Under current ATO rules for the 2025–26 financial year, Australia operates two company income tax rates — 30% for the general case and 25% for companies that qualify as base rate entities. Getting this right matters well beyond the annual return: it affects the tax provision in the accounts, the rate at which dividends are franked, and the PAYG instalment rate applied to quarterly tax payments. Errors in one area cascade into errors in the others.
The Two Rates and the Base Rate Entity Test
The general company tax rate is 30%, and it applies to any company that does not meet the base rate entity conditions.
A company is a base rate entity for an income year if it satisfies both of the following:
- Its aggregated turnover for the income year is less than $50 million.
- No more than 80% of its assessable income for that income year is "base rate entity passive income."
Both conditions must be met. A company with $30 million in turnover that earns 85% of its income from dividends from related companies does not qualify — it fails the passive income test. A company with $60 million in turnover that earns only 5% passive income does not qualify — it fails the turnover test.
The aggregated turnover calculation includes the turnover of affiliated entities and entities connected to the company under the general affiliates rules in the ITAA 1997, not just the company's own revenue. A subsidiary of a large group with $10 million in its own revenue may have aggregated turnover well above $50 million once the parent group's revenue is included.
| Item | General company | Base rate entity |
|---|---|---|
| Tax rate | 30% | 25% |
| Aggregated turnover | Threshold not met | Less than 50 million dollars |
| Passive income | Threshold not met | No more than 80% of assessable income |
| Maximum franking rate | 30% | 25% |
| Passive income definition | n/a | s.23AB Income Tax Rates Act 1986 |
| Misclassification impact | Overstates provision by five percentage points | Loses excess franking credits if over-franked |
What Counts as Base Rate Entity Passive Income
The passive income test is applied to the composition of the company's assessable income. Base rate entity passive income is defined in s.23AB of the Income Tax Rates Act 1986 and includes:
- Dividends (other than from companies connected with or affiliated with the taxpayer)
- Non-portfolio dividends received from non-residents
- Franking credits attached to dividends
- Royalties
- Rent
- Interest income (with limited exceptions for financial institutions whose ordinary course of business includes lending money)
- Net capital gains
- Amounts that flow through trusts and partnerships to the extent those amounts are themselves passive income at the trust/partnership level
A company that primarily provides services — accounting, IT, consulting, labour — earns service fee income that is not passive income. If that income is more than 20% of total assessable income, the 80% passive threshold is not breached, and the company qualifies at the 25% rate.
A holding company whose income is primarily dividends from its subsidiaries, or interest from loans to related entities, fails the passive income test. This is the single most common error — treating a holding company as a base rate entity when it is not one.
Franking Accounts and the Correct Franking Rate
When a company pays a dividend, it can attach franking credits representing the tax the company has paid on the underlying profits. The maximum franking rate is the company's applicable corporate tax rate for the year in which the dividend is paid — not for the year in which the profits were earned.
A base rate entity (25% tax rate) can only frank dividends at 25%. A company subject to the 30% rate can frank at 30%.
Over-franking occurs when a company incorrectly believes it is a base rate entity and attaches 25% franking credits to a dividend when it should have attached 30% credits. In this scenario, the ATO limits the shareholder's franking credit offset to the rate that is consistent with the company's actual tax rate — excess credits are not refundable and are lost. The company may also face a franking deficit tax liability.
Under-franking occurs when a company incorrectly applies 30% franking to a dividend paid by a genuine base rate entity. The shareholder receives fewer credits than they are entitled to, reducing the benefit of the dividend imputation system.
Tax Provision Calculations
For companies that prepare financial statements under AASB 112 (Income Taxes), the current tax provision must be calculated at the correct tax rate. If a company is incorrectly classified as a general company (30%) when it qualifies as a base rate entity (25%), the tax provision will be systematically overstated by five percentage points of taxable income.
Deferred tax assets and liabilities are calculated at the enacted tax rate expected to apply when the temporary difference reverses. If there is any reason to expect that the company's status may change in the year the temporary difference reverses — for example, turnover is expected to cross the $50 million threshold — the deferred tax calculation should reflect the rate expected to apply at reversal, not the current rate.
This is particularly relevant for companies in rapid growth phases: a company currently qualifying at 25% that expects to exceed the aggregated turnover threshold in two to three years should be provisioning for the rate that will apply when those deferred tax liabilities reverse.
PAYG Instalments
The ATO sets a PAYG instalment rate for companies based on prior-year net income tax. If a company's tax rate changes — because it qualifies as a base rate entity for the first time, or loses that status — the instalment rate will reflect the prior-year rate until the ATO recalculates following lodgement of the return.
A company that transitions from the 30% rate to the 25% rate in Year 1 will make instalments at the old rate during Year 2 until the return for Year 1 is lodged and assessed. This creates an overpayment that will be refunded after the Year 1 return is processed. Bookkeepers with clients undergoing a rate transition should explain this timing difference and ensure the client is not managing cash flow on the assumption that overpaid instalments are immediately accessible.