At a glance
A foreign incorporated company will be a tax resident of Australia where:
- It carries on business in Australia; and
- Has either its central management and control (“CM&C”) in Australia, or its voting power is controlled by shareholders who are residents in Australia.
Following the case Bywater Investments Ltd v Commissioner of Taxation (2016), the ATO revised its guidance by issuing Taxation Ruling TR 2018/5 and Practical Compliance Guideline PCG 2018/9.
TR 2018/5 states that, for a foreign incorporated company to be a tax resident of Australia under the CM&C test, it must carry on business in Australia.
The ATO argues that if a company carries on business anywhere and has its CM&C in Australia, it will be deemed to carry on business in Australia regardless of where the physical trading activities occur, as the CM&C is part of its overall business. This contrasts to the previously accepted view that active businesses were carried out at the physical location where its trading activities were carried out, while passive businesses were carried out at the place of CM&C.
This has the effect that, in the ATO’s view, a foreign incorporated company may be an Australian tax resident regardless of where the physical operations are undertaken and where day to day management decisions are made. This effectively makes the first limb of the tax resident definition redundant. It should be noted that the interaction with any applicable Double Tax Agreements and Multilateral Instruments should still be considered in any analysis.
The impact
We expect the impact of the new rules may include the following:
- Foreign incorporated companies may be required to join the Australian tax consolidated group where relevant. This will require an entry Allocable Cost Amount (“ACA”) calculation and may give rise to assessable capital gains in certain circumstances.
- The subsequent disposal or dilution of ownership will trigger an exit from the tax consolidated group, requiring an exit ACA calculation.
- Potential taxing of dividends received from Australian resident foreign incorporated companies, if that company is not a member of the Australian tax consolidated group, whereas these dividends were historically non-assessable.
- Capital gains exemptions may no longer apply.
- The foreign incorporated entities will need to determine what profits relate to foreign permanent establishments versus Australian operations.
Previously proposed changes
The 2020-21 Federal Budget handed down in October 2020 saw the Morrison Government announce the corporate tax residency rules would be clarified so a foreign incorporated company would only be considered an Australian tax resident if there is significant economic connection with Australia, being where:
- The company’s core commercial activities are undertaken in Australia; and
- Its CM&C is in Australia.
The proposed changes would more closely align with the generally accepted position prior to the Bywater case and the release of the ATO’s updated guidance.
Unfortunately, these proposed changes have not yet been enacted, partly due to the change of Government in May 2022. It is uncertain as to the Albanese Government’s position regarding this issue.
2023-24 Federal Budget
Included on our wish list for this year’s Federal Budget –due to be handed down on 9 May 2023 – is an announcement to proceed with the clarifications to the law as previously announced.
This would provide more certainty to Australian groups with offshore operations, while avoiding potentially adverse unintended consequences.
What can outward investing businesses do?
It’s critical that outward investing businesses are aware of their own governance arrangements and how their group is affected by the ATO guidance and the impending end of the transitional arrangements which, in the absence of an announcement in the Federal Budget, are anticipated to end on 30 June 2023.
Further, substantiation of positions taken and the process of getting to that position is as important as ever – maybe even more so now. Therefore, it’s critical that taxpayers, with the assistance of their tax service providers, do this in a diligent manner.
How we can help
Should you wish to discuss the nuance of a particular issue or any of the above, please contact your Grant Thornton adviser.
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