Company Residency

Contents

  • Context 
  • The definition of a company tax resident
  • Central management and control
  • Complications presented by the central management and control test
  • Voting power controlled by resident shareholders
  • Dual Resident Companies
  • What happens if a foreign company is reclassified as a resident company?
  • Conclusion

Context 

The extent to which Australia imposes tax on a company (or any entity for that matter) is dependent on the residency of that company.  

For example, the basic rule regarding the assessable income is that a company which is an Australian tax resident will be taxed on all income (ordinary or statutory income) regardless of whether the source of the income is in Australia or outside of Australia.  

If a company is not an Australian tax resident, the basic rule is that a corporate entity will only be taxed on income (ordinary or statutory income) which is sourced in Australia.  

The residency status of the company will also have an impact on the application of capital gains tax. The CGT regime will only impose tax on CGT events happening to CGT assets where the CGT asset is classified as Taxable Australian Property as that is defined under Division 855 of the ITAA 1997 

The residency status of a company may also have a bearing on the rights available to that entity under the application of any tax treaty that Australia has entered into with another nation.  

The definition of a company tax resident  

The definition of a company resident and the effective criteria for determining whether a company is a resident of Australia for taxation purposes is set out in section 6(1) of the ITAA 1936 

Note that the definition of resident in respect of a company is different from the definition of resident that applies to individuals, or trusts or partnerships.  

The term resident for a company is defined as follows:  

“A company which 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.’  

You will see that there are two key avenues for a company to be classified as a resident that flow from this definition.  

  1. That the company is incorporated in Australia.  
  1. That the company carries on business in Australia and has central management and control in Australia or its voting power is controlled by resident shareholders.  

These tests will be addressed in turn under the below headings.  

The company is incorporated in Australia

The incorporation of a company in Australia refers to the process of a company coming into existence by being registered with the Australian Securities & Investments Commission.  

Keep in mind that it is possible for a business to exist prior to incorporation. For example, where a business operates through a sole trader, trust or partnership structure and is re structured to operate through a company. 

Also keep in mind that it is possible for an Australian originated business to have been incorporated in a foreign jurisdiction. 

Carries on a business in Australia

The term business is defined in the tax legislation as ‘any profession, trade, employment, vocation or calling, but does not include occupation as an employee’.  

There is no specific definition of carrying on a business. However, the prevailing view is that this involves the carrying on of trading or investment operations in Australia.  

The ATO in Taxation Ruling 2019/1 sets out the circumstances where it considers a company is carrying on a business.  

This includes by making an assessment of the following key factors: 

  • Whether the person intends to carry on a business  
  • The nature of the activities, particularly whether they have a profit making purpose. 
  • Whether the activities are repeated and regular and organised in a business like manner, including the keeping of books, records and the use of a system. 
  • The size and scale of a company’s activities including the amount of capital employed in them, and  
  • Whether the activity is better described as a hobby, or recreation.  

Interestingly, there is a view expressed in case law and by the ATO in Taxation Ruling 2018/5 that it is possible for a company to be carrying on a business where there is no direct trading or investment operation in Australia, but where the central management and control of the company is based in Australia. This is because the central management and control of the company is considered to be inherently inseparable from the operation of the business. The logic being that the exercise of management and control is a key activity of the business in and of itself. In this way, the central management and control test essentially makes the carrying on a business test obsolete.  

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Central management and control

The term central management and control is undefined in the tax legislation. However, the prevailing view is that it refers to the location at which high level decisions are made.  

High level decisions versus lower level decisions

High level decisions refer to decisions of gravity for the company. Taxation Ruling 2018/1 specifies examples which include:  

  • Setting investment and operational policy, including setting the policy on disposal of trading stock, and/or the use and development of capital assets and deciding to buy and sell significant assets of the company.  
  • Appointing company officers and agents and granting them power to carry on the company’s business (and the revocation of such appointments and power) 
  • Overseeing and controlling those appointed to carry out the day to day business of the company, and  
  • Matters of finance, including determining how profits are used and the declaration of dividends 

These high level decisions should be distinguished from lower level decisions concerning the day to day activities and operations of the company. The location of the exercise of lower level decision should not be taken into account in determining the location of the exercise of central management and control. Taxation Ruling 2018/1 provides a number of examples of lower level decisions:  

  • Keeping a company’s share register, including registering transfers of shares. 
  • Keeping and adopting a company’s accounts 
  • Where a company pays dividends, and  
  • The minimum acts necessary to maintain a company’s registration.  

