Determining whether a company is a tax resident of Australia has become more complicated… again. Taxpayers and advisers now need to navigate the ATO’s new position on ‘central management and control’, the potential application of a double tax agreement and now the multilateral instrument (MLI).
The consequences of getting it wrong can be significant and can include additional tax (sometimes without credits), interest and penalties if the error has existed for some time.
So where do we start?
A simple example to work through the provisions
Haibo is the sole director and shareholder of UK Co. UK Co was incorporated in the UK and carries on business in the UK.
Haibo immigrates to Australia with his family in 2019. Haibo now makes high-level decisions in relation to UK Co while in Australia.
The day-to-day running of UK Co continues to be managed in the UK. Haibo is not involved in management and commercial decisions of UK Co’s business.
Residency under Australian domestic tax law
A company is an Australian tax resident under the domestic law in Australia if it is either:
- incorporated in Australia; or
- not incorporated in Australia but 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.
Following the High Court decision in Bywater Investments, the ATO released a new public ruling on the central management and control test of residency, TR 2018/5.
The ATO concludes that the place of ‘central management and control’ is where high-level decisions are made as a matter of fact and substance.
With Haibo, the sole director, making strategic decisions while in Australia, UK Co is now a tax resident of Australia under the second test of the Australian domestic tax law.
The application of a double tax agreement
The domestic law may then be affected by a double tax agreement. This will generally be the case where two countries claim a company as a tax resident under their respective domestic tax laws and there is a double tax agreement between those countries. The residency article in the double tax agreement generally contains a ‘tie-breaker’ provision – which has the effect of deeming the company to be a tax resident of only one country.
For companies, the residency tie-breaker provision is generally where the company’s ‘place of effective management is situated’.
Unlike ‘central management and control’, ‘place of effective management’ refers to where ‘key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made’.
In the example, as the management and commercial decision for conducting UK Co’s business are made in the UK, the ‘place of effective management’ is in the UK.
Minding the MLI
The MLI is a multilateral tax treaty that effectively allows countries to amend their bilateral tax treaties without having to go through the long process of renegotiating the existing treaty. This is done by allowing countries to opt into various provisions.
Australia’s double tax agreements are not automatically affected by the MLI. Both countries have to agree to the MLI applying.
At 28 May 2019, Australia’s double tax agreements with France, Japan, New Zealand, Poland, the Slovak Republic and the United Kingdom have been modified by the MLI with effect from 1 January 2019. Other double tax agreements are due to be modified within the next 12 months.
One effect of the MLI on the Australia-UK double tax agreement is that the ‘place of effective management’ test is replaced with the following test:
Where by reason of the provisions of [the DTA] a person other than an individual is a resident of both [Australia and the UK], the competent authorities… shall endeavour to determine by mutual agreement the [country] of which such person shall be deemed to be a resident… having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors.
Back to the example, UK Co is incorporated in the UK and managed in the UK, so subject to ‘any other relevant factors’, should be determined by the competent authorities to be a tax resident solely of the UK.
However, to obtain that determination, UK Co will need to submit information to the ATO or HMRC, which is an unfortunate bureaucratic by-product of the MLI.
The ATO and New Zealand Inland Revenue appear to have recognised this, and have issued a website ‘determination’ that effectively reinstates the ‘place of effective management’ test over the MLI in certain cases. It currently states:
For taxpayers that satisfy all of the eligibility criteria outlined below for the relevant year, the Australian Taxation Office (ATO) and New Zealand Inland Revenue (IR) jointly determine that:
- Where an eligible taxpayer reasonably self-determines its place of effective management (PoEM) to be located in Australia, it will be deemed to be a resident of Australia for the purposes of the Convention between Australia and New Zealand for the avoidance of double taxation with respect to taxes on income and fringe benefits and the prevention of fiscal evasion (Australia-New Zealand treaty)
- Where an eligible taxpayer reasonably self-determines its PoEM to be located in New Zealand, it will be deemed to be a resident of New Zealand for the purposes of the Australia-New Zealand treaty.
In addition to the different layers that now need to be considered, advisers also need to be careful about interpretation: double tax agreements and MLIs have different rules of interpretation to domestic legislation. This is so that the object of the treaty (which may be subject to different translations) is given primary consideration.
The risk of getting the residency status of a company wrong can be significant. It can result in additional tax, together with interest and penalties if the error is not rectified for some time.