Foreign subsidiaries could be Australian tax residents under new ATO ruling

Companies have until 30 June 2019 to review operations

Foreign incorporated companies could be classed as Australian tax residents under a new ATO ruling, unless they change their governance arrangements by 30 June 2019.

The ATO’s ruling overturns the established position on how to determine where a company’s central management and control is located. Australian-based groups with foreign subsidiaries and those investing through foreign incorporated companies should assess their corporate structures immediately if they want to continue as non- tax residents.

From a board’s eye view to a more holistic approach

Central management and control has traditionally been held to reside in a company’s board of directors. This meant that if the board met outside of Australia, the company was treated as non-resident for tax purposes.

That position changed in early 2017 when the ATO withdrew an earlier decision on the matter (TR 2004/15) and updated its view in a draft ruling (TR 2017/2D).

The ATO changed its position in light of the High Court of Australia decision in Bywater. In that case, the High Court ruled that central management and control didn’t necessarily reside in a company’s board if that board abrogated its decision-making authority to another party and merely rubber-stamped its decisions without considering whether they were in the company’s best interests.

Central management and control key to tax status

The ATO confirmed its draft ruling recently in TR 2018/5 Income Tax: central management and control test of residency.

Its new position is that central management and control is more closely linked to where decisions are really made, rather than where the board meets. In particular, it has ruled:

  1. If a company’s central management and control is located in Australia, it will be considered to be conducting business in Australia and will be an Australian tax resident.
  2. A company doesn’t have to trade or invest in Australia to be considered an Australian tax resident. By basing its central management and control in Australia, it will be held to be conducting business here.
  3. Determining where a company’s central management and control is located is a matter of assessing where high-level decisions are made. High-level decisions include determining the direction of the company, as well as its policies and the types of transaction it will enter. They don’t include overseeing the company’s day-to-day operations.

Factors relevant to central management and control

When determining where a company exercises its high-level decision-making capacity – and therefore where central management and control reside – the ATO says it will now consider:

  • Where the people exercising central management and control make their decisions;
  • Where the company’s governing body meets;
  • Where the company declares and pays dividends;
  • Whether the nature of the business dictates where control and management decisions are made; and
  • Where the minutes or other documents recording high-level decisions are made.

Carrying less weight, but also relevant is:

  • Where the people controlling and directing the company’s operations live;
  • The location of the company’s books, register of shareholders and registered office;
  • Where the company holds shareholder meetings; and
  • Where shareholders live.

The impact of the ATO’s revised position

There is now a materially higher risk that foreign incorporated subsidiaries will be classed as Australian tax residents. The adverse tax implications of this could include:

  • Double taxation. The foreign company may have to pay tax in Australia on its worldwide income while still retaining its tax residency in another jurisdiction.
  • Denial of deductions. If the foreign company and its income are brought into an Australian tax consolidated group, the ATO may deny certain deductions, including interest deductions.
  • Removal of concessions. The company may lose any entitlement to concessions for controllers of controlled foreign companies (CFCs). This could include exemptions from Australian tax on foreign dividends, as well as any reductions in capital gains or losses from the disposal of foreign shares.

Complying with the ATO’s approach

To help companies understand and comply with its new approach, the ATO has also released Practical Compliance Guideline PCG 2018/D3. This provides guidance on how companies can determine:

  • The location of their central management and control;
  • Where their high-level decision making happens;
  • Whether a person is a real decision maker or merely influential; and
  • What activities constitute central management and control and what is day-to-day management.

What do you need to do?

The ATO Guideline provides that companies who want to continue being treated as non-tax residents have until 30 June 2019 to change their governance arrangements so that central management and control is exercised outside of Australia. Companies must also meet a number of ATO conditions or they will be subject to the new ruling.

This means that if you have an interest in a foreign incorporated company, we strongly recommend that you:

  1. Review your structure and governance arrangements;
  2. Analyse where the central management and control of any foreign incorporated companies really lies; and
  3. Make certain that you properly document any board meetings and other records so that you can prove how and where key decisions are made.

If you’d like help to perform these reviews or if you have any questions on how the ATO’s ruling affects you please contact Rachel Pritchard rpritchard@cooperpartners.com.au  or Robyn Dyson rdyson@cooperpartners.com.au or call (08) 6311 6900.

 

This information is general advice only and neither purports, nor is intended to be advice on any particular matter.
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