New corporate tax residency test from the 2020-21 Budget – déjà vu for experienced players

By Harrison Dell, Senior Associate

The 2020-21 budget included a change to the corporate tax residency test. While it does provide some much-needed simplification in this area, it is not the panacea which offshore companies may have been hoping for following the High Court decision in Bywater Investments v Federal Commissioner of Taxation [2016] HCA 45 (Bywater).

 

Corporate tax residency pre-Bywater

Pursuant to the definition of ‘resident’ in section 6(1) of the Income Tax Assessment Act 1936, a company will be a resident of Australia if:

[it] is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.

Before the Bywater case, the bolded section above was interpreted as a two-pronged test requiring a company to:

  1. have its central management and control (CMC) in Australia; AND
  2. carry on a business in Australia.

 

Both aspects were seen as separate and distinct requirements. This was confirmed by the ATO in its Taxation Ruling TR 2004/15, which has now been withdrawn.

Accordingly, if a foreign company had only its CMC in Australia but did not carry on a business in Australia, it would not be an Australian tax resident. However, it may still be taken to be a ‘controlled foreign company’ and its income attributed to the Australian resident owners.

Conversely, if a foreign company carried on a business in Australia, but did not have its CMC in Australia, the company would not be an Australian tax resident in that case either, although in that case, the foreign company may be taken to have a permanent establishment in Australia depending on the company’s specific activities and any double tax agreements.

 

The Bywayer case

In the Bywater case, the High Court determined that certain the offshore companies controlled by Mr. Vanda Gould (an Australian resident) were Australian tax residents and therefore taxable on their worldwide income. Mr Gould’s general argument that the companies were not Australian tax residents because they did not carry on a business in Australia was unsuccessful.

The High Court found that Mr. Gould’s companies had their CMC in Australia. According to the High Court’s decision, a company carried on business wherever its CMC was located, so the location of the CMC in Australia alone was enough to render Mr. Gould’s companies as Australian residents.   Practically speaking, the High Court’s decision amalgamated the two prongs of the corporate residency test with a single test of CMC.

The reasoning in the High Court’s decision in Bywater was surprising and had overturned the widely accepted interpretation of the company residency test. The decision in effect took a broad interpretation of the test for company residency, thereby making it far more likely that foreign companies with an Australian connection could be deemed to be Australian residents.

Since Bywater, the ATO issued Taxation Ruling TR 2018/5 and Practical Companion Guide PCG 2018/9 to assist corporate groups comply with the new interpretation. The guidelines are now followed by ATO officers when reviewing company residency under a review or audit.

 

The way forward – a new test

To undo the impact of the Bywater case, the Federal Government announced a new corporate residency test in its 2020-2021 Budget. Under this new test, a foreign company will be an Australian resident if it has a ‘significant economic connection to Australia’. This requirement will be satisfied if both:

  • The company’s core commercial activities are in Australia; and
  • the company’s central management and control is in Australia.

While the announcement does not explain when a company’s ‘core commercial activities will be in Australia’ (and this will not be known until further guidance or legislation is released), it is apparent that the new test will operate as two-pronged test just as the former residency test did pre-Bywater.

 

Retrospective application

This change to the company residency test is retrospective to 15 March 2017, being the date when the Bywater decision was handed down. Clients have a choice whether to apply the previous residency test as it was in Bywater, or this newly announced test from 15 March 2017.

Accordingly, companies which have been reviewed or audited in accordance with Taxation Ruling TR 2018/5 may now be in a position to argue that they are non-residents. Any affected companies should review their affairs and consider taking remedial action once the new law is passed. Of course, Velocity Legal can assist with this.

In the meantime, we are looking forward to the changes being legislated and gaining some clarity on the new concept of ‘core commercial activities’ in the test for corporate residency.

 

Insight Authors…

HARRISON DELL

Senior Associate

A background as an ATO auditor, a decade in the family cinema business and a bachelor of psychology make Harrison an incredible problem solver. His unique insights give practical solutions for all tax and duty matters with a special interest in trusts, business succession planning, international tax and corporate tax issues. Harrison can do more than just heavy lifting with ATO dealings, he’s also an amateur powerlifter.

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