Since 2017 there has been considerable uncertainty around the tax residency of companies incorporated outside of Australia, but where Australian based directors control the management of the company.
Following the High Court decision in Bywater Investments Ltd v Federal Commissioner of Taxation, the ATO departed from the long-standing two-pronged test. The ATO adopted a view (applicable from 15 March 2017) that if a foreign company’s central management and control (CMC) was exercised in Australia, that foreign company would be deemed to carry on its business in Australia (irrespective of where its actual day-to-day operations were), and would therefore be considered an Australian tax resident. Essentially, the ATO view post the Bywater case equated the requirement of CMC with that of carrying on a business in Australia.
Historically the corporate tax residency test was interpreted as a two-pronged test – carrying on business in Australia, and central management and control in Australia. Both requirements needed to be present before a foreign incorporated company was treated as tax resident in Australia. This meant that where foreign incorporated companies carried on their business activities outside of Australia, they would not be viewed as Australian tax resident, even where CMC was in Australia.
As a result of the ATO’s revised interpretation, foreign incorporated companies, particularly those forming part of Australian out-bound groups, were forced to reconsider their tax residency and take additional (and in most instances, impractical) steps to ensure they remained foreign tax resident.
In August 2019 the Treasurer requested that the Board of Taxation conduct a review of the operation of Australia’s corporate tax residency rules. The Board of Taxation recently finalised its review and submitted its report to the Federal Government for consideration. The final report is yet to be published, however, the overall conclusion was that “…the rules determining the tax residency of a foreign incorporated company are in need of urgent reform”.
In response to the findings of the Board of Taxation, the Federal Government will make technical amendments to clarify the corporate residency test. A company incorporated offshore will be treated as Australian tax resident if it has a ‘significant economic connection to Australia’. This test will be satisfied where both the company’s core commercial activities are undertaken in Australia and its CMC is in Australia. Whilst the enabling legislation is yet to be released, it appears as though the intention is for the two-pronged test to return.
Favourably, while the amendments will only have effect from the first income year after the date of Royal Assent of the enabling legislation, taxpayers will have the option of applying the new law retrospectively from 15 March 2017 (the date the ATO withdrew its ruling dealing with the two-pronged test and replaced it with its post-Bywater interpretation).