Is Your Company Paying the Right Tax Rate?
The difference between a 25% and 30% company tax rate can mean thousands of dollars to your business each year. Yet many Australian companies get their tax rate wrong, either overpaying tax or facing unexpected bills when the ATO catches up with them.
The Australian Taxation Office has recently reminded businesses that your company’s tax rate isn’t set in stone—you need to check it every single year. Even small changes in where your income comes from can push you from the lower 25% rate to the standard 30% rate. Here’s what every company director and business owner needs to know about getting their tax rate right in 2026.
Understanding the Two-Tier Company Tax System
Australia operates a two-tier company tax system. Companies that qualify as “base rate entities” pay tax at 25%, whilst those that don’t pay the standard 30% rate. To qualify for the lower 25% rate in 2025–26, your company must satisfy two critical tests. First, your combined business turnover must be less than $50 million, including not just your company’s sales but also the turnover of any related businesses you control. Second, and this is where most businesses get caught, no more than 80% of your company’s income can come from passive sources like investments, rent, or interest. Miss either test—even by a dollar—and your company pays 30% tax instead of 25%.
The turnover test is relatively straightforward for most businesses. You add up your total sales for the year, include any turnover from connected entities or businesses that act according to your directions, and if the total is under $50 million, you’ve passed the first hurdle. It’s the second test, the 80% passive income rule, that trips up even experienced business owners.
The 80% Passive Income Trap
Many business owners assume that if they’re actively running a business, they’ll automatically get the lower tax rate. Unfortunately, the ATO has a very specific definition of what counts as passive income, and it’s broader than most people realise. Passive income includes bank interest from savings accounts, term deposits, or loans you’ve made to others. It includes dividends from other companies you’ve invested in, along with all the franking credits attached to those dividends. Rental income from investment properties or equipment you lease out counts as passive. So do royalties from licensing your intellectual property or trademarks.
Here’s where it gets tricky. Capital gains from selling assets also count as passive income, and this includes profits from selling business assets you’ve actively used in your operations. This catches many business owners completely off guard. You might run a manufacturing business for twenty years, actively using a factory building every single day, but when you sell that building, the profit is treated as passive income for tax purposes. Investment profits from buying and selling shares are passive, as is income you receive from trusts and partnerships where that underlying income is itself passive in nature.
The good news is that genuine trading income doesn’t count towards the 80% limit. Sales of products or services to customers, professional fees and consulting work, manufacturing and production revenue, and commissions from services you actively provide all sit outside the passive income calculation. The fundamental question the ATO is asking is whether you’re earning money by actively working in your business day-to-day, or whether the money is coming from investments and assets sitting in the background generating returns without much effort from you.
Why Last Year’s Answer Doesn’t Count
Here’s something crucial that catches many businesses by surprise. You cannot simply check your base rate entity status once and assume it stays the same forever. You need to recalculate whether you qualify for the 25% rate every single year based on what actually happened in that specific year. What happened in previous years is completely irrelevant to the current year’s calculation. Even if you’ve confidently paid 25% tax for the past five years, one year where your passive income tips over 80% means you’ll pay 30% for that year.
This annual reassessment requirement creates genuine traps for unsuspecting business owners. Consider a business that normally earns $3 million from trading activities and perhaps $50,000 from bank interest and dividends. In a typical year, passive income represents less than 2% of total income, so the company comfortably qualifies for the 25% rate.
But then the owners decide to sell an investment property the company has held for years. The property sale generates a $2 million capital gain. Suddenly, in that year, the company’s total income jumps to $5.05 million, with $2.05 million of it being passive. The passive income percentage has leapt from under 2% to over 40%. The company still qualifies for the 25% rate because 40% is below the 80% threshold, but if that property gain had been larger, they could easily have been pushed over the limit.
Asset sales aren’t the only scenario that can unexpectedly change your income mix. A quieter trading year where sales drop but investment income remains steady can shift the balance. If your business normally makes $4 million in sales but has a difficult year and only makes $2 million, whilst still receiving $600,000 in rental income and dividends, you’ve gone from passive income being 13% of the total to being 23%.
Still safe, but moving in the wrong direction. A large one-off trust distribution, receiving a substantial dividend from another company, restructuring transactions that trigger capital gains, or changing your business model from active trading to more of a licensing or investment approach can all affect whether you qualify for the lower rate.
Seeing It in Practice
Let’s look at how this works with some realistic scenarios. Imagine ABC Manufacturing Pty Ltd, a genuine manufacturing business that earns $2.6 million from selling products and $100,000 in bank interest. Their total income is $2.7 million, and passive income represents just 3.7% of that total. ABC comfortably qualifies for the 25% tax rate because their passive income is nowhere near 80% and their turnover is well under $50 million. This is exactly the type of active trading business the lower tax rate was designed to support.
