If you operate through a company, one question matters more than most at tax time:
Does the lower company tax rate apply?
The answer depends on whether the company qualifies as a base rate entity.
This is where many directors get caught out. The company tax rate is not the same for every company in Australia. And simply being “small” does not automatically qualify a business for the lower rate. There are specific tests. Miss one, and the higher rate applies.
Let’s walk through it properly.
What is a base rate entity?
A base rate entity is a company that qualifies for the lower company tax rate under Australian tax law.
To be a base rate entity Australia, a company must satisfy two key tests in the income year:
- The base rate entity turnover test
- The base rate entity passive income test
Both tests must be passed. Not one. Both.
What is the base rate entity company tax rate?
For eligible companies, the base rate entity tax rate is 25%.
Companies that do not qualify pay the standard company tax rate of 30%.
That five per cent difference sounds modest, but it isn’t. On $500,000 of taxable income, that is a $25,000 difference in tax. Over several years, it compounds quickly.
This is why getting the classification right is critical.
The Base Rate Entity Turnover Test
To pass the base rate entity turnover test, the company’s aggregated turnover must be:
Less than $50 million for the income year.
Aggregated turnover includes:
- The company’s own annual turnover
- The turnover of connected entities
- The turnover of affiliates
This is where things can get complicated. Groups of companies often overlook the “connected entity” rules. On paper, each company looks small. Combined, they are not.
If annual turnover is under $50 million and there are no complex group structures, the first hurdle is cleared.
But this is only half the story.
The Base Rate Entity Passive Income Test
This is the main issue.
To qualify as a base rate entity, no more than 80% of the company’s assessable income can be base rate entity passive income.
If 80% or more of total assessable income is passive, the company fails the test.
This is where most people get caught out.
What counts as passive income?
For the purposes of the base rate entity passive income test, passive income generally includes:
- Dividends (unless certain exceptions apply)
- Interest income
- Royalties
- Rent
- Net capital gains
- Distributions from trusts (unless the trust is carrying on a business and the income is active business income)
Many directors assume that if the company is active in some way, it qualifies. That assumption is risky.
It is not about activity levels. It is about the composition of income.
The Biggest Mistake Directors Make
Many business owners assume:
“My turnover is under $50 million, so I get the lower company tax rate Australia offers.”
That assumption is wrong.
The passive income test is often overlooked. Particularly where companies hold investments alongside trading activities.
This is the biggest mistake we see. A company earns solid trading income, but significant interest or trust distributions push passive income above 80%. The result? The higher tax rate applies.
While the business looks active, numbers tell a different story.
Why This Classification Matters Beyond Tax
The company tax rate base rate entity status also affects:
- Franking credits attached to dividends
- Shareholder tax outcomes
- Tax planning strategies
If a company incorrectly applies the 25% rate, franking accounts can be distorted. Fixing that later is messy. Amendments. Recalculations. Penalties in some cases.
This is not an area for guesswork.
How Do You Know If Your Company Qualifies?
Start with three questions:
- Is aggregated turnover under $50 million?
- What is total assessable income for the year?
- How much of that income is passive?
Then calculate the passive income percentage.
If passive income is less than 80%, and turnover is below the threshold, the company qualifies as a base rate entity.
If passive income is 80% or more, the standard 30% rate applies.
It sounds simple, but it isn’t always. Trust distributions, intercompany dividends, and group structures complicate the analysis. In practice, this is rarely handled correctly without a careful review.
Frequently Asked Questions
What is a base rate entity?
A base rate entity is a company that qualifies for the lower 25% company tax rate because it meets both the turnover test (under $50 million aggregated turnover) and the passive income test (less than 80% passive income).
What is the base rate entity company tax rate?
The base rate entity tax rate is 25%. Companies that do not qualify pay 30%.
What income counts as passive income for base rate entities?
Passive income includes dividends, interest, rent, royalties, net capital gains, and certain trust distributions. The key issue is whether the income is primarily investment-based rather than generated from active business operations.
How do I know if my company qualifies as a base rate entity?
Check turnover first. Then calculate what percentage of assessable income is passive. If passive income is under 80% and turnover is below $50 million, the lower rate applies. If not, the company pays 30%.
