Australian tax residency for foreign incorporated companies

The Australian Tax Office (ATO) has recently published a new tax ruling and practical guidance on company residency for Australian tax purposes. Although the practical guidance hasn’t been finalised, what is clear is that it is now potentially easier than ever before for a foreign incorporated company to become an Australian resident for tax purposes.

Background

In broad terms, a company is treated as an Australian resident company for tax purposes if:

a) It is incorporated in Australia; or

b) It is incorporated overseas but it carries on business in Australia, and either:

i) Australian tax residents control the company’s voting power; or

ii) Its “central management and control” is in Australia.

The new tax ruling and practical guidance focus on the concept of “central management and control.”

The ATO’s former ruling on this matter, issued in 2004, said that a company’s central management and control would not be in Australia if, broadly speaking, substantially all the meetings of the company’s board were held in a foreign location.

New Position

The new ATO guidance requires a far more detailed analysis of the facts when establishing the location of central management and control, essentially adopting a “substance over form” approach.

A foreign incorporated company that carries on virtually any kind of business anywhere in the world, can now be an Australian resident for tax purposes even if every single director’s meeting is held overseas.

Furthermore, the ATO also asserts that the “central management and control” of a company forms part of the company’s business – thus killing two “residency test” birds with one stone.

This means companies no longer need to be carrying on an Australian business under “normal concepts” to be treated as Australian tax residents.

Three of the ways that a foreign company’s central management and control can be in Australia under the new guidance are:

1. The company’s core policies and strategic decisions are made in Australia; so, it may be enough to locate central management and control in Australia, even if the policies or decisions are not formally adopted until ratified by an overseas directors’ meeting.
2. The role of the company’s overseas directors; if overseas directors do nothing more than mechanically accept recommendations made to them, the central management and control will be located where the real decision maker is located.
3. High-level decisions about the company’s business are made in Australia; if the sole shareholder and director(s) of a foreign company are in Australia at the time of making a fundamental decision regarding the company’s business operations, central management and control may be in Australia – even if there is no other connection to Australia.

This list is far from exhaustive, but shows how fundamentally the ATO is refocussing its ability to tax foreign operations that are essentially managed/controlled from Australia.

Any of these scenarios may result in a foreign incorporated company becoming an Australian resident company for tax purposes, and there are many more possibilities that arise from the ATO’s new guidance.

The consequences

If a foreign incorporated company becomes an Australian tax resident, it may mean:

• All of the foreign company’s income is exposed to Australian taxation;
• All of the foreign company’s capital gains are exposed to Australian taxation;
• Certain types of tax losses arising in foreign jurisdictions may be unavailable in Australia;
• The foreign company might be forced to join an Australian tax consolidated group, with potentially detrimental outcomes, including cancellation of tax losses;
• Australian taxes paid by the foreign incorporated company may create franking credits that do not have any value to its shareholders.

These are just some of the consequences that may arise.

Transitional compliance approach

The ATO recognises that the new guidance will have consequences for many existing arrangements. Accordingly, a “transitional compliance approach” is available, so that existing arrangements can be altered to maintain the non-resident status of foreign incorporated companies.

The transitional period for making these alterations is between 15 March 2017 and 13 December 2018.

As you would expect, the transitional compliance approach has conditions attached, not least being that the foreign incorporated company must not be part of a tax avoidance scheme.

Next steps

Clients that utilise foreign incorporated companies in their structures should immediately:

1. Review existing corporate governance and decision-making processes and arrangements, particularly where the foreign company structure was established before March 2017.
2. Consider what changes may be required to existing processes to ensure that foreign incorporated companies do not become Australian residents.
3. Ensure that the requirements of the transitional compliance approach can be met.
4. Examine the company’s approach to documenting key decisions, including minutes of directors’ meetings, circulating resolutions, management reports, and the like.

If there is no way that adequate changes can be made which preserve the existing non-resident tax status for foreign incorporated companies, consider whether the entity should be restructured, or otherwise dealt with, to manage the Australian tax outcomes.

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