New ATO draft ruling on company tax residence
Last November, the High Court’s decisions in Bywater Investments and Hua Wang Bank (Bywater) confirmed that a number of companies incorporated overseas were nevertheless Australian resident for tax because they “carried on business” and had their “central management and control” (CM&C) in Australia. The facts were extreme: the primary judge found that the companies were controlled by an accountant in Australia and that their apparent control by offshore directors was a “crooked pantomime”, “fake” or even a “sham”.
Following that decision, the ATO has now withdrawn its 13-year old ruling on CM&C (TR 2004/15) and released new draft ruling TR 2017/D2 (Draft Ruling), which has clearly been written with such extreme fact patterns in mind.
The obvious substantive change is that the ATO now considers that CM&C is always part of a company’s business, so if CM&C is in Australia then the company will be resident here. Previously the ATO’s position was that, depending on the business, these could be two separate things, so CM&C could be in Australia without the company carrying on business here or causing it to be a resident. The Draft Ruling says that Bywater requires this change of position, although there are some doubts about this.
The ATO still accepts that normally a company’s directors exercise CM&C, provided there is proper governance. However, the old ruling effectively accepted as a compliance matter a presumption that CM&C is exercised by a company’s directors and hence located where board meetings occur, unless that would produce an artificial or contrived outcome. The ATO will no longer accept that presumption.
The most common issue is likely to be just how much influence an Australian parent can have over an overseas subsidiary before the subsidiary becomes a resident, and limited guidance on this can be taken from Bywater given the extreme facts.
At one point the Draft Ruling says that “a person whose instructions or wishes [the directors] must or are accustomed to follow may exercise [CM&C]”, which is getting at shadow directors but also appears worrying in a parent/subsidiary context. But this is contradicted in the following paragraph which says that the person must be “more than merely influential, and actually dictates or controls the decisions made by the directors…”.
In Bywater the taxpayers argued that treating the companies as resident would turn on its head 40 years of commercial practice (since Esquire Nominees) that the directors of overseas subsidiaries of Australian companies can act as instructed by their parents without the fear of CM&C thereby being located in Australia.
Thankfully, on balance the approach in the Draft Ruling is that the issue is not the degree of influence of the parent, but whether there is proper governance by directors – i.e. as a matter of fact, do they have the power to make the key decisions, take their duties seriously, perform them according to law and act in the best interests of the company? Are they doing more than mere “rubber stamping” and would they “refuse to follow advice or directions of outsiders that are improper or inadvisable”? Having directors with both (i) the requisite skills to perform their duties, and (ii) sufficient knowledge of the business to make informed decisions, will also be important in evidencing that they are the real decision makers.
Much of this is consistent with the old ruling, although now made more explicit. It is also consistent with the substance over legal form theme in the current international tax context generally, as evident in BEPS, the DPT and the MAAL. The Draft Ruling is certainly a reminder of the need for directors to be appropriately qualified, properly briefed/informed, meet regularly, and for board minutes to record not just what decisions were made but why the directors made them.
What needs to be discussed in the Draft Ruling though is in what circumstances the ATO may think proper governance by directors is not the end of the matter – i.e. not just the extreme or artificial fact patterns such as in Bywater where there was clearly not proper governance overseas. Hopefully the final ruling will include examples covering these and other fact patterns – currently the Draft Ruling has none.