Now consider XYZ Holdings Pty Ltd, which receives $500,000 in dividends from shares it owns, $200,000 in rental income from investment properties, and $50,000 in bank interest. Total income is $750,000, and every dollar of it is passive. XYZ pays 30% tax because 100% of its income is passive, even though the total amount isn’t particularly large. The size of your income doesn’t determine your tax rate—the type of income does.
The really challenging situations occur when a normally active business has an unusual year. Think about Operating Co Pty Ltd, which typically earns $3 million in trading income and perhaps $50,000 from investments—a passive income percentage of just 1.6%, easily qualifying for the 25% rate year after year.
But in 2025–26, the company sells a commercial property and makes a $2 million profit. That year, passive income jumps to $2.05 million out of total income of $5.05 million, representing 40.6% of the total. The company still qualifies for the 25% rate because they’re below the 80% threshold, but it’s uncomfortably close. If circumstances had been slightly different—perhaps they sold two properties instead of one—they could have easily tipped over the limit and faced an unexpected 30% tax rate for that year.
The Franking Credits Compilation
Getting your tax rate wrong doesn’t just affect how much tax your company pays directly. It also creates complications with franking credits when you pay dividends to shareholders. When your company distributes profits to shareholders as franked dividends, the franking credits attached to those dividends are calculated based on your company’s tax rate. If you’re a base rate entity paying 25% tax, your franking credits are calculated at that rate. If you’re paying 30% tax, the franking credits are higher.
The problem arises when you think you’re a base rate entity paying 25% tax, you frank your dividends accordingly, and then it turns out you should have been paying 30%. Suddenly you’ve underestimated the franking credits, distributed incorrect information to your shareholders, and need to go back and fix everything. You’ll need to notify shareholders of the correct dividend and franking credit amounts, send out corrected dividend statements, and adjust your franking account records. This creates significant administrative burden, potential embarrassment, and disappointed shareholders who end up with different franking credits than they were expecting.
Getting Your Calculation Right
Working out your base rate entity status correctly starts with understanding your total turnover. Add up your company’s sales for the year, and include the turnover of any businesses connected to you or that act as your affiliates. Connected entities are those you control or that control you—typically other companies in your group with common ownership. Affiliates are individuals or entities that act in accordance with your directions or wishes. For most straightforward business structures, this calculation is relatively simple, but if you have multiple related entities, you need to be thorough.
The next step is identifying every source of passive income in your business. Go through your profit and loss statement line by line and pull out interest received from any source, dividends and trust distributions you’ve received, rental income from properties or equipment, royalty income, and critically, any profits from selling assets during the year. Don’t forget that franking credits attached to dividends you receive count as part of your assessable income, so they need to be included in both your total income and your passive income calculations.
Once you’ve identified all your passive income sources, the mathematics is straightforward. Divide your total passive income by your total assessable income, and multiply by 100 to get a percentage. If that percentage is more than 80%, you don’t qualify as a base rate entity and you’ll pay 30% tax. If it’s 80% or less, and your turnover is under $50 million, you qualify for the 25% rate.
The timing of income recognition can become strategically important if you’re hovering near the 80% threshold. You might consider whether you can delay selling assets until the following year, whether you can bring forward some trading income through early invoicing or contract timing, or how to strategically time trust distributions. These timing decisions need to be made for genuine commercial reasons, not purely for tax avoidance, but understanding the implications can help you make informed decisions about when to undertake certain transactions.
Common Mistakes That Create Problems
One of the most common mistakes is assuming that being a small business automatically means you get the 25% tax rate. Whilst it’s true that only businesses under $50 million turnover can qualify, that’s just the first test. You still need to pass the 80% passive income test, and plenty of small businesses fail it. A small family company that holds investment properties and shares might have turnover well under $50 million but still pay 30% tax because all its income is passive.
Another frequent error is thinking that last year’s answer applies to the current year. Business owners get comfortable knowing they’ve always been a base rate entity, and they don’t recalculate when circumstances change. Every year stands alone in the ATO’s eyes. What qualified you for 25% tax last year is irrelevant to whether you qualify this year.
Capital gains trip up many businesses because owners don’t realise that profits from selling business assets count as passive income. You might think that selling a factory you’ve used in your manufacturing business for fifteen years would be treated as active business income, but it’s not. The capital gain goes into the passive income bucket, potentially pushing you over the 80% threshold in the year of sale.
Forgetting about franking credits is another subtle mistake. When you receive franked dividends from other companies, you need to include both the cash dividend and the franking credit in your assessable income calculations. Some businesses only count the cash they receive and forget about the franking credits, which understates their total assessable income and can throw off their passive income percentage calculation.
