Corporate Tax Residency in Australia

Following the decision in the Bywater case discussed in our September 2018 newsletter and the ATO’s subsequent release of Taxation Ruling TR 2018/5 and Practical Compliance Guideline PCG 2018/9, the Board of Taxation (the Board) is currently conducting a review of the operation of Australia’s corporate residency rules.  The Board will consider whether existing rules:

  • Minimise commercial uncertainty and ambiguity;
  • Are consistent and aligned with modern day corporate and board practices;
  • Protect the tax system against multinational profit shifting; and
  • Otherwise support Australia’s tax integrity rules as they apply to multinational corporations.

Under current Australian tax legislation, a residence based approach is used in determining tax liability.  Essentially, the assessable income of an Australian resident includes worldwide income, while foreign residents are subject to tax only on income derived from Australian sources.

Accordingly, corporate residency determines the scope of Australia’s taxing rights over the profits of corporate taxpayers.

Corporate tax residency also drives other tax outcomes such as the operation of double tax agreements, the application of the Controlled Foreign Company regime, and liability for withholding tax.

Under the existing rules, a “resident of Australia” includes a:

“company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.”

Under this definition, a company that is not incorporated in Australia can only be a resident of Australia if it carries on business in Australia, and also has either its central management and control located in Australia, or voting power is controlled by Australian residents.

The “central management and control” component of the definition has caused uncertainty over the years.  Following a previous Board review in 2003, the ATO expressed its view in Taxation Ruling TR 2004/15 (now withdrawn) that carrying on a business in Australia is a separate requirement to the central management and control test.  The ATO adhered to this view until the High Court decision in Bywater Investments Ltd & Ors v Federal Commissioner of Taxation [2016] HCA 45 (‘Bywater’) prompted reconsideration of this stance.

In Bywater, the High Court was required to determine whether a number of foreign companies were Australian resident.  The directors of each of the companies resided in foreign jurisdictions, and board meetings were also conducted in foreign jurisdictions.  Despite this, managerial control and beneficial ownership of each company was solely attributable to an individual who resided in Australia, and that the arrangements in question had been put in place to obscure the location where managerial control was being exercised.

While the majority in Bywater acknowledged that “Ordinarily … a company is resident where the meetings of its board are conducted”, this will not be the case where the board of directors “operates as a puppet” for the actual controller.  The Court found in Bywater that each company was an Australian resident, and held that “as a matter of long-established principle, the residence of a company is first and last a question of fact and degree to be answered according to where the central management and control of the company actually abides.  As a matter of long-established authority, that is to be determined, not by reference to the constituent documents of the company, but upon a scrutiny of the course of business and trading”.

In response to the decision in Bywater, the ATO withdrew TR 2004/15 and replaced it with TR 2018/5 Income Tax: central management and control test of residency, in which amongst other matters, it expressed a revised view of the central management and control test.  According to the view expressed in TR 2018/5, “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.”  In other words, the ATO view is that it is possible that the central management and control test can be satisfied by a foreign incorporated company that carries out its operational activities entirely outside Australia.

In its review of the corporate residency rules, the Board will examine a number of perceived limitations that have been identified with the central management and control test, with a view to evaluating whether there is sufficient justification to replace it with an alternative test.  Some of the limitations that have been brought to the Board’s attention are:

  • The compatibility of the central management and control test with certain features of modern corporate governance (eg with the use of modern communications technology),
  • The practicality of establishing the requisite degree of central management and control in Australia when it is being exercised in both Australia and another jurisdiction concurrently,
  • The uncertainty associated with the relevant time frame within which central management and control is required to be ascertained, and
  • The degree to which, in the context of an outbound corporate structure, the fiscal outcome remains effectively the same regardless of the outcome of the central management and control test. The intended functions of the central management and control test may have been effectively superseded by the subsequent introduction of rules like transfer pricing, capital gains tax, permanent establishment, and controlled foreign company rules.

The Board released a consultation paper and called for submissions by 4 October 2019, and are expected to report back to the government by 31 December 2019.

With regard to dual resident companies, it should be noted that Australia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, also known as the Multilateral Instrument (MLI) on 7 June 2017, which takes effect in Australia as follows:

  • For withholding taxes, on income derived on or after 1 January 2019;
  • For all other taxes, for income years starting on or after 1 July 2019;
  • For dispute resolution, generally on or after 1 January 2019.

The MLI will modify the operation of Australia’s tax treaties with some countries that have also signed.  In particular, the rules formerly included Article 4 – Residence, may be replaced by a requirement to apply to the competent authorities in the relevant countries to determine the residence of corporate entities.  Further details on the effect of the MLI on Australia’s tax treaties can be found on the ATO website, but currently both the Australia/New Zealand and Australia/UK treaties include the competent authority in determining the residence of dual resident companies.  Without competent authority agreement, such companies would be considered resident in both countries with no access to treaty benefits.

Needless to say, much care must be taken with regard to corporate tax residency.  If you have clients that may be carrying on business in Australia or have directors located here, you should contact Darren O’Malley of this office to discuss their circumstances.