Technical Update:

ATO’s final view on tax residency of foreign companies: Less than two months left to prepare

12 October 2018

The ATO’s final guidance in relation to the central management and control test of corporate residency confirms that it will adopt a stricter interpretation of the rules on foreign incorporated companies claiming to fall outside the Australian tax net on the basis that they are non-resident taxpayers. There is however a transitional period that expires on 21 December 2018 (the draft PCG states 13 December 2018 but it is expected to be about 21 December 2018) that will allow certain companies to apply the old rules. Taxpayers should therefore contact BDO immediately to examine the management of their foreign operations.

TR 2004/15, Bywater case and TR 2017/D2

Where a company is an Australian resident for tax purposes, it will be taxed in Australia on its worldwide income and where it is a foreign resident for tax purposes, it will be taxed in Australia only on its income sourced in Australia. The definition of “resident of Australia” for tax purposes includes a company that is not incorporated in Australia where it

  • Carries on business in Australia; and
  • Has its central management and control in Australia.

The Australian Taxation Office’s (ATO) previous interpretation in tax ruling TR 2004/15, issued on 20 October 2004, was that a foreign incorporated company that has major operational activities (e.g. major trading, service provision, manufacturing or mining activities) outside Australia would not be a resident of Australia because it was not considered to be carrying on business in Australia, even though its central management and control may be in Australia. However, on 16 November 2016, the High Court’s decision in Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation(Bywater)indicated that a company not incorporated in Australia and without its major operational activities in Australia will be carrying on business in Australia if its central management and control is in Australia.

The Bywater case also confirmed that a company will not necessarily have its central management and control where its board meets, if it is apparent that the decisions are in fact made by someone else. This point was included in TR 2004/15 but it did not have much relevance in cases where the company had its major operational activities outside Australia, because TR 2004/15 also said that, in such cases, the company was not necessarily carrying on business where the central management and control was located. However, following the Bywater decision, the ATO had to reconsider this view. Therefore, it can no longer be assumed that because a company is not incorporated in Australia (with foreign directors and board meetings held outside Australia) the company will be a non-resident for Australian tax purposes if it could be concluded that the real decisions of the board are made by someone else in Australia. An analysis of all relevant factors is required to determine whether the real central management and control of the company is situated in Australia.

Following the High Court’s decision in Bywater, the ATO withdrew TR 2004/15 and released draft tax ruling TR 2017/D2 which extrapolates from the Bywater decision, reverses the ATO’s previous position and effectively combines the ‘carrying on a business’ and ‘central management and control’ tests by concluding that a company will be carrying on business both where its central management and control is locate and where its major operational activities are located.

TR 2018/5

On 21 June 2018, the ATO released a final taxation ruling TR 2018/5 which finalised TR 2017/D2 and confirmed that any entity which has its central management and control located in Australia and carries on business (anywhere in the world) is an Australian tax resident, subject to any double tax agreement (DTA), even where the company’s business (active or passive) is located in a foreign jurisdiction. TR 2018/5 is broadly consistent with TR 2017/D2 with some changes to format and some clarification changes.

Some of the important comments in the final ruling include:  

  • Where a company is run by its directors in accordance with its constitution and the company law rules applicable to that company give its directors the power to manage the company, the company’s directors will control and direct its operations, however this is not the end of the enquiry as there is no presumption that the directors of a company will always exercise its central management and control
  • A foreign incorporated company will have its central management and control at the place where those people making the high-level decisions are located and not where such decisions are recorded and formalised or where the company’s constitution or by-laws or articles of association require the entity to be controlled and directed (this is not necessarily where those persons live)
  • A company’s central management and control can be located in more than one place.

TR 2018/5 further clarifies that the question of ‘residency’ will ultimately turn on the individual facts and circumstances and “no single factor alone will necessarily determine where central management and control of a company is exercised. The relevance and weight to be given to each will depend on the facts and circumstances of the case and surrounding circumstances.” Usefully TR 2018/5 also provides guidance on the matters most likely and least likely to influence a court’s decision and also contains specific examples of what does and does not constitute an act of central management and control.

Date of application

TR 2018/5 applies from 15 March 2017, being the date of release of the ruling in its draft form (TR 2017/D2) and also the date of withdrawal of the ATO’s previous ruling on central management and control (TR 2004/15). BDO note that taxpayers that previously relied on TR 2004/15 should revisit their positions as a matter of urgency but also note there are some practical approaches that can be taken under the ATO’s Draft Practical Compliance Guideline PCG 2018/D3 that also provides transitional treatment for companies that relied on the now withdrawn TR 2004/15, as discussed below. Taxpayers can also take comfort in knowing that if they made changes to corporate governance procedures for foreign incorporated companies, ATO compendium TR 2018/5EC clarifies that the ATO will not apply Part IVA changes in how a company is managed merely in order to ensure that it remains non-resident after the withdrawal of TR 2004/15.

