How To Calculate Base Rate Entity Passive Income

Calculate your Base Rate Entity (BRE) passive income under the corporate tax transparency rules

Comprehensive Guide: How to Calculate Base Rate Entity Passive Income

Understanding how to calculate Base Rate Entity (BRE) passive income is crucial for Australian businesses to determine their eligibility for the lower 25% corporate tax rate. This guide provides a detailed explanation of the calculation process, relevant thresholds, and compliance requirements under the Australian Taxation Office (ATO) regulations.

What is a Base Rate Entity?

A Base Rate Entity (BRE) is a company that:

• Has an aggregated turnover of less than $50 million, and
• Derives no more than 80% of its assessable income as passive income

BREs are eligible for the lower 25% corporate tax rate (reduced from 30%) for the 2021-22 income year and later income years.

Key Components of Passive Income

Passive income includes the following types of income as defined by the ATO:

1. Corporate distributions (dividends)
2. Franking credits attached to distributions
3. Interest income (excluding certain financial institutions)
4. Royalties and rent
5. Gains on qualifying securities
6. Net capital gains
7. Income from partnership or trust distributions to the extent it’s passive

Step-by-Step Calculation Process

1. Determine Total Assessable Income

Calculate the entity’s total assessable income for the income year. This includes:

• Ordinary income (business income, salaries, etc.)
• Statutory income (capital gains, etc.)
• All passive income components listed above

2. Identify and Sum Passive Income Components

Separately identify all passive income components from the total assessable income. Common items include:

Income Type	Included in Passive Income?	Common Examples
Dividends	Yes	Unfranked and franked dividends from Australian companies
Interest	Yes	Bank interest, bond interest, loan interest received
Royalties	Yes	Licensing fees, patent royalties, copyright royalties
Rent	Yes	Commercial property rent, equipment rental income
Capital Gains	Yes (net amount)	Sale of investments, property sales (after CGT discounts)
Business Income	No	Sales revenue, service fees, consulting income

3. Calculate the Passive Income Percentage

Use the following formula to determine the passive income percentage:

Passive Income Percentage = (Total Passive Income / Total Assessable Income) × 100

4. Apply the 80% Threshold Test

If the calculated passive income percentage is:

• 80% or less: The entity qualifies as a BRE and is eligible for the 25% tax rate
• More than 80%: The entity does not qualify as a BRE and is subject to the 30% tax rate

Practical Examples

Example 1: Qualifying BRE

Scenario: ABC Pty Ltd has:

• Total assessable income: $1,000,000
• Passive income (dividends and interest): $750,000
• Business income: $250,000

Calculation:

Passive Income Percentage = ($750,000 / $1,000,000) × 100 = 75%

Result: ABC Pty Ltd qualifies as a BRE (75% ≤ 80%) and pays tax at 25%.

Example 2: Non-Qualifying Entity

Scenario: XYZ Investments Pty Ltd has:

• Total assessable income: $800,000
• Passive income (dividends, rent, capital gains): $680,000
• Business income: $120,000

Calculation:

Passive Income Percentage = ($680,000 / $800,000) × 100 = 85%

Result: XYZ Investments does not qualify as a BRE (85% > 80%) and pays tax at 30%.

Common Mistakes to Avoid

• Incorrectly classifying income: Some income types may appear passive but are actually business income (e.g., interest income for financial institutions)
• Ignoring aggregated turnover: The $50M threshold applies to the entire group, not just the individual entity
• Double-counting franking credits: Franking credits should be included in passive income but not double-counted with the underlying dividend
• Forgetting capital gains: Net capital gains are included in passive income calculations
• Using wrong income year: The rules changed for 2017-18 and later income years

ATO Compliance Requirements

To ensure compliance with ATO requirements:

1. Maintain detailed records of all income sources
2. Separately track passive and active income components
3. Use the ATO’s assessable income guidelines for classification
4. Complete the Company Tax Return accurately, particularly labels related to passive income
5. Consult with a tax professional for complex structures or borderline cases

Recent Changes and Updates

The BRE rules have evolved since their introduction. Key changes include:

Income Year	Turnover Threshold	Passive Income Test	Tax Rate
2015-16 to 2016-17	$10M	Not applicable	28.5%
2017-18 to 2019-20	$25M	80% passive income test introduced	27.5%
2020-21	$50M	80% passive income test continues	26%
2021-22 onwards	$50M	80% passive income test continues	25%

Advanced Considerations

Trust Distributions

For trusts, the passive income rules work differently:

• Distributions from trusts are generally passive unless they represent business income
• The character of income retains its nature as it flows through the trust structure
• Special rules apply for family trusts and discretionary trusts

Consolidated Groups

For consolidated groups:

• The passive income test applies at the head company level
• Inter-entity transactions within the group are generally disregarded
• The $50M turnover threshold applies to the entire consolidated group

International Considerations

For entities with international operations:

• Foreign passive income (dividends, interest, royalties) is included in the calculation
• Foreign business income may be excluded if it meets the ATO’s active income test
• Double tax agreements may affect the classification of certain income types

Strategic Tax Planning

Businesses can employ several strategies to manage their BRE status:

1. Income recharacterization: Where possible, restructure passive income to be active (e.g., through related service entities)
2. Timing of income recognition: Defer passive income to future years if near the 80% threshold
3. Group restructuring: Separate passive income activities into different entities
4. Investment strategy: Focus on active business investments rather than passive assets
5. Franking credit management: Optimize the use of franking credits to maximize after-tax returns

Frequently Asked Questions

Q: Are all dividends considered passive income?

A: Generally yes, but there are exceptions for:

• Dividends from non-portfolio investments (10% or more ownership)
• Dividends that are effectively connected with carrying on a business

Q: How are capital gains treated in the passive income test?

A: Net capital gains (after applying discounts) are included in passive income. However:

• Gains from active assets used in a business may be excluded
• The small business CGT concessions can affect the calculation

Q: What happens if we exceed the 80% threshold by a small amount?

A: There is no de minimis rule – exceeding 80% by even 0.1% means the entity doesn’t qualify as a BRE for that income year.

Q: Can we average the passive income percentage over multiple years?

A: No, the test is applied annually based on the current income year’s figures.

Additional Resources

For further information, consult these authoritative sources:

• ATO Capital Gains Tax Guide
• ATO Company Tax Return Instructions
• Income Tax Assessment Act 1997 – Division 232 (Base Rate Entities)
• IRS Passive Activity Rules (for comparison)

Conclusion

Calculating Base Rate Entity passive income requires careful analysis of all income sources and proper classification between passive and active components. The 80% threshold test is strict, with no room for approximation. Businesses should:

• Implement robust accounting systems to track income types
• Regularly review their income mix throughout the year
• Consult with tax professionals when near the threshold
• Document their classification decisions for ATO compliance

Proper management of BRE status can result in significant tax savings, making this an important consideration for all Australian companies with turnover under $50 million.