Is a base rate entity the same as a small business entity?
No. A base rate entity is used to work out whether a company can access the lower company tax rate. A small business entity is a separate concept used for different tax concessions.
A company may qualify as a base rate entity for the 25% company tax rate, but that does not automatically mean it qualifies for every small business tax concession.
Does base rate entity status change every year?
Yes. Base rate entity status is tested each income year. A company may qualify in one year and fail in another if its aggregated turnover changes or if passive income becomes too high.
This is why directors should not assume last year’s tax rate automatically applies again this year. The ATO also notes that prior-year aggregated turnover is not relevant when working out whether a company is a base rate entity for a particular income year.
Does the base rate entity tax rate apply to trusts?
No. The base rate entity rules apply to companies. Trusts, partnerships and sole traders do not directly pay tax at the 25% company tax rate.
However, trust distributions received by a company may still affect the company’s passive income calculation, depending on the nature of the trust income.
Can a company with rental income still be a base rate entity?
Yes, but rental income is generally treated as passive income for the base rate entity test. If rental income and other passive income make up too much of the company’s assessable income, the company may fail the passive income test.
This is especially relevant for companies that hold investment properties alongside trading activities.
Can a company with capital gains qualify as a base rate entity?
Yes, but net capital gains are generally included as base rate entity passive income. A large capital gain in one financial year may push passive income above the allowed level.
This means a company can qualify in one year but lose base rate entity status in a year when it sells an investment asset.
How do trust distributions affect base rate entity status?
Trust distributions can affect base rate entity status because some distributions may be treated as passive income. The treatment depends on the type of income distributed by the trust.
For example, a distribution linked to rent, interest, dividends or capital gains may affect the passive income percentage differently from active business income distributed through a trust.
Does base rate entity status affect franking credits?
Yes. Base rate entity status can affect the maximum franking credit rate attached to dividends. This matters because the company tax rate and franking rate do not always work as simply as directors expect.
If a company uses the wrong rate, it may create franking account problems or shareholder tax issues. The ATO provides separate guidance on allocating franking credits and maximum franking rates.
What happens if a company uses the wrong company tax rate?
If a company incorrectly applies the 25% rate when the 30% rate should apply, it may need to amend its company tax return and pay the shortfall. Interest or penalties may also apply depending on the situation.
The issue can also flow through to franking credits if dividends were franked using the wrong rate.
Do foreign companies qualify as base rate entities in Australia?
A foreign company may need to consider Australian company tax rules if it is treated as a corporate tax entity for Australian tax purposes and has Australian assessable income. However, the outcome depends on residency, source of income, tax treaty issues, and whether the company meets the relevant base rate entity tests.
This is an area where professional advice is usually needed.
Does base rate entity status affect PAYG instalments?
It can. PAYG instalments are based on expected tax payable, so the applicable company tax rate may affect instalment calculations. If a company’s tax rate changes from 25% to 30%, or from 30% to 25%, the business may need to review its cash flow and instalment planning.
Should directors check base rate entity status before paying dividends?
Yes. Directors should check base rate entity status before paying dividends because it may affect franking credits and shareholder tax outcomes.
This is especially important where the company has passive income, trust distributions, capital gains, rental income, or a changing group structure.
Can a bucket company be a base rate entity?
Yes, but it depends on the company’s income mix and aggregated turnover. Many bucket companies receive trust distributions, so the passive income test becomes important.
If most of the company’s income is passive or investment-style income, the company may not qualify for the lower 25% rate.
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Final Thoughts
The rules around base rate entities are not complicated, but they are precise. Precision matters.
The turnover test is rarely the problem. The passive income test is where things fall apart. Especially for companies holding property or investments alongside trading activities.
A five per cent tax difference may not look dramatic at first glance. Over time, it is significant. Misclassification is expensive. Directors who understand these rules make better decisions about structure, distributions, and long-term planning. Those who ignore them often pay more than necessary or face corrections later.
Clear Tax continues to support businesses, founders, and advisers in handling company tax obligations with clarity and confidence. Because when it comes to company tax rates, assumptions are costly. Accurate classification is everything.
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