company is not automatically the shareholder’s income. The company’s taxable income is calculated under the ordinary ITAA 1997 framework. Salaries paid to employees/directors, interest, rent, trading income, capital gains and deductions are characterised at company level. Shareholder consequences arise only when a separate transaction — dividend, salary, loan, payment, capital return or asset transfer — occurs.

2. Company tax rates

Australia operates a lower company tax rate for qualifying base rate entities and the ordinary company rate for other companies. For current years, a qualifying base rate entity is generally taxed at 25%, while the ordinary company tax rate is 30%. The base-rate-entity test includes an aggregated-turnover threshold and a limit on base rate entity passive income. The income year must always be stated because rates and thresholds are legislative policy settings.

3. Base rate entity passive income

The lower rate is not determined by turnover alone. A company can be below the turnover threshold but fail the passive-income test. Dividends, interest, rent, royalties and net capital gains can fall within the statutory passive-income concept subject to the detailed definitions and exceptions. This is designed to target the lower rate to active business companies rather than passive investment vehicles.

4. Company income and deductions

The ordinary rules remain central: s 6-5 for ordinary income, s 8-1 for general deductions, Division 40 for depreciating assets, Division 70 for trading stock and Parts 3-1 and 3-3 for CGT. Entity choice does not replace characterisation. A company cannot deduct private shareholder expenses merely because it pays them.

5. Transactions with owners

A payment to an owner may be salary, dividend, loan, repayment of genuine debt, capital return or private benefit. Each classification has different consequences. This is why company accounting ledgers are evidence but not the law. The underlying legal rights and transaction must be identified.

6. Company tax and shareholder tax are integrated, not identical

The imputation system addressed in Chapter 9 recognises company tax through franking credits when profits are distributed as frankable dividends. But company tax is still paid by the company and shareholder tax is still calculated separately. Division 7A, covered in Chapter 10, prevents private companies from bypassing dividend taxation by extracting value through certain payments, loans or debt forgiveness.

7. Governance and documentation

Company tax advice often depends on board resolutions, employment contracts, loan agreements, dividend statements, franking-account records and ownership registers. The legal analysis should therefore identify what documentation must exist, not simply calculate tax after the event.

8. Company-tax method

From this chapter, revise and look over these resources