Every year Australian companies must decide whether the Australian Taxation Office will tax them at 25 per cent or at the headline corporate rate of 30 per cent. The answer turns on one deceptively simple idea called the base rate entity test. Pass both limbs of the test in the income year and the company enjoys the lower 25 per cent rate. Fail either limb and the rate jumps to 30 per cent. Everything else you read about aggregated turnover thresholds, passive income limits or connected entities ultimately feeds back into that single annual decision about which rate applies.
What is a base rate entity
A base rate entity is an Australian resident company that satisfies two requirements during the income year. First its aggregated turnover is less than fifty million dollars. Second no more than eighty per cent of its assessable income is passive according to a definition set out in the tax law. The moment either requirement is missed the company ceases to be a base rate entity for that year and the higher rate applies. The test is refreshed every income year which means last year’s outcome does not bind this year’s result.
The two tests you must pass
Although taxpayers often speak about the base rate entity test as one hurdle it is really two separate calculations that must both land in the company’s favour. Those two calculations operate independently. A service company with healthy trading income could have turnover of twenty million dollars yet still fail because too much of its revenue stream is passive. Conversely an active manufacturing business could earn ninety per cent trading income but still lose access to the concession because its aggregated turnover tips over fifty million dollars after grouping rules draw in connected entities. Understanding each limb in detail is therefore essential.
Aggregated turnover
Turnover in everyday business language is usually read as the sales figure that appears on a profit and loss statement. The legislation builds on that concept but then expands it. A company must include not only its own ordinary income from carrying on business but also the ordinary income of any entity that is connected with it or that is an affiliate. The grouping exercise can be painstaking because it asks you to look through shareholding, control arrangements and even informal influence to see whether someone in substance operates together with the test company.
Importantly the tax law measures aggregated turnover for the current income year in which the tax rate decision is being made. The Australian Taxation Office makes it clear that prior year turnover is irrelevant. That position contrasts with some other small business concessions that look to prior year values. Many businesses trip up by assuming last year’s figure carries forward. In reality the company must run the calculation again each year using actual or reasonably estimated current year numbers before its return is lodged.
The fifty million dollar threshold has stood still since the 2021–22 year and no indication exists at the time of writing that Treasury will index or move it. The simplicity of a single national figure helps planning but it can still take careful forecasting for rapidly growing groups to know whether they will cross the line by year end.
Passive income test
Even if the turnover hurdle is cleared, the company must still show that passive income forms no more than eighty per cent of its assessable income. The concept is called base rate entity passive income by the legislation. In broad terms passive income includes interest, rent, royalties, dividends other than dividends from non passive underlying companies, net capital gains, some gains on financial arrangements and similar investment returns. The idea is to ensure the concession is available to active trading businesses rather than investment vehicles.
The eighty per cent figure is applied to the company’s assessable income not its turnover. That distinction matters because many passive returns sit outside ordinary income. For example unrealised gains on shares may not be assessable until realised. When they are realised they all spike in a single year potentially pushing the passive ratio over eighty per cent for that year.
Income streams must be analysed carefully to decide whether they are passive or active. For example a property development company may hold land as trading stock. Sales proceeds from that land are treated as income from trading not as rental or investment income. On the other hand a company that merely collects rent from an office it owns will find that rent classified as passive.
Companies with mixed activities need granular bookkeeping to allocate income correctly. Misallocation is one of the most common causes of mistakes discovered in ATO reviews. A passive income worksheet tied back to general ledger codes is good practice and also creates evidence should the ATO ask for substantiation.
What company tax rate applies if you fail the test
Where the company satisfies both limbs the headline tax rate drops from 30 per cent to 25 per cent for that income year. Dividends paid out of those profits can be franked at the same 25 per cent rate. Where the company fails either limb the full 30 per cent rate applies and any franking credits attached to dividends must also reflect 30 per cent. Errors in the franking percentage can compound tax exposure because shareholders may claim credits they are not entitled to, leading the ATO to disallow the credits and impose penalties on both the company and the recipients.
Common mistakes businesses make
A review of ATO audits and public guidance shows three errors surface repeatedly. First many taxpayers rely on prior year turnover when self assessing, forgetting that the current year is decisive. Growth businesses in particular can cross over the threshold mid year and miss the change. Second taxpayers neglect to bring connected entities and affiliates into the turnover calculation. A privately owned group may have several companies holding different assets with common control. Aggregated turnover will pool all of them. Third companies may misclassify an income stream as active when it is in substance passive. A frequent example is interest charged to related parties. Even though the arrangement appears to arise from operating business, interest remains passive under the statute and counts toward the eighty per cent test.
Who should pay extra attention
Although every company technically performs the calculation yearly, certain profiles demand extra care. Businesses that mix operating divisions with investments for cash management or succession planning often drift over the eighty per cent limit without noticing. Family groups that interpose corporate beneficiaries in trust structures sometimes trigger aggregation because the company is connected back to the controllers of the trust. Rapidly scaling technology start-ups might remain under fifty million dollars on a standalone basis but breach it once venture holding entities or overseas subsidiaries are added. Property groups that hold both development land and long term investment property should model the upcoming year’s income flows to monitor the passive ratio.
