Mary runs an up-and-coming software company that operates largely in the property sector. Her company is multinational; she operates in both Australia and New Zealand. However, while she is an Australian resident for tax purposes and manages some app development and sales through the Australian arm of her company, the New Zealand arm is by far the most profitable and runs almost autonomously under its own management team. She and the board hope to continue to expand operations in New Zealand and take her property software solutions to new markets in the Asia-Pacific in the coming years.
But a new ruling by the ATO may hinder her plans. She may be forced to pay tax in Australia for the profits made by the New Zealand arm of her company.
A New ATO decision targets operations, not ownership
The ATO’s Practical Compliance GuidelinePCG 2018/9, released late last year, aims to identify where a company’s management and operational decision-making resides for tax purposes.
Currently, foreign-owned or otherwise, a company is seen to reside in Australia for tax purposes when it carries on a business in Australia and has its Central Management and Control (CM&C) in Australia (the “CM&C test”), and when its voting power is controlled by shareholders who are residents of Australia (the “voting power test”). If it is seen to be a resident company doing business in Australia, it will be taxed on its worldwide income; if it is a foreign resident in Australia, it will taxed on any income sourced only in Australia.
From Mary’s point of view, being taxed in Australia for her international income would see a significant increase in the tax her company would need to pay. This would reduce the potential for her company to launch expansion plans in the near future.
Historically, the CM&C test and the voting power test have been applied as composite tests with the requirement to carry on business in Australia considered separately from both. Likewise, the ATO interpreted these tests in such a way that if a foreign incorporated company performed the bulk of its operations outside Australia it would not be considered a resident of Australia even if its central management and control resided in Australia.
This is no longer the case.
The High Court’s decision in Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation(Bywater) on 16 November 2016 indicated that if foreign incorporated companies had their central management and control in Australia, that would suffice to make the company a resident in Australia for tax purposes. And, under the recent ATO Guideline, the CM&C and voting power of a company, when located in Australia, appears to be enough for a multinational to be taxed in Australia as a resident company even when a large amount of its operations occur overseas.
Is it still worthwhile running my business out of Australia?
The reason for this shift in the ATO’s approach is clear. It does not want companies that have their Directors and Boards in Australia running most of their businesses out of foreign tax havens in order to avoid paying tax in Australia on international profits. But this change in the application of the CM&C and voting power tests creates uncertainty for people like Mary. She has a management team here in Australia, and pays tax on Australian profits. Her board is based in Australia. But the New Zealand arm is a New Zealand company, and pays tax on its considerable profits in New Zealand. Will she now have to pay tax in Australia on these profits, and, considering the tax credit she will receive for the tax she already must pay in New Zealand, is she likely to lose out in paying the Australian tax rate?
Companies have a deadline. The transitional period ends on 30 June 2019; you have under two months to make changes to your governance in such a manner that your company is not deemed a resident in Australia for tax purposes.
So, where will you be paying the most tax? Is it worthwhile running your business out of Australia for tax purposes?
This raises concerns for both foreign incorporated companies and Australian multinationals, since the determining factor is the location of the decision-making nexus of the company, or the CM&C. You will need to employ a Virtual CFO or adroit business advisory team to best determine the tax costs in Australia versus those in foreign jurisdictions. Both foreign incorporated companies and Australian multinationals will need to review their governance; this is likely to lead to additional costs in the face of the deadline. Australian multinationals are more likely to be impacted since they are most likely to have their Directors and Board residing in Australia. You will now need to consider whether it is time to separate the running and operations of the offshore arms of your business, or if it is time to shift the management of the company outside Australia altogether. This is an issue of reporting, decision-making, and operations, not ownership.
Being smart with the grey area between foreign operations and local compliance
There is a window for restructuring your business in order to avoid paying surprise taxes. While subsidiaries of public companies are provided with an ongoing compliance approach, under strict conditions a foreign incorporated company can also benefit from this compliance safe harbour. Moreover, the grey area of defining Australian versus foreign decision-making gives you room to determine a prudent approach to your tax compliance under this Guideline.
Consider the following:
- Where do the influential decision-makers of the company reside? Are they merely influential or are they real, practical decision-makers? Have the Directors of the company here and overseas had an equal involvement in the operations of the company?
- How is your board structured? Are all the board members Australian residents for tax purposes?
- How do decision-making meetings take place? Do they occur in Australia, overseas, or in dual jurisdictions with video-conferencing?
- Does the location and onus on the decision-making change over time? Which high-level decisions are considered one-off, and which are considered normal, substantial, or regular in the exercise of your company’s CM&C?
- How do the board minutes reflect the location and scope of decision-making in your company and its CM&C? Is there a difference between where reporting takes place, where decision-makers reside, and where high-level decisions are made?
- How does the company hierarchy and structure reflect the CM&C of the company?
Mary is keen to explore all the options available to her in restructuring the decision-making of her company in order to ensure the New Zealand operations of her company (and its profits) are governed by CM&C that resides in New Zealand for tax purposes. This includes rearranging the make-up of the board, having more key meetings in New Zealand, utilising remote and video conferencing, and shifting key decisions to the management team in New Zealand. She is aware this is crucial; it is the difference between paying Australian tax on her company’s worldwide income (for a resident company) and paying tax only on the company’s Australian-sourced income (for a non-resident company).
If you are an Australian multinational or a foreign incorporated company that does business in Australia, it is vital that you invest in a new governance plan. This plan needs to take into account the above, as well as other areas of Australian tax law, such as exemptions for non-portfolio dividends and branch income, CGT, CFC rule applicability, or access to Foreign Income Tax Offsets (FITOs), which are not directly addressed by the new ATO Guidelines. An experienced tax specialist, who understands both the ins-and-outs of doing business in Australia and has experience in guiding multinationals in foreign jurisdictions, is essential in making sure your business is ready before the upcoming deadline.
Important Disclaimer: Readers should not act solely on the basis of the material on this page. Items herein are general comments only and do not constitute or convey advice. Legislation and proposals of legislation are also subject to constant change. We therefore recommend that formal advice be sought before acting in any of the areas. This news article is issued as a guide to the readers. Calibre Business Advisory Pty Ltd and its associated entities disclaims any losses that may be incurred as a result of the reader undertaking any action based on this article.