PCG 2018/D3

Draft Practical Compliance Guideline PCG 2018/D3 was issued the same day as TR 2018/5, with practical guidance to assist foreign incorporated companies determine whether they are residents under the central management and control test of company residency in subsection 6(1) ITAA 1936. Draft PCG 2018/D3 simplifies the approach taken in TR 2018/5 by stating that the location of a company’s central management and control is determined by reference to:

  • Where it is controlled and directed as a matter of substance; and
  • How its control and direction is exercised over time.

PCG 2018/D3 notes that most companies should have little difficulty identifying where central management and control is located as this will normally be where the directors make their decisions. However, if there is some lapse in directorial standards or corporate governance, unusual facts such as the directors’ role being usurped by outsiders, or control and direction being exercised in multiple places, it may be more difficult to identify the location of a company’s central management and control. To assist PCG 2018/D3 contains 14 examples covering various scenarios that demonstrate the application of TR 2018/5, which reflect the ATO’s focus on ‘high-level decisions’.

PCG 2018/D3 also contains a compliance concessions saying the ATO will not apply resources to review or see to treat a foreign incorporated company as a resident applying the central management and control test where the company:  

  • Is a subsidiary of a public company and an ordinary company that is not a hybrid; and  
  • Exercise a substantial majority of the central management and control in a foreign jurisdiction; and 
  • Has not undertaken any artificial or contrived arrangement affecting the location of central management and control.

This means that most subsidiaries of public companies that have appropriately documented their board meetings should have a good level of comfort that their residency position should not be challenged. BDO also note that unfortunately, there is no such concession for private company groups other than under the transitional compliance approach as discussed below.

Transitional period

PCG 2018/D3 also has a transitional compliance approach where a company can continue to rely on withdrawn TR 2004/15 where immediately prior to the withdrawal of TR 2004/15, the company had relied on that ruling. The transitional period is the period between and including the date TR 2004/15 was withdrawn (15 March 2017) and 21 December 2018 (the draft PCG states 13 December 2018 but it is expected to be about 21 December 2018). This means that taxpayers needs to review existing governance protocols and if required make any necessary changes during the next few months. There are a number of strict conditions that must be satisfied before a foreign incorporated company can qualify for the transitional compliance approach, and it will be important for companies to document compliance with these requirements. 

Double Taxation Agreements

Under the new approach in TR 2018/5, it is more likely for companies to have domestic tax law residency in two countries therefore the relevant DTA should be considered to determine whether a tie-breaker exists. However, many DTAs rely on place of effective management as the tiebreaker, which is a similar concept to central management and control. In some cases, it may be worthwhile to consider any positions that identify differences between these two concepts.

Implications for Australian owned multinationals

TR 2018/5 reverses 14 years of accepting that the central management and control test will only make a foreign company a tax resident of Australia if the company actually physically carries on business in Australia, in favour of the approach that if central management and control is in Australia, that is an act of carrying on business in Australia. This change causes more problems for Australian owned multinationals, rather than foreign owned because they are far more likely to have some Australian directors or group policies that make it more likely that the Australian parent’s views for its foreign subsidiary will be followed. However, most Australian multi-national groups should be able to deal with these issues if they obtain appropriate advice of what they need to do to show the directors of their foreign subsidiaries were making the board decisions outside Australia.

BDO Comment

The ATO’s new guidance is a timely reminder for Australian taxpayers to carefully examine the management of their foreign operations. Given that Australian tax resident companies are taxable in Australia on their worldwide income, the consequences of not having adequate controls and protocols in place to ensure that the central management and control of a foreign company remains outside Australia can be severe. However, the impact of ATO’s new approach in relation to foreign operating subsidiaries of Australian groups, with business operations, activities and directors overseas can be alleviated under the foreign branch rules in the tax legislation, provided they obtain appropriate tax advice.

Foreign incorporated companies will need, at a minimum, to: 

  • Review their governance arrangements to confirm whether central management and control is (and continues to be) exercised outside Australia;
  • Ensure appropriate documentation and records are maintained of board meetings and key decisions made; and
  • Apply careful attention to the way that foreign subsidiaries boards are run, where there are potential decision making ‘influencers’ in Australia and when a majority of directors have not participated in decision making from the place of incorporation of a foreign company.

BDO anticipate that this will lead to additional costs and red tape for many Australian companies with offshore operations and aspirations. BDO can assist taxpayers with revisiting governance, systems and processes in relation to the management of foreign incorporated companies as a matter of urgency given the tight 13 December 2018 deadline. Taxpayers have less than two months to utilise the transitional compliance approach, to adjust directorial, management and documentation issues to reduce the risk of Australian resident status.