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Corporate tax residency – tax ruling highlights the need for foreign companies to manage residency risk

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Introduction

Foreign companies that may be controlled by an Australian entity should review their key decision-making procedures following the newly issued Australian Taxation Office (ATO) Taxation Ruling, TR 2018/5 (TR 2018/5) which gives guidance on when the ATO could find a foreign company’s central management and control (CMC) is located in Australia.

Background

Section 6 of the Income Tax Assessment Act 1936 states a company is a tax resident of Australia if the company satisfies one of the following tests:

  • the company is incorporated in Australia; or
  • if the company is not incorporated in Australia, the company:
    • carries on business in Australia, and
    • has either:
      -       its CMC in Australia, or
      -       its voting power controlled by shareholders who are residents of Australia.

Since 2004, the ATO view on company tax residency was found in Taxation Ruling TR 2004/15 (now withdrawn) (TR 2004/15). In TR 2004/15, the ATO view was that for a company to be a resident under the second statutory test in section 6, two separate requirements had to be met. The first was that the company must carry on business in Australia and the second that the company's CMC must be in Australia.

In November 2016, the High Court handed down its decision in Bywater Investments Ltd & ORS v FC of T; Hua Wang Bank Berhad v FC of T Bywater) which created a storm. Without delving into the detail, in Bywater, an individual was indirectly involved in the incorporation of multiple foreign companies. Each company had its own set of directors in each foreign location. However, the individual, a resident of Australia, was considered the controlling mind of all relevant companies.  The taxpayer conceded that the business of the companies involved was being carried on in Australia. Therefore, the main issue in the case was whether the CMC for all relevant companies was in Australia.

The High Court held that where the CMC was in Australia, the company would be a resident of Australia regardless of where the company’s business is conducted.  That is, a business need not be carried on in Australia for a company to be an Australian tax resident provided CMC was in Australia.

In March 2017, following Bywater, the ATO withdrew TR 2004/15 and released Draft Taxation Ruling, TR 2017/D2 (TR 2017/D2) which said if a company has its CMC in Australia, and it carries on business, it will be carrying on business in Australia within the meaning of the CMC test of residency. The ATO view was, it was not necessary for any part of the actual trading or investment operations from which the company’s profits are made to take place in Australia.

TR 2017/D2 caused much angst among taxpayers and their advisors. Nevertheless, on 21 June 2018, after a period of consultation from industry, the ATO finalised this draft ruling as TR 2018/5.

What does TR 2018/5 say?

Despite some modifications, TR 2018/5 is consistent with the Commissioner of Taxation’s (Commissioner) views in TR 2017/D2. At the same time as finalising TR 2018/5, the ATO also released Draft Practical Compliance Guideline, PCG 2018/D3 (PCG 2018/D3) (see below) that provides guidance in relation to the application of TR 2018/5.

In TR 2018/5, at paragraphs 7 and 8, in reliance on Bywater having “endorsed” statements from the earlier case of Malayan Shipping Co Ltd v FCT (1946) 71 CLR 156 (Malayan Shipping) the ATO states:

“If a company carries on business and has its central management and control in Australia, it will carry on business in Australia within the meaning of the central management and control test of residency.

It is not necessary for any part of the actual trading or investment operations of the business of the company to take place in Australia. This is because the central management and control of a business is factually part of carrying on that business. A company carrying on business does so both where its trading and investment activities take place, and where the central management and control of those activities occurs”.

In TR 2004/15, the ATO distinguished the comments by some commentators that Malayan Shipping set out a general principle that if a company's CMC was in Australia this meant that company is also carrying on business in Australia. TR 2018/5’s reference to Malayan Shipping represents a change to the ATO’s view; that Malayan Shipping provides support for this point. 

Given the changed ATO view, if CMC is located in Australia, unless dormant a company incorporated outside Australia is almost certainly going to satisfy the residency test under section 6.

The key message for taxpayers going forward, is to focus on assessing where CMC will be located rather than a mechanical consideration of where a company may carry on its business.

TR 2018/5 states as “a starting point” the ATO will consider that the directors of a company will exercise CMC. However, where facts suggest otherwise, the ATO will also consider amongst other factors:

  • where the governing body of the company meets;
  • where the company declares and pays dividends;
  • the nature of the company’s business and whether it dictates where CMC decisions are actually made in practice; and
  • evidence where minutes or other documents recording where high-level decisions by the company are made.

Importantly, exercise of CMC by the directors of a company looks at real decision making not merely the implementation or rubber stamping of decisions made by others.

PCG 2018/D3

PCG 2018/D3 includes examples distinguishing the difference between:

  • a high-level decision vs a decision relating to day-to-day management of the company;
  • a person who is ‘merely influential’ vs to a ‘real decision maker’; and
  • decisions made in one location vs decisions made in multiple locations.

Whilst some useful examples are included in PCG 2018/D3, most are simple and of limited utility. As the ATO itself says, the examples and guidance in PCG 2018/DC are “general in nature” and foreign incorporated companies are encouraged to approach the ATO on a case by case basis to discuss their specific circumstances.

Submissions in response to PCG 2018/D3 close on 20 July 2018.

What are the implications of TR 2018/5?

The ATO view in TR 2018/5 will affect foreign companies with Australian owners or controllers (including directors).

It is timely for Australian groups with foreign-incorporated subsidiaries to consider whether they are appropriately managing tax residency risk from a go-forward perspective. This can include re-visiting and/or implementing tax residency protocols and ensuring that they can be applied practically.

To discuss this article or international taxation and tax residency generally, please contact either Neil Brydges, Sam Campbell, or Kelvin Yuen.

Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia  
nbrydges@sladen.com.au

Sam Campbell
Associate | Business Law
Sladen Legal
M +61 423 515 454 | T +61 3 9611 0135
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
scampbell@sladen.com.au

Kelvin Yuen
Lawyer
Sladen Legal
T +61 3 9611 0177
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
kyuen@sladen.com.au

Neil Brydges