Corporate residency | Federal Budget 2020-21 Considerations
Tax Law - 07 Oct 2020
Whether you are establishing offshore operations, or you are already operating internationally, Australian tax residency of foreign subsidiaries is a critical tax consideration for any business owner. Getting it wrong can lead to a host of punitive outcomes, including:
- Bringing foreign companies into the Australian tax net, with corporate income tax at rates up to 30% and exposure to Capital Gains Tax (CGT);
- Giving rise to Permanent Establishment issues between Australia and the other jurisdictions with attendant compliance and administrative costs; and
- Potentially losing the benefit of a Double Tax Agreement between Australia and the other jurisdiction, giving rise to double taxation.
The longstanding approach of the Australian Taxation Office (ATO) (since at least 2004) was to apply a two-stage test, where a subsidiary would be an Australian resident if both these requirements were met:
1. The subsidiary carried on business in Australia; and
2. Central management and control (CMC) of the subsidiary was exercised in Australia.
This provided a level of comfort that trading subsidiaries should be seen to be carrying on a business in the other jurisdiction, not Australia, and therefore should not be an Australian tax resident.
Following comments by the High Court in the Bywater case, on 15 March 2017 the Commissioner of Taxation (Commissioner) issued what would become TR 2018/5 (TR). In the TR the Commissioner changed his opinion, stating that CMC was an integral part of carrying on a business, so that if CMC was exercised in Australia by implication the company was then carrying on business in Australia, and would be an Australian tax resident.
This caused great angst in the business community. The existing comfort for foreign trading entities was lost, and despite providing some guidance in the TR and associated publications there was no clear test for when CMC would be exercised in Australia.
Recognising this, the Government asked the Board of Taxation (Board) to review the application of the corporate tax residency test. The Board’s key recommendation was that the corporate tax residency legislation be clarified so that a foreign subsidiary should only be treated as an Australian tax resident where there is a sufficient economic connection to Australia, where both:
1. The subsidiary’s core commercial activities are undertaken in Australia; and
2. The subsidiary’s CMC is exercised in Australia.
The Government’s budget announcement implements the Board’s recommendation verbatim. If enacted, it should provide business owners the comfort over trading subsidiaries that existed prior to the Commissioner’s change in position. Finally, the announcement proposes that taxpayers will be able to apply the new definition of corporate residency with effect from 15 March 2017, effectively overriding the Commissioner’s treatment of CMC as the sole consideration of corporate residency.
Co-written by Ally Evans & Chelsea Fennell
The information contained in this blog is general in nature and should not be considered to be legal, tax, accounting, consulting or any other professional advice. In all cases, you should consult with a professional advisor familiar with your factual situation for advice concerning specific matters before making any decisions. By reading this blog, you confirm your understanding of this disclaimer.