Tax residence of foreign companies in light of Bywater

The Australian Taxation Office (ATO) has withdrawn its longstanding ruling TR 2004/15 dealing with the tax residence of foreign companies and issued a new draft ruling TR 2017/D2 following the High Court decision in Bywater Investments Limited & Ors v Commissioner of Taxation; Hua Wang Bank Berhad v Commissioner of Taxation [2016] HCA 45.

Section 6(1) of the Income Tax Assessment Act 1936 provides that a company is resident in Australia if it is incorporated in Australia or, if not incorporated in Australia, it 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. TR 2017/D2 sets out the ATO’s preliminary but considered view on the central management and control test of residency.

BYWATER INVESTMENTS CASE OVERVIEW

In Bywater, the High Court held that the central management and control of a foreign company is a question of fact and degree that depends on where central management and control of the company is actually situated. This is determined by considering the course of business and trading of the company and not by reference to its constituent documents. There is no general principle or presumption that the central management and control of a company is taken to be located where the directors reside or where meetings of the directors take place.

The taxpayers were four companies incorporated in foreign jurisdictions. While each of the taxpayers had a complex structure which was designed to disguise the true controllers and owners, the directors and shareholders of the taxpayers were residents of foreign jurisdictions associated with certain offshore professional and corporate services firms. The taxpayers were engaged in share trading activities on the Australian Securities Exchange. One of the taxpayers also engaged in a money lending business involving Vanda Gould, a Sydney accountant, his clients and their related entities. Each of the taxpayers made profits from these activities in the relevant years of income.

The primary judge found that all deliberative decisions of the taxpayers were made by Gould and the directors were not involved in the decision-making process. The directors merely acted at the direction of Gould or merely performed “back office” functions and the holding of directors meetings overseas and the ownership structure of each of the taxpayers was a facade to conceal Gould’s role in their activities. Therefore, the central management and control of the taxpayers was as a matter of fact in Sydney where Gould made the substantive decisions. The Full Federal Court agreed and so did the High Court.

NO PRESUMPTION THAT CENTRAL MANAGEMENT AND CONTROL IS EXERCISED WHERE BOARD MEETINGS ARE HELD

The High Court’s decision was in some respects unsurprising as once it determined that the matter was a question of fact and degree, the factual findings of the trial judge meant that the taxpayers could not succeed.

However, the real significance of the decision was the manner in which the Court confined the decision of Gibbs J in Esquire Nominees Limited v Federal Commissioner of Taxation (1973) 129 CLR 177, which many practitioners have considered to stand for the proposition that the central management and control of a company is to be found where the board of the company holds its meetings, even if the only thing done at those meetings is to record decisions actually made elsewhere by someone else.

The High Court held that Esquire Nominees was consistent with the principle that a company’s central management and control is a factual determination and nothing in that decision suggested that a company must be taken to be resident where its board of directors meets. The High Court distinguished that case on the basis that Gibbs J found as a fact that substantive decisions were made by the board and even though the directors complied with the advice of Australian accountants, they did so because they accepted that it was in the interest of the beneficiaries of which the company acted as trustee, and if they had been advised to do something improper they would not have acted in this way.

TR 2017/D2 closely follows the approach of the High Court and makes the following points:

identifying who exercises central management and control is a question of fact
it is not determined by identifying who has the legal power or authority to control and direct a company, the crucial question is who controls and directs a company’s operations in reality
there is no presumption that the directors exercise central management and control, although where a company is run in accordance with its constitution and the normal company law rules, its directors will control and direct its operations
a person who has legal power or authority to control and direct a company, but does not use it, does not exercise central management and control
a person without any legal power or authority to control or direct a company may exercise central management and control
a person who exercises the powers of a director, even though not formally appointed, or a person whose instructions or wishes the directors must or are accustomed to follow may exercise all or part of a company’s central management and control
an outsider who merely influences those with legal power to control and direct a company, even if they can and do exert strong influence, is not the relevant decision maker and does not exercise central management and control of the company
however, if an outsider is more than merely influential, and actually dictates or controls the decisions made by the directors, the outsider will exercise central management and control of the company

CENTRAL MANAGEMENT AND CONTROL TEST RELEVANT CONSIDERATIONS

Usefully, TR 2017/D2 set out the relevant considerations to identify where central management and control is exercised:

where the governing body of the company meets
where the company declares and pays dividends
where the shareholders’ meetings are held
where the register of shareholders is kept
where the company’s books are kept
where its registered office is located
where those who control and direct the company’s operations live
where the shareholders reside
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

None of these factors is determinative on its own and the relevance and weight to be given to each will depend on the facts and circumstances.

CARRYING ON BUSINESS IN AUSTRALIA IN THE CONTEXT OF THE NEW RULING

The other significant part of the judgement is the Court’s consideration of Malayan Shipping Co Ltd v Federal Commissioner of Taxation (1946) 71 CLR 156, which it acknowledged was not directly relevant to the matters before it. The High Court referred to the contention made on behalf of the taxpayer in the Malayan Shippingthat, although the central management and control of the company was located in Melbourne, upon a proper construction of section 6(1), a company should not be regarded as resident in Australia, notwithstanding that its central management and control was exercised from Australia, unless the company was also carrying on its business operations in Australia. The Court then remarked (at [57]), “Unsurprisingly, Williams J rejected that contention.”

Despite this comment being unnecessary for determination of the case, it appeared to cast doubt on the ATO’s position in TR 2004/15 that a company will not be a resident if it does not carry on business in Australia, notwithstanding that its central management and control is in Australia and that the decision in Malayan Shipping should be confined to its own facts.

As you would expect, the ATO has seized upon this and has determined that Bywater and Malayan Shippingstand for the following propositions:

if a company has its central management and control in Australia, and it carries on business, it will carry on business in Australia within the meaning of the central management and control test
it is not necessary for any part of the actual trading or investment operations from which its profits are made to take place in Australia since the central management and control of a business is factually part of carrying on that business
a company carrying on business does so both where its trading and investment activities take place, and where the central management and control of those activities occurs

The ATO’s position means that a foreign company whose trading or investment operations occur wholly outside of Australia will be a resident of Australia if its central management and control is in Australia.

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