This represents a change in the position previously taken by the ATO outlined in TR 2005/15, which has been withdrawn. The ATO is giving taxpayers affected by this change until 30 June 2019 to tidy up their governance arrangements before it will employ resources on auditing the residency of these types of entities.
The ATO has issued a final ruling (TR 2018/5) and a Practical Compliance Guideline (PCG 2018/9) about the ‘central management and control’ test for determining the tax residence of a company. The ATO states that where a foreign incorporated company has central management and control in Australia this will be sufficient, in and of itself, for that company to be considered to be Australian tax resident. This is a change from the position previously taken by the ATO in the now withdrawn TR 2004/15,whereby a company that had its central management and control in Australia was considered a resident only if it also carried on business in Australia.
What are the rules about?
On Thursday 21 June 2018, the Commissioner issued a final ruling: TR 2018/5 and a draft Practical Compliance Guideline (PCG): PCG 2018/D3 about the central management and control (CMAC) test. TR 2018/5 takes the view that when a company has its CMAC in Australia it will also satisfy the ‘carrying on a business in Australia’ requirement. This is a change from the position previously held by the ATO in TR 2004/15 (now withdrawn) whereby this position was only taken in relation to companies without active businesses.
Although CMAC generally rests with a board of directors, the new ruling reiterates the ATO’s view that it is relevant to look at the people actually making the decisions even if they are not the directors. Therefore, a foreign incorporated company may be an Australian tax resident when decisions made by individuals in Australia are merely implemented or rubberstamped by directors in the foreign jurisdiction.
Case study: How the changes will operate
Trade Co is incorporated in Singapore, but its board of directors holds the majority of its meetings in Australia where decisions on the major contracts entered into by Trade Co, its finance, major policies and strategic directions are made. Trade Co undertakes all its trading activities in Singapore.
Under the old rules Trade Co would not be a resident of Australia as it was not considered to be carrying on a business in Australia (based on the view in TR 2004/15).
Under the new rules, Trade Co would be considered a tax resident of Australia as its CMAC is in Australia.
What practical guidance has been provided by the ATO?
The draft PCG was finalised as PCG 2018/9 on 5 December 2018. The PCG contains practical guidance and examples to assist foreign incorporated companies and their advisors in applying the principles set out in TR 2018/5. The PCG focuses on the following:
where a company’s central management and control is located identifying high-level decision making, situations where decisions are made in more than one place (i.e. board meetings are held remotely) and an ongoing compliance approach.
The ATO states in the PCG that as a general rule of thumb, board minutes are the starting point for identifying who exercises CMAC. However, the ATO also makes it clear that this is a general rule only and that there are circumstances in which the place [MN1] of board meetings will not be determinative. Examples include situations where a company has not kept board minutes, the company makes high-level decisions outside of board meetings, or the board minutes are false (including where they record the ‘rubberstamping’ of decisions made elsewhere).
Transitional compliance approach
Importantly, the finalised PCG provides for a transitional period in which the Commissioner will not apply resources to consider the residency status of certain affected companies, such as those who become resident because of the Commissioner’s change in view on the management and control test.
This gives taxpayers a window of opportunity to review and update the way in which companies are managed and controlled so that such companies are not treated as Australian residents by the Commissioner.
Ongoing compliance approach
In the PCG, the Commissioner also provides a series of conditions which, if met by the foreign incorporated company, will mean that the ATO will not employ resources to review the residency status of the company on an ongoing basis. However, it should be noted that this concessionary treatment is only available to public companies or their subsidiaries, specifically: (a) a controlled foreign company of an Australian public group, (b) a listed holding company of a foreign public group, or (c) a wholly owned subsidiary of a foreign public group that is resident in a listed country (the seven listed countries include:Canada, France, Germany, Japan, New Zealand, the UK and the US).
Who do the changes apply to?
The changes apply to foreign incorporated companies with Australian resident directors or Australian resident strategic decision makers. Foreign incorporated companies with non-resident directors/strategic decision makers who habitually exercise management and control in Australia could also be affected.
When do the changes apply from?
The transitional compliance period will end on 30 June 2019.
What are the changes trying to achieve?
Under the new approach the Commissioner will be taxing all companies with their management and control in Australia as Australian resident companies. In looking at where management and control is located, the Commissioner is using a substance over form approach – i.e. overseas directors that are merely implementing, or ‘rubberstamping’ decisions made by individuals in Australia won’t be considered to be undertaking management and control outside Australia.
How can you mitigate the risk of the foreign incorporated company in your group being considered an Australian resident?
The ATO has given certain affected taxpayers until 30 June 2019 to review their position and bring their governance arrangements into line with the amended ATO view.
Accordingly, it is critical that:
(a) taxpayers are aware that foreign incorporated companies in their corporate group can be Australian tax resident, and
(b) affected taxpayers have adequate governance arrangements in place to ensure that central management and control of the company is not located in Australia.
Where companies are not eligible for the transitional or ongoing relief provided by the Commissioner in PCG 2018/9, extreme care should be taken in changing their governance or business operations as this could cause unintended consequences.
Resident companies are taxed very differently from non-resident companies and as such any misunderstanding in respect of residency status will likely have fundamental and potentially negative Australian tax consequences.
What are the next steps?
If you have a foreign incorporated company in your group or are proposing to set up a foreign incorporated company, now is the time to consider its tax residency status. Please get in touch with your Pitcher Partners expert if you would like further support.