William Buck Tax Services Director Sharon Grice answers some questions commonly asked by her clients regarding international tax matters in the time of COVID-19.
Corporate Tax Residency
Q: I am a director of a foreign incorporated company that is not an Australian tax resident. I cannot travel to attend board meetings due to the COVID-19 travel restrictions. Will this affect the entity’s corporate tax residency?
A: Ordinarily, if Central Management and Control (CM&C) was deemed to be in Australia, even if the company is not incorporated in Australia, it will be considered by the ATO to be an Australian resident for tax purposes. Practically, this means that you would need to travel to attend foreign board meetings to prevent bringing your company into the Australian tax net. This, however, becomes an issue due to the international travel bans and restrictions currently imposed to reduce the spread of COVID-19.
According to current ATO Guidance, corporate tax residency will not be affected if the only reason for holding board meetings in Australia or for foreign directors attending board meetings in Australia, is because of the impacts of COVID-19. This position is echoed in a guidance released by the OECD. If this has the potential to impact you, we recommend seeking specialist tax advice regarding your specific circumstances.
Q: I own a foreign resident company. Due to COVID-19, some of my employees have an unplanned lengthy presence in Australia. Does this create a permanent establishment in Australia (Inbound Employee)?
A: The presence of your foreign entity’s employees working in Australia may create a permanent establishment in Australia. This affects the application of non-resident withholding tax and the extent to which Australia can tax your profits earned in Australia.
However, the ATO have advised that it will not consider that there was a creation of an “inbound employee Permanent Establishment (PE)” if all the following requirements are met:
- Your foreign resident company did not have a PE in Australia before the effects of COVID-19
- There are no other changes in the company’s circumstances; and
- The unplanned presence of employees in Australia is the short-term result of them being temporarily relocated or restricted in their travel as a consequence of COVID-19.
Recommendation – contemporaneous documentation
There is a lack of clarification on the period to which current ATO guidance applies given the uncertainty surrounding COVID-19.
Adopting a conservative approach, we assume that the relevant period starts from when the international travel restrictions apply. However, given the uncertainty surrounding this guidance, we strongly recommend that all affected taxpayers keep contemporaneous file notes for having the temporary unplanned presence of employees in Australia.
It is also important to keep detailed file notes of how your company always satisfies all of the above requirements. If this has the potential to impact you, we recommend seeking specialist tax advice regarding your specific circumstances.
Q: I own an Australian resident company. Due to COVID-19, the company’s employees are working overseas. Does this create a permanent establishment overseas (Outbound employee)?
A: The presence of your Australian resident entity’s employees working in a foreign country may create a permanent establishment in that foreign country. This affects the application of non-resident withholding tax and the extent to which that foreign country can tax your profits earned overseas.
The ATO has not yet provided any guidance on treating “outbound employee PE” profits as non-assessable in Australia. However, the OECD has released guidance on the creation of a PE in a foreign country through an agent. The OECD states that it is unlikely that a PE will be established in the foreign country, provided it is a temporary and short-term occurrence. However, you should take note of the threshold requirements set out by the relevant overseas domestic and tax law. If this has the potential to impact you, we recommend seeking specialist tax advice regarding your specific circumstances.
Recommendation – contemporaneous documentation
The OECD also recommends that you maintain a record of the facts and circumstances of the bona fide presence in or outside of Australia or the foreign country if such evidence is requested by relevant tax authorities.
Thin capitalisation and safe harbour
Q: My business has previously relied on the safe harbour test to satisfy Australia’s thin capitalisation obligations. However, my business’ weakened balance sheet due to COVID-19 may mean that I am no longer able to rely on the safe harbour test. Are there any other options available?
A: The economic downturn caused by COVID-19 may have significantly impacted your balance sheet due to asset value impairments or short-term drawdowns on debt facilities. As a non-ADI taxpayer, this would potentially mean that you may not be able to rely on the safe harbour or worldwide gearing tests to determine your maximum allowable debt levels.
The ATO has recommended businesses in this situation explore the alternative measurement periods to test the suitability of the safe harbour test. For example, if you ordinarily use the opening/closing method, you may instead elect to use the frequent measurement method. If this situation has the potential to impact you, we recommend seeking specialist tax advice regarding your specific circumstances.
Simplified Arm’s Length Debt Test (ALDT)
If you have to rely on the arm’s length debt test (ALDT) for the relevant year, provided that you have met the requirements below, the ATO has stated that it will generally not review the application of the ALDT, other than to verify that the use of the test was primarily due to the balance sheet effects of COVID-19.
Simplified ALDT approach requirements:
- You would have satisfied the safe-harbour test but for the COVID-19 related balance sheet effects.
- It is expected that you will use best endeavours to apply all criteria of the ALDT.
- For entities that are classified as inward investing entities (and not also outward investing entities) – this compliance approach only applies to the extent that no additional related party funding is received, other than short-term (less than 12 months) debt facilities. Any new capital funding would generally be expected to be equity and not debt.
- The ATO would not expect inward investing entities to require the use of ALDT merely because dividends were paid, thereby weakening the Australian balance sheet.
Documentations to be kept
The ATO have advised that resources will still be allocated to verify that a taxpayer’s use of the ALDT is directly caused by COVID-19.
We therefore strongly recommend that you keep detailed records of your attempts at exploring all alternative valuation measurements and how you have met the above requirements.
If this COVID-19 balance sheet situation has the potential to impact you, we recommend seeking specialist tax advice regarding your specific circumstances.
Weakened balance sheet to persist
If your economic circumstances are expected to persist over the longer term and, as a result, you are likely to rely on the ALDT in the next income tax year, there are opportunities for you to discuss your circumstances with the ATO. We can work with you to liaise with the ATO if required.