Tax Insight: ATO Calls “Time” on Corporate Residence Concession

The ATO released today an update to its Practical Compliance Guideline on corporate residence. The update is not promising.

Background

The definition of “resident” in the Income Tax Assessment Act 1936 treats a foreign-incorporated company as a resident of Australia if it “carries on business in Australia, and has … its central management and control in Australia …” In a 2004 Ruling, the ATO had set out its view that the test comprised two elements. The first element focused on “[the] major operational activities relative to the whole of its business …” – a company would be regarded as carrying on business “wherever those activities take place and not necessarily where its CM&C is likely to be located.” This was good news for Australian groups with subsidiaries formed offshore if the operations of the subsidiaries were confined to foreign countries, as was often the case.

Unhappily, this position was upended in 2016 by the High Court decision in Bywater Investments, which the ATO viewed as deciding that a company is carrying on business where its central management is located (as well as the places where it has mines, factories, offices, warehouses and so on). Consequently, in 2018 the ATO issued a new Ruling which effectively conflated the two tests into one:

… if a company … has its central management and control in Australia, it will carry on business in Australia within the meaning of the central management and control test of residency. It is not necessary for the substantive trading or investment activities of the business that generate its profits to take place in Australia …

Aware of the implications of this new view, the ATO issued a Practical Compliance Guideline at the same time to try to smooth the transition to the new world. The PCG advised companies which had been relying on 2004 view that the ATO, “will not apply resources to review or seek to disturb a foreign-incorporated company’s status as a non-resident during the transitional period …” The transitional period was extended on several occasions as the ATO pondered its next steps.

The decision to allow the 2004 interpretation to survive for a time was no doubt informed by the fact that in 2019, the Treasurer commissioned the Board of Taxation to conduct a review of the operation of Australia’s corporate residence rules, and that report, which was delivered to the Government in July 2020, had recommended a test which was very reminiscent of the 2004 two element test:

… for a foreign incorporated company to be an Australian tax resident there needs to be a sufficient economic connection to Australia … [which means] the company's core commercial activities are being undertaken in Australia. Central management and control in Australia, by itself, will not be sufficient except in very limited circumstances …

In the 2020–21 Budget delivered in October 2020, the former Government announced that it would adopt the Board’s proposal:

The Government will amend the law to provide that a company that is incorporated offshore will be treated as an 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 central management and control is in Australia… This measure is consistent with the Board’s key recommendation in its 2020 report …

Unhappily, neither the former government nor the current government took any steps to implement this decision over the next 2 years.

The update

The ATO released an update to the 2018 PCG on 22 December 2002.

There is one piece of good news in the update. Prior to the release of the update, the transitional period was due to expire on 31 December 2022. The update announces, “the transitional period is extended until 30 June 2023.”

But the bad news is, it seems the ATO has finally lost patience with this inertia and has decided to take the nuclear option: “the transitional period will not be extended further beyond this date.”

In other words, the ATO is telling the Government it has 6 months in which to enact the 2020 decision (or do something else instead). After that date, the ATO will start administering its new view, and foreign companies with no commercial activities in Australia but with senior management decisions being made in Australia may nevertheless find themselves treated as residents. The risk of problems will most likely arise for Australian groups which form (or buy) offshore subsidiaries but want to have some senior decision-making made from Australia. There could also be problems for foreign groups which have offshore subsidiaries but for some reason have some decision-making made from Australia.

One can expect the Government will be lobbied long and hard by industry and the tax profession to fix this problem, preferably by 30 June 2023.