In brief - ATO has issued its final ruling and a new draft practical compliance guideline
The Australian Taxation Office
(ATO) has finalised draft ruling TR 2017/D2
on central management and control of foreign companies by issuing TR 2018/5
which has effect from 15 March 2017. The ATO has also issued a new draft practical compliance guideline PCG 2018/D3
which contains some additional guidance and examples, and two limited safe harbours.
My previous article, Tax Residence Of Foreign Companies In Light Of Bywater
considers the implications of TR 2017/D2, and the final ruling generally replicates the draft ruling. Unfortunately, the final ruling retains the principle (which overturns the ATO's longstanding approach in TR 2004/15) that for a company to be considered a resident of Australia, it is not necessary for any of the actual trading or investment operations of the company to take place in Australia so long as its central management and control is in Australia.
A subtle change in the final ruling is that the relevant considerations to identify the location of central management and control have been divided into two categories:
1. Matters most likely to influence a court's decision:
- where those who exercise central management and control do so, rather than where they live
- where the governing body of the company meets
- where the company declares and pays dividends
- the nature of the business and whether it dictates where control and management decisions are made in practice
- minutes or other documents recording where high-level decisions are made
2. Other matters, of lesser weight, the courts have considered:
- where those who control and direct the company's operations live
- where the company's books are kept
- where its registered office is located
- where the company's register of shareholders is kept
- where the shareholders' meetings are held
- where its shareholders reside
PCG 2018/D3 outlines three-step process for determining location of a company's central management and control
The ATO has issued PCG 2018/D3 in response to comments made during the consultation phase. It contains a discussion of the relevant evidence to determine the location of central management and control (including when board minutes will be treated as conclusive evidence), identification of a company's high-level decision making as distinct from day-to-day management, identification of the real decision makers, and situations where central management and control may be exercised in more than one place.
The following principles can be extracted from PCG 2018/D3:
Determination of the location of a company's central management and control is a three-step process. The first step is to identify the high-level decisions of the company as distinct from day-to-day management decisions. This is a question of fact to be determined in light of the company's overall business activities. The more extensive a company's business activities, the more likely it is that high-level decisions will be different from day-to-day management decisions.
The next step is to identify the persons who make those decisions. This will normally be the directors of the company if they comply with the standards of directors imposed by law. This will not be the case where there are lapses in corporate governance or the role of the director is usurped by others.
The final step is to determine where those persons make the high-level decisions.
The directors will be regarded as the persons exercising central management and control if:
- high-level decisions are made by the directors at board meetings
- the decisions are evidenced by minutes
- the minutes are a true and detailed account of proceedings
- the directors do not habitually follow directions from others (including a shareholder or parent company) without considering the merits of those directions, and
- the directors do not give full and unfettered authority to another person to make high-level decisions
If the above conditions are satisfied and the minutes indicate the place that meetings are held, the directors will be taken to exercise central management and control where the meetings are held.
If the directors meet in more than one location or do not physically meet but make decisions by written resolution or by using technology, the position is more complicated and the outcome may be that central management and control is exercised in more than one location.
Transitional and ongoing compliance approaches for foreign-incorporated companies
PCG 2018/D3 contains two safe harbours - a transitional safe harbour and an ongoing safe harbour.
The transitional safe harbour applies from 15 March 2017 to 13 December 2018 (transitional period) if the company satisfies the following conditions:
- it relied on TR 2004/15 to determine that it was not a resident of Australia
- it has not undertaken or entered into any artificial or contrived arrangements or tax avoidance schemes
- it is an ordinary company that is not a foreign hybrid
- it would become a resident solely because its central management and control is located in Australia, and
- during the transitional period it:
- changes its governance arrangements so that its central management and control is exercised outside Australia by the end of the transitional period
- does not commence carrying on business in Australia (other than because its central management and control is exercised in Australia), and
- does not undertake or enter into any artificial or contrived arrangements or any tax avoidance schemes
The ongoing safe harbour is limited to foreign companies that:
- may be treated as residents merely because part of the company's central management and control is exercised in Australia, because directors regularly participate in board meetings from Australia using technology
- are subsidiaries of a public group and are controlled foreign companies, and
- are ordinary companies that are not foreign hybrids
The other conditions for the ongoing safe harbour are that:
- a substantial majority of the company's central management and control is exercised in a foreign jurisdiction where it is resident for tax purposes through board meetings that the majority of directors attend, and
- the company has not undertaken or entered into any artificial or contrived arrangements, tax avoidance schemes, arrangements to conceal ultimate beneficial or economic ownership or arrangements involving abuse of board processes
The transitional safe harbour is a welcome initiative and a reasonable response to the feedback received during the consultation phase, although the transitional period should be longer.
The ongoing safe harbour is unnecessarily restrictive, for example it only applies to public groups and requires the presence of a majority of board members at board meetings held overseas. There is also uncertainty about the meaning of the exercise of a "substantial majority" of a company's central management and control. If the ongoing safe harbour is retained in its current form, it may be of little practical benefit for foreign companies.
The central management and control test has its origins more than a century ago. The guidance provided by the ATO clearly demonstrates that there are difficulties in applying it to the common practice of virtual meetings. It may be time for the federal government to reconsider the application of the test to determine the residency of foreign companies.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2022.