Quick checklist before lodging
Every company can ask four quick questions during year end workpapers preparation. Has aggregated turnover for the current year been calculated using actual or reasonably projected figures. Have connected entities and affiliates been correctly identified and included. Has each income stream been reviewed and coded as passive or active based on legislative definitions. Has the resulting tax rate and franking percentage been matched in the company tax return and franking account? Answering yes to all four dramatically reduces audit risk.
Worked example
Imagine Coastal Fabrication Pty Ltd, an Australian resident company that manufactures aluminium components for boat builders. Its own sales revenue for 2025–26 is twenty seven million dollars. The sole shareholder also controls a passive investment company that earns bank interest of six million dollars. Under the grouping rules Coastal Fabrication must aggregate that six million dollars with its own turnover, bringing aggregated turnover to thirty three million dollars which is still below fifty million dollars. Coastal Fabrication also received four million dollars in franked dividends from a listed company and three million dollars in interest on surplus cash. Its assessable income therefore comprises twenty seven million dollars from trading activity, four million dollars from dividends and three million dollars from interest, a total of thirty four million dollars. Passive income is seven million dollars, leaving passive income ratio at about twenty per cent. Both limbs are satisfied so Coastal Fabrication is a base rate entity and is taxed at 25 per cent.
Now consider the same facts but with trading sales of eleven million dollars rather than twenty seven million dollars. Aggregated turnover would still be under fifty million dollars but passive income would be seven million dollars out of eighteen million dollars, equating to about thirty nine per cent. That still passes the eighty per cent test. If however dividends and interest rose to fifteen million dollars while sales stayed at eleven million dollars, passive income would be fifteen million dollars out of twenty six million dollars, or fifty eight per cent, still under eighty per cent. Only when passive income moves beyond eighty per cent does the concession fall away. Companies that sit close to the boundary might adjust timing of investment disposals or consider moving investments into a separate entity to preserve the lower rate.
Active and passive income comparison
| Income type | Usually active or passive | Comment |
|---|---|---|
| Sale of goods manufactured by the company | Active | Ordinary business revenue counts toward active income |
| Fees for services personally delivered by employees | Active | Includes consulting, professional services and similar |
| Rent from leasing commercial property | Passive | Unless the company runs a separate property trading business |
| Interest on bank deposits | Passive | Classified as base rate entity passive income |
| Franked dividends from unrelated listed companies | Passive | Excluded unless underlying company is not passive |
| Royalties received for intellectual property licensing | Passive | Specifically listed in the definition of passive income |
| Net capital gain on sale of investment shares | Passive | Treated as passive even where shares were held for strategic purposes |
| Profit on sale of trading stock property by developer | Active | Land held as trading stock produces active income |
The comparison makes one lesson clear. The labels used in management accounts do not decide the outcome, legislative definitions do.
Edge cases for foreign subsidiaries and branches
Australian resident companies that control foreign subsidiaries or operate foreign branches must also think about how overseas revenue feeds into aggregated turnover and passive income. Where an overseas subsidiary is connected or where the Australian company holds significant ownership, the subsidiary’s ordinary income can form part of aggregated turnover even if it is not taxable in Australia. For the passive income ratio foreign source dividends may qualify for exemption but still count as assessable income when calculating the eighty per cent test. Branch profits earned directly by the Australian company will always flow straight into the calculation. Non-resident companies carrying on business through an Australian permanent establishment are subject to different rate rules and cannot rely on the base rate entity provisions.
Frequently asked questions
What is a base rate entity
A base rate entity is a company whose aggregated turnover is below fifty million dollars and whose passive income does not exceed eighty per cent of assessable income in the income year.
What company tax rate do base rate entities pay
Base rate entities pay company tax at 25 per cent for the income year and may frank dividends at the same rate.
What is aggregated turnover
Aggregated turnover is the ordinary income of the company plus the ordinary income of any entity that is connected with or an affiliate of the company for the income year.
What counts as base rate entity passive income
Interest, rent, royalties, certain dividends, net capital gains and gains on financial arrangements are common forms of passive income for the purposes of the test.
Does last year’s turnover decide this year’s base rate entity status
No. The company must use current year figures to assess base rate entity status. Prior year turnover is not relevant.
Can a company fail the test even if turnover is under fifty million dollars
Yes. If more than eighty per cent of its assessable income is passive the company will not qualify as a base rate entity despite low turnover.
Do you need to apply to be a base rate entity
No formal application is required. The company self assesses each year and reflects the appropriate tax rate in its income tax return.
Final thoughts
The base rate entity test is straightforward in concept yet challenging in practice because every figure in the calculation must be correct for the lower rate to apply. Turnover must be grouped, passive income correctly identified and the analysis repeated every year. The difference between 25 per cent and 30 per cent tax can be substantial especially for growing businesses, so a robust year end procedure is essential. By understanding each limb, keeping clean records and revisiting the position before lodging, Australian companies can secure the benefit of the lower rate and avoid the penalties that flow from getting the test wrong.