The classification of a decision as a high level decision or lower level decisions will obviously vary according to the nature of the company’s specific activities and business.  

Determining who exercises central management and control

The determination of who is a decision maker that exercises central management and control is a matter of fact and substance. All the relevant facts and circumstances must be considered.  

Ordinarily, the power to make high level decisions rests with directors. Ordinarily, the power to make high level decisions does not rest with shareholders (notwithstanding that the shareholders have power to appoint directors).  

However, the central management and control will not rest with a director (or another person) with a mere status or title of authority where that position is awarded only as a formality without that person having any practical decision making ability. That is, the person must practically have the right to consider what decisions to make in the interests of company and then have the right to exercise power to make such decision. If a director (or another person with a title of authority) mechanically implements or rubberstamps company decisions that have already made, they are not a real decision maker who exercises central management and control.  

Where high level decision making is found to rest with a person without a formal decision making position within the company, that person will be a decision maker who exercises central management and control.  

In a similar way, a person who has genuine power to control and direct decision making but refrains from doing will not be considered a decision maker who exercises central management and control.   

A case in point was Bywater Investments Ltd. The case involved a number of taxpayer companies which were incorporated overseas. The companies collectively argued that they were not resident companies for taxation purposes on the basis that the central management and control test was not satisfied because decisions were formalised outside of Australia at board meetings. The court rejected that argument and held that central management control is determined by reference to where decision making actually occurs, not where decisions are formally made or rubber stamped to reflect decisions already made.  

The Bywater case established a couple of key indicators to use when considering whether directors exercise control.  

Firstly, whether the directors could and would refuse to follow advice or directions from outsiders that is improper or bad advice. If so, it is more likely than not that the directors are the real decision makers. If not, it is more likely that an outsider is exercising central management and control.  

Secondly, what is the director’s knowledge of the business? The greater the inside knowledge of the business, the more likely that they are exercising control.  

Note that a person may be considered to control and direct a company without actively intervening in the company’s affairs on an ongoing basis. This is provided they:  

  • Have appointed agents or managers whom they tacitly control to conduct the company’s day to day business.  
  • Tacitly control and regularly exercise oversight of the affairs of the company, including monitoring the company’s performance, and 
  • Do not need to actively intervene because the company’s affairs are running smoothly and in the manner they desire.  

A further question to answer is whether a person is merely influential over decision making as opposed to genuinely exercising central management and control. The ATO view in Taxation Ruling 2018/1 is that a person who merely influences decision (even if the influence is strong), will not be a relevant decision maker. The person must actually dictate and control decisions of the company.  

The location of central management and control being exercised

Keep in mind that the location at which the central management and control is exercised is the location at which the high level decisions are made by those making such decisions. Put another way, it the place where decisions are made that is determinative of the location of central management and control. It is not the residency of the person making the decision or the place where that person lives.  

For example, assume the directors of a company (who have power to exercise control) travel to a particular country in order to formulate, contemplate and execute high level decisions on behalf of the company. In this case, the relevant central management and control takes place in that country. However, if the directors of that company instead formulate, contemplate and decide on high level decisions from a local workplace or from home, that location will be the relevant place in which central management and control is taking place. Any meeting overseas to merely formalise a decision already considered and made will not cause that location to be where central management and control is exercised.  

It is possible that control and direction may be undertaken in multiple places. In this case, central management and control may be divided between several places. However, control will only be viewed as exercised in a location if the control is exercised to a substantial degree that makes it sufficient to conclude that the company is really carrying on business at that location.   

The factors that may be taken into account to determine the location of the exercise of central management and control include.  

  • 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.  
  • 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 shareholder’s meetings are held.  
  • Where its shareholders reside.  

Note that the nature of a company’s business activities may dictate where high level decision making must occur as a practical matter. Refer to the case of North Australian Pastoral and Waterloo Pastoral. 

Keep in mind that the ATO is cautious about contrived circumstances intended to affect the location of central management and control. A previous Practical Compliance Guidance (no longer in force as at 1 July 2023), sheds light on the ATO approach when it comes to anti avoidance type behaviours.  