What Happens When You Get It Wrong
If you’ve been paying tax at 25% when you should have been paying 30%, the consequences are more than just paying the difference. The ATO will amend your assessment to collect the additional 5% tax you owe, which on a company profit of $1 million amounts to $50,000. They’ll also charge interest on that shortfall calculated from when the tax was originally due, which can add thousands more to your bill depending on how long it takes for the error to be discovered.
Beyond the money, there are potential penalties if the ATO considers the error was due to lack of reasonable care. If they think you should have known better, or that you didn’t take reasonable steps to ensure your tax return was correct, they can apply penalties on top of the tax and interest. The penalties can range from 25% to 75% of the tax shortfall depending on the severity of the error and whether you tried to fix it voluntarily.
If you’ve been franking dividends at the wrong rate, the administrative burden compounds. You need to notify all your shareholders of the correct amounts, which can be embarrassing and damage confidence in your company’s financial management. You need to issue corrected distribution statements, which creates work for both you and your shareholders’ accountants. You need to adjust your franking account to reflect the correct franking rate, which affects your available franking credits going forward. For companies with multiple shareholders or those who have paid multiple dividends during the year, this correction process becomes genuinely complex.
Taking Action for Your 2026 Company Tax Return
As you approach the end of the 2025–26 financial year, or as you prepare your company tax return if the year has already ended, there are practical steps you should take to ensure you get your tax rate right. Start by reviewing where every dollar of your company’s income came from during the year. Create two lists—one for active business income from trading, services, and operations, and another for passive income from investments, interest, rent, capital gains, and distributions.
Calculate your passive income percentage accurately. Don’t estimate or guess. Get the actual numbers from your accounting records, do the division, and see where you land. If you’re well below 80%, you can have confidence you qualify for the 25% rate. But if you’re close to 80% or over it, you need to prepare for the 30% rate and all its implications.
If you’ve been in business for several years, take time to review your previous tax returns, particularly if you’ve had asset sales, received large trust distributions, or experienced significant investment income in recent years. Check whether you correctly assessed your base rate entity status in those years. If you discover an error, it’s better to identify it yourself and make a voluntary disclosure to the ATO than to wait for them to find it during an audit.
Looking forward to the 2026–27 year and beyond, consider whether you have plans that will affect your income mix. Are you planning to sell property or other assets? Will you be restructuring your business? Are you expecting to receive large distributions from trusts or other entities? Understanding the tax rate implications now allows you to plan strategically and avoid surprises.
Make sure any dividends you’ve paid during the year were franked at the correct rate. If you paid dividends early in the financial year assuming you’d be a base rate entity, but it turns out you’re not, you may need to correct those franking credits before year end. Getting advice before paying dividends, rather than trying to fix problems afterwards, is far more efficient.
For businesses with complex structures, multiple income sources, or those operating close to the 80% threshold, professional advice isn’t a luxury—it’s a necessity. The cost of getting expert help to correctly assess your position is almost always less than the cost of getting it wrong and facing amended assessments, interest, and penalties.
The Bigger Picture
Qualifying for the 25% company tax rate instead of 30% can save your business substantial money each year. On a company profit of $500,000, the difference is $25,000 that could be reinvested in equipment, used to hire staff, or distributed to shareholders. Over five years, that’s $125,000—enough to make a real difference to most small and medium businesses.
However, the benefit only materialises if you get the assessment right. The 80% passive income test is more nuanced than it first appears, and the requirement to reassess every single year based on actual results means you can’t set and forget. Business circumstances change, income sources vary from year to year, and one-off events like asset sales can dramatically affect your income mix.
The ATO has made it clear they’re paying attention to base rate entity status, particularly for companies that may have incorrectly self-assessed as qualifying for the lower rate. With sophisticated data matching and analysis capabilities, they can identify businesses whose income composition suggests they should be paying the higher rate but haven’t been. Getting ahead of this issue by accurately assessing your own position is far better than waiting for the ATO to ask questions.
Getting your company tax rate right isn’t just about following rules and ticking compliance boxes. It’s about making sure you’re not paying more tax than the law requires whilst also ensuring you’re not exposing yourself to future problems. Take the time to properly understand where your income comes from, calculate your passive income percentage accurately, and reassess your position every year. Your business—and your bank account—will thank you for it.
Need help working out your company’s correct tax rate or checking your franking is accurate? Our team at MaxGrowth can review your income composition, calculate your correct base rate entity status, and make sure everything is set up properly for both current and future years. Contact us today for a comprehensive review.
Disclaimer: This article provides general information about company tax rates current as of April 2026. Every business is different, and tax rules can be complex. Always get professional advice specific to your situation before making tax decisions. For detailed technical guidance, refer to ATO Law Companion Ruling LCR 2019/5.
