Company Tax: 25% Base Rate Entity Rules
How the two-tier company tax system works in Australia, the base rate entity test (turnover and 80% passive income), franking credit generation at each rate, and the real arithmetic of dividends versus salary extraction.
Australian companies pay 25% if they qualify as a base rate entity, or 30% otherwise. Qualification requires aggregated turnover below $50 million and no more than 80% of assessable income being base rate entity passive income. These two tests are assessed year by year under ss 23AA and 23AB of the Income Tax Rates Act 1986, meaning a company can move between rates from one income year to the next.
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The two-tier company tax system
Australia taxes companies at two rates. Base rate entities pay 25% on taxable income. All other companies pay 30%. The rates are set by s 23 (general rate) and s 23AA (BRE rate) of the Income Tax Rates Act 1986. There is no phased transition or blended rate: a company either qualifies as a BRE for the full income year or it does not.
The base rate entity test
A company is a base rate entity for an income year if it satisfies both limbs of the test in s 23AA of the Income Tax Rates Act 1986. First, aggregated turnover for the year must be less than $50 million. Second, no more than 80% of its assessable income can be base rate entity passive income (BREPI). If either test fails, the company pays 30%. Both tests are applied independently each income year.
What counts as BREPI
Section 23AB of the Income Tax Rates Act 1986 defines base rate entity passive income. It includes dividends and non-share dividends (with limited exceptions for certain non-portfolio dividends traced strictly), interest income, rent and royalties where the company is not actively exploiting property or IP as part of a business, net capital gains, and certain income allocated from trusts and partnerships that is itself passive when traced through (such as distributions of interest, rent, or capital gains).
Aggregated turnover and connected entities
Aggregated turnover is the company's own annual turnover from carrying on a business, plus the annual turnover of any connected entities and affiliates, after eliminating internal dealings. Connected entities are those where one controls the other (or the same persons control both) by reference to 40% or more of voting power, rights to income, or rights to capital. Affiliates are persons who act, or could reasonably be expected to act, in accordance with your directions or wishes in relation to their business affairs. The $50 million threshold applies to this aggregated figure, not standalone revenue.
Entities that typically fail the BRE test
Three common company types routinely fail the 80% passive income test. A share-holding company whose only income is fully franked dividends and interest from a share portfolio has virtually 100% BREPI. A passive property holding company that earns only residential rent without running an active property business has rental and capital gain income treated as passive. A group treasury or cash-box company whose primary income is interest and gains on financial instruments similarly fails. By contrast, an operating trading company with sales, wages, and operating expenses, plus some incidental interest or rents, will usually have well under 80% passive income.
Franking credits and the imputation system
Part 3-6 of ITAA 1997 integrates company and shareholder tax. When a company pays income tax at 25% or 30%, the tax paid is recorded as franking credits. When a dividend is paid, the company attaches franking credits up to its maximum rate. The shareholder grosses up the dividend (adds the credit to the cash amount), includes the grossed-up figure in assessable income, and claims a tax offset equal to the franking credit. If the shareholder's marginal rate is lower than the company rate, excess credits are refundable to individuals and complying super funds.
Maximum franking credit rule
A 25% BRE cannot frank dividends as if taxed at 30%. The maximum franking credit per dollar of cash dividend from a 25% company is calculated as: dividend multiplied by 0.25 divided by 0.75. Over-franking triggers corrective debits and potentially penalties. The benchmark rule in Subdivision 203-B ITAA 1997 requires all frankable distributions in a franking period to be franked at the same benchmark franking percentage, set by the first distribution in the period.
Dividends versus salary extraction
How profits are extracted from a company determines the total tax outcome. Paying yourself a salary is deductible to the company (reducing company tax to nil on that portion), but you pay at your marginal rate on the full amount, the same effective result as being a sole trader. Paying a fully franked dividend from a 25% company means the company pays 25% first, you gross up and claim the credit, and pay top-up tax if your marginal rate exceeds 25% or receive a refund if it is lower. Fully distributing as dividends largely eliminates the retention advantage. The material benefit of a company structure emerges when profits are partially retained at 25%, deferring personal tax until a future distribution.
Worked example: $150,000 profit, fully distributed as franked dividend
Priya in Melbourne runs a consulting company. Profit before tax: $150,000. Company tax at 25%: $37,500. After-tax profit: $112,500. Fully franked dividend: $112,500. Grossed-up dividend: $150,000. Franking credit: $37,500. Individual tax on $150,000 at approximately 39% (including Medicare Levy): approximately $58,500. Less franking credit of $37,500, leaving top-up tax of approximately $21,000. Combined company plus personal tax: approximately $58,500. This is very close to what Priya would pay as a sole trader.
Worked example: $150,000 profit, $50,000 retained
Tariq in Brisbane runs the same business through a company. Company tax at 25% on $150,000: $37,500. After-tax profit: $112,500. He distributes $75,000 (pre-tax $100,000 slice) as a franked dividend with $25,000 in credits, and retains $37,500 (pre-tax $50,000 slice). Individual tax on the grossed-up $100,000 at approximately 34.5%: approximately $34,500. Less $25,000 credit, leaving top-up of approximately $9,500. Combined current-year tax: approximately $47,000 on $150,000, an effective rate of roughly 31%. The retained $37,500 sits at 25% and only triggers further personal tax when eventually drawn.
Company tax losses: carry-forward and integrity rules
Companies can carry forward tax losses indefinitely until absorbed, subject to loss integrity rules in Divisions 165 and 166 of ITAA 1997. To deduct a prior-year loss, the company must satisfy either the Continuity of Ownership Test (COT) or, if COT fails, the Same Business Test (SBT) supplemented from 1 July 2015 by the Similar Business Test (SiBT) under s 165-210 ITAA 1997.
Continuity of Ownership Test (COT)
The same persons must beneficially hold more than 50% of voting power, rights to dividends, and rights to capital at all times from when the loss is incurred until the end of the income year in which the loss is used. A breach of continuity (for example, a majority share sale) means COT fails for those losses going forward.
Same Business Test and Similar Business Test
If COT fails, the company must show it carries on the same business (SBT) as when the loss was incurred and has not entered new kinds of business or new transaction types. The Similar Business Test (from 1 July 2015) is more flexible: it considers whether the current business is similar to the former business based on assets used, activities carried on, identity of the business, and whether changes represent natural commercial evolution rather than a completely new line.
Company versus sole trader: when the structure pays off
If a company retains profits, tax stops at the corporate level (25% for a BRE), deferring any additional personal tax until a future distribution. If your marginal rate is 39% or 47%, leaving earnings in a 25% company defers 14 to 22 percentage points of tax. Fully distributing as salary or franked dividends largely eliminates this advantage and moves back towards the sole trader effective rate. The structural benefit is most pronounced for businesses generating $120,000 or more in profit that can reinvest retained earnings rather than distributing everything to the owner each year.
Key statute references
The core legislative framework for company tax and base rate entity status spans two Acts.
Statute references
- Income Tax Rates Act 1986, ss 23, 23AA, 23AB
- ITAA 1997 Part 3-6 (Imputation)
- ITAA 1997 Subdivision 203-B (Benchmark franking rule)
- ITAA 1997 Divisions 165-166 (Company loss integrity)
- ITAA 1997 s 165-210 (Similar Business Test)
Frequently asked questions
What happens if my company's passive income exceeds 80% in one year but drops below 80% the next?+
Does a holding company that only receives franked dividends qualify as a base rate entity?+
How does aggregated turnover work when I own multiple related companies?+
Is it better to pay myself a salary or a franked dividend from a 25% company?+
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