Residency test for companies – central management and control

Australian business groups with overseas operations are reminded to take care following the outcome of the High Court decision in Bywater Investments Limited & Ors. v Commissioner of Taxation; Hua Wang Bank Berhad [2016] HCA 45, and the recent release of Draft Tax Ruling TR 2017/D2 by the Australian Taxation Office (ATO).

The draft ruling sets out the Commissioner of Taxation’s view on the application of the central management and control test for companies following the landmark High Court decision.

The definition of ‘resident’ in section 6(1)(b) of the Income Tax Assessment Act 1997 (Cth) states that a company is a resident of Australia if it is incorporated in Australia, or, 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.

In the Bywater Investments case, the High Court held that while the company’s officers resided outside of Australia, they did no more than ‘rubber-stamp’ the decisions made by an Australian resident – rendering the company an Australian resident for tax purposes. The decision confirmed that the residency test should be undertaken by considering the actual central management and control of the taxpayer.

The case is discussed in detail in Talking Tax Issue 59.

The draft ruling states that four matters are relevant in considering the central management and control test:

  • whether the company carries on business in Australia
  • the meaning of ‘central management and control’
  • who exercises central management and control and
  • where the central management and control is exercised.

Carrying on business in Australia

The draft ruling states that it is not a requirement of carrying on a business in Australia that any of the trading or investment profit-making operations take place in Australia. Rather, carrying on a business in Australia merely requires that the central management and control are in Australia because that is factually part of carrying on the business.

Meaning of central management and control

The ruling states that the key element in central management and control is ‘the making of high-level decisions that set the company’s general policies, and determine the direction of its operations and the type of transactions it will enter’. This is distinguished from the day-to-day conduct of the company’s operations, or the mere ability of a majority shareholder (or person with such power) to appoint those who control the company.

Who exercises central management and control?

The identity of the person who exercises central management and control is not determined by who has the legal power, but rather who directs a company’s operations in reality. Mere legal power or authority to manage a company is neither sufficient, nor necessary, for a finding that a person is exerting central management and control. Regardless of formal appointment, a person who is more than merely influential and in reality dictates or controls the decisions made by the directors will exercise central management and control.

As highlighted by the Court in Bywater Investments, this is dependent on whether the person actually considers a decision, or makes a decision because they are instructed it is in the best interests of the company. The willingness of the directors to refuse to follow advice, and their level of knowledge about the business, are relevant to whether they are, in reality, considering a decision. While formal documentation is also relevant, it will be disregarded (as was the case in Bywater Investments) where contrary evidence proves how control was actually exercised.

Location that central management and control is exercised

The draft ruling states that a company is controlled and directed where the decision making occurs as a matter of fact and substance, rather than where the decisions are recorded or formalised. The Court in Bywater Investments considered a range of factors in its determination including: the location of meetings; where dividends are declared and paid, where the company register and books are located, where the registered office is located, the residence of those controlling and directing operations; the residence of the shareholders; and where formal documents are made.

Although it may transpire infrequently, the ATO has also recognised that central management and control may occur in two locations where a substantial part of the control and direction occurs in each place.

Submissions on the draft ruling are due by 12 May 2017.

Superannuation law companion guidelines

The ATO has released the final versions of Law Companion Guideline LCG 2016/9 regarding the implementation of the transfer balance cap from 1 July 2017. The draft companion guideline is discussed in detail in Talking Tax Issue 60.

The guideline discusses the following changes to the superannuation laws:

  • the concessional contributions cap of $25,000 for all taxpayers (reduced from the previous amount of $30,000 for all taxpayers under 49 years and $35,000 for taxpayers 49 years and older) and
  • the introduction of the transfer balance cap of $1.6 million for amounts transferred into the tax-free retirement phase account.

The ATO has also provided an update on its website in respect of both the concessional contributions cap and the transfer balance cap.

Practitioners are reminded to make use of the material that is made available by the ATO, as these changes are novel, and can be somewhat difficult to navigate.

Proposed changes to penalties for small businesses and individuals

The ATO have released a Community Findings Report in response to feedback from the ‘Proposed changes to penalties for small businesses and individuals’ consultation paper (Consultation Paper) released in September 2016.

The Consultation Paper addressed the way in which the ATO would penalise small businesses and individuals in relation to the lodgement of their tax returns. The Consultation Paper is discussed in detail in Talking Tax Issue 50.

The Findings Report reveals that the majority of respondents supported the ‘one chance’ approach for small businesses and individuals. The ‘one chance’ would operate so that no penalty would be imposed for the first error and late lodgement where there had been:

  • a failure to take reasonable care for errors in income tax returns and activity statements and
  • a failure to lodge income tax returns and activity statements on time.

If introduced, it is hoped that the changes will give the ATO a degree of flexibility when dealing with small businesses and individuals. However, there remains a concern by some that overzealous ATO auditors may seek to sidestep the ‘one chance policy’ by pursuing taxpayers for harsher penalties where they may otherwise not have.

Tax news

New ATO triage service

In an address to the Tax Institute National Convention, Commissioner of Taxation Chris Jordan (Commissioner) has announced the implementation of a new Fast Intensive Triage Service (FITS) in the dispute resolution area.

The FITS is a new triage service for the handling of all incoming objections. As part of the service, ATO staff will make early contact with taxpayers and their agents within days of receiving an objection, and will:

  • assess the likely time required to resolve each matter at the earliest possible opportunity and
  • where the matter is complex, promptly allocate it to the appropriate person in the dispute resolution area.

The introduction is welcomed, and it is expected that FITS will provide a streamlined process for the resolution of simpler objections, and ensure that more complex claims are swiftly escalated for resolution.

The FITS was implemented on 16 March 2017.

Panama papers investigation update

The Commissioner has stated that while no one has yet been charged in relation to the 2016 Panama Papers leaks, he expects that prosecutions are inevitable.

So far, the ATO have completed 15 raids, targeting six accountants and 60 taxpayers. Further, the ATO have received voluntary disclosures from a number of taxpayers. The Commissioner has said that those who voluntarily disclose behaviour that is not ‘particularly criminal’ will not be prosecuted.

Taxpayer’s affected by the Panama Papers leaks should speak to their advisers about making a voluntary disclosure immediately. The Hall & Wilcox tax team has significant experience in assisting with, and making, voluntary disclosures and in dealing with the ATO in such matters, and encourage taxpayers affected by the leaks to contact a liaison partner.

Jail time for tax fraudster

The New South Wales District Court has sentenced a taxpayer to three years’ jail for three counts of refund fraud.

The offences occurred in 2010, when the taxpayer, along with a co-accused, arranged for the lodgment of 217 fraudulent income tax returns with the ATO (using the identities of other taxpayers) through three unknowing registered tax agents. The fraudulent refunds totaled $1.335 million.

In its media release, the ATO has reminded taxpayers that it takes tax-related crime very seriously, and that fraudulent tax refunds deprive the whole community of public funds.

The District Court decision is a reminder that the risks associated with tax fraud extend beyond penalties and interest, and can include significant jail sentences.