Risky anti avoidance type behaviours include:  

  • where there is an arrangement whereby decision makers travel to an overseas location (particularly one in which the company does not have a business operations) in order to make high level decisions to avoid central management and control being located in Australia.  
  • where a majority of the high level decision makers spend a majority of their time in Australia but make decisions overseas.  

Remember that the anti avoidance rules enable the cancellation of tax benefits achieved under a scheme and the imposition of further penalties.  

Complications presented by the central management and control test

There are many complications presented by the corporate residency rule, at least partly due to how subjective the rule is. These present challenges for businesses in determining residency status. Common examples of complications include:  

  • What is the borderline between influencing decisions (which falls short of the exercise of central management and control) and the exercise of control? 
  • What is the borderline between a high level and low level decision?  
  • What happens where a few high level decisions are made in Australia but the majority are made elsewhere?  
  • At what point in time does decision making occur (e.g. at the time the thought of a decision is first communicated, or when the decision is first agreed to, or where the decision is finalised formally)? Theoretically, certain aspects of the decision making process could occur in different locations. Note that the ATO considers that decision making occurs at the time when a person (or group of persons) actively consider and decided to do, or not do something.  

Voting power controlled by resident shareholders

The company should assess the residency of shareholders and determine whether more than 50% of total voting power is held by resident shareholders.  

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Dual Resident Companies  

A prescribed dual resident is essentially a company that is a tax resident of Australia and another country.  

A prescribed dual resident can lose out on certain tax advantages available to ordinary resident companies. For example: 

  • a prescribed dual resident is not entitled to certain forms of CGT roll over relief on the transfer of certain assets.   
  • a prescribed dual resident is treated as a non resident under the thin capitalisation rules and under the anti avoidance provisions.  
  • a prescribed dual resident may be prevented from joining a tax consolidated group with its parent company.  

A prescribed dual resident is defined in section 6(1) of the ITAA 1936 as a company that satisfies either of the following conditions:  

First condition: 

  • The company is a resident of Australia within the meaning of subsection 6(1); and  
  • There is an agreement (within the meaning of the International Tax Agreements Act 1953) in force in respect of a foreign country; and  
  • The agreement contains a provision that is expressed to apply where, apart from the provision, the company would, for the purpose of the agreement, be both a resident of Australia and a resident of the foreign country; and  
  • That provision has the effect that the company is, for the purposes of the agreement, a resident solely of the foreign country.  

Essentially, this means that a company is treated (pursuant to a tax treaty) as a resident solely in a foreign country (not Australia).  

Alternative condition:  

  • The company is a resident of Australia within the meaning of subsection 6(1) for no other reason than it carries on business in Australia and has its central management and control in Australia; and  
  • The company is also a resident of another country; and  
  • The company has its central management and control is in another country.  

Essentially, this applies where a company is a resident of Australia but where there is a division in central management and control between Australian and another country.  

What happens if a foreign company is reclassified as a resident company?

If circumstances change, a non resident company can become a resident company for taxation purposes. For example, where central management and control of the business shifts to Australia, or where a majority of the company shares are purchased by Australian resident shareholders. 

There are a number of tax implications for a foreign company that becomes a resident company. For example:   

  • The rules for the assessment of income of an Australian resident will apply. That is, all ordinary and statutory income will be assessable to the company, regardless of the source of that income. As a result, foreign sourced income derived by the company will be assessable.  
  • The CGT rules may apply to capture capital gains on CGT assets which are not Taxable Australian Property.  
  • The company may not be entitled to receive protection from double taxation outcomes. Such protection is usually otherwise available under a relevant double tax agreement.  
  • The participation exemptions in Subdivision 768-A and 768-G of the ITAA 1997 may not be available in relation to share disposals and distributions.  

Conclusion

You can see that the company residency test casts a wide net. For example, the residency test makes it is possible for a foreign incorporated company with no physical operation or investment in Australia to be classified as a resident, even where the day to day decision making occurs outside of Australia.  

It is worth noting that the federal government in the 2020-21 budget announced the intention to amend the corporate residency test. The central focus of the new test was on assessment of the level of economic connection with Australia. However, at present there is no indication whether the proposed amendments will proceed.  

The company is required to keep records to that might relate to the assessment of whether it is a resident or non resident for taxation purposes. For example:  

  • Recording the location of a person as they undertake decision making.  
  • Recording the content of decisions made.  
  • Analysing the extent of operations and investments in Australia.  
  • Confirming the residency status of shareholders and assessing when this changes.  

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.