Important Changes To Residency Rules For Foreign Incorporated Companies

07.04.17

Following a recent high court decision, the Australian Tax Office (ATO) has made changes to the rules around the residency test for foreign incorporated companies.

The changes may affect Australian company groups with transactions and business interests overseas whose foreign incorporated companies are now deemed as Australian tax residents under the broader definition, therefore drawing them into the Australian tax net.

Australian tax residents are assessable on their worldwide income, meaning the changes could have significant tax consequences for impacted businesses.

WHO IS CONSIDERED A TAX RESIDENT OF AUSTRALIA? 

Under general Australian tax law, a company will be a ‘resident of Australia for tax purposes’ if:

• it is incorporated in Australia; or
• it is not incorporated in Australia, but it carries on business in Australia, and either:
• its central management and control is in Australia; or
• its voting power is controlled by shareholders who are Australian tax residents.

Previously the Commissioner’s view was that a company not incorporated in Australia would be deemed a resident if two separate requirements are met. The first is that the company is carrying on business in Australia and the second is that the company's central management and control (“CMandC”) is located in Australia.

In simple terms, depending on the business, the ATO’s previous view was these two requirements could be treated separately; CM&C could be in Australia without the company being seen as carrying on business in Australia. However, this approach has now been turned on its head in the draft ruling TR 2017/D2.

WHAT HAS CHANGED?

Under the new approach in TR 2017/D2, the ATO will not accept that the CM&C of a foreign incorporated company can be in Australia without the company being a tax resident. 

Essentially, CM&C is deemed to be part of a company’s business and as such if CM&C is in Australian then the company will be a resident here, even if trading activities are outside Australia.

Other key aspects of TR2017/D2 include:

• Central management and control is the control and direction of a company's operations. The ATO has made clear the key element is the making of high-level decisions that set the company's general policies. The ATO’s view is that managing the company's day-to-day activities and operations is not an act of central management and control.

• “Decision making” does not include mere implementation of, or rubberstamping of decisions made by others. It involves active consideration and making decisions based on the best interests of the company. This will certainly affect how business decisions are made and the role of the directors in this regard.

• Substance over form is critical. Identification of who actually exercise CM&C is a question of fact and is based on who actually controls and directs in reality.

• Relevance of formal documentation in respect of decision making and central management and control. Decision making is only considered relevant if documentation supports reality.

The above highlights the ATO’s toughened stance on the tax residency of foreign incorporated companies and is specifically relevant to Australian based companies with outbound operations.

It is critical these corporate groups review how their foreign incorporated companies are being managed and decisions are being made in light of this new definition of central management and control.

If you have any questions in relation to the above changes, or international tax issues in general, please contact us or speak to your ESV engagement partner on +61 2 9283 1666.