Bywater – justification for a changed view
On 21 June 2018, the ATO released Taxation Ruling TR 2018/5 (Ruling). The Ruling finalises Draft Taxation Ruling TR 2017/D2 (Draft Ruling), which was a response to the High Court’s decision in Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation1 (Bywater).
The Ruling also replaces the withdrawn Taxation Ruling TR 2004/15 (Withdrawn Ruling). In this regard, it reflects a significant shift in the Commissioner’s interpretation of Malayan Shipping Co Ltd v. Federal Commissioner of Taxation (1946) 71 CLR 156 (Malayan Shipping), and the circumstances in which the central management and control of a business are regarded as factually part of carrying on that business.
The Ruling was issued along with Ruling Compendium TR 2018/5EC (Compendium) and Practical Compliance Guideline PCG 2018/D3 (PCG). The Compendium provides the Commissioner’s response to the submissions received after the release of the Draft Ruling, and the PCG seeks to assist taxpayers in applying the principles set out in the Ruling.
Despite the fact that the ATO has stated that it will adopt a transitional compliance approach, the shift in the Commissioner’s interpretation of Malayan Shipping may create uncertainty for taxpayers; in particular, foreign incorporated subsidiaries of Australian companies that trade and operate outside Australia.
Legislative and judicial context
Section 6(b) of the Income Tax Assessment Act 1936 (Act) defines ‘resident’ or ‘resident of Australia’, relevantly, as:
(b) a company which is incorporated in Australia, or which, 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 Bywater, the High Court considered whether a company not incorporated in Australia had its ‘central management and control’ (CM&C) exercised in Australia.2 After an extensive review of the relevant authorities, the majority found:
As a matter of long-established principle, the residence of a company is first and last a question of fact and degree to be answered according to where the central management and control of the company actually abides. As a matter of long-established authority, that is to be determined, not by reference to the constituent documents of the company, but upon a scrutiny of the course of business and trading. […] Each case depends on its own facts and circumstances, albeit that those cases that have been decided may provide a degree of guidance in relation to those still to come.3
That is, the Court found that the nature of a company’s CM&C is a question of fact. The question is to be answered after an examination of the actual practices of the company, rather than by mere reference to the ‘constituent documents’ of the company.4
The majority also rejected the notion that a company should be, as a matter of fact, taken to be resident of the country in which its board meetings are held. Specifically, the Court rejected the following argument from the appellants in Bywater:
… the “real business” or “superior or directing authority” of a company are, as a matter of fact, to be found where the board of the company holds its meetings, even if the only thing done at those meetings is to record decisions actually made elsewhere by an outsider and the only purpose of situating the board in that place is to ground a claim that the company is not resident in Australia for tax purposes.5
The Ruling confirms the position taken by the ATO in its Draft Ruling. The changes in the Ruling are, in the main, minor alterations to wording for clarification. A paragraph dealing with the relevance of formal documentation has been deleted, and the Ruling now expressly excludes any discussion of the voting power test, or when a company carries on a business.
However, in the Withdrawn Ruling the Commissioner’s interpretation of case law regarding section 6(b) of the Act was considerably different. Specifically, the Withdrawn Ruling stated:
- Where a parent company in Australia exercises CM&C in relation to a subsidiary (but does not conduct the day-to-day activities of the business in the way that the managing director did in Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 156; (1946) 8 ATD 75; (1946) 3 AITR 256 (Malayan Shipping)), the subsidiary would need to also be carrying on business in Australia for it to be a resident under the second statutory test.
That is, until the release of the Draft Ruling, the Commissioner considered that section 6(b) of the Act imposed a test with two separate requirements. First, the company must be found to be carrying on business in Australia. Second, the company must be found to have its CM&C exercised in Australia.6
In the Withdrawn Ruling, the Commissioner further states that:
- While it is clear that mere trading is not sufficient on its own to satisfy the second statutory test, and that CM&C can be relevant to determining where the business is being carried on, it is considered that major operational activities which are the essence of a company’s income earning activities and which are carried out with a high degree of autonomy would be sufficient to constitute the carrying on of business in Australia where those activities occur in Australia.
Conversely, the Commissioner’s updated view is that if a company’s CM&C is exercised in Australia, then it necessarily carries on business in Australia. In this regard, the Commissioner contends that the central management and control of a business is factually part of carrying on that business.
A question arises whether, in the circumstances, the Commissioner has effectively conflated the two tests (and reversed his view of Malayan Shipping) under the guise of providing updated guidance following Bywater.
In the Compendium, the Commissioner responds to issues raised after the release of the Draft Ruling.
At item 16 of the table in the Compendium, the Commissioner insists that ‘[t]here are two legislative requirements in the test’. It may be reasoned that this statement sits uneasily with the interpretation, and possible conflation, of the relevant tests by the Commissioner in the Ruling.
When queried about his updated interpretation of Malayan Shipping, the Commissioner states that:
The High Court authority is clear on this point. In Malayan Shipping Williams J unequivocally observed:
… if the business of the company carried on in Australia consists of or includes its central management and control, then the company is carrying on business in Australia and its central management and control is in Australia.”
In comparison to the statements made by the Commissioner in the Withdrawn Ruling regarding Malayan Shipping, the shift in his interpretation is readily apparent.
The Compendium also emphasises the importance of the PCG, and at numerous point in the Compendium the Commissioner directs taxpayers to the PCG.
The PCG contains 14 examples that demonstrate the application of the Ruling, which reflect the Commissioner’s focus on ‘high-level decisions’.
In the Ruling, the Commissioner defines high-level decisions as decisions ‘that set the company’s general policies, and determine the direction of its operations and the type of transactions it will enter.’
According to the Commissioner, high-level decisions are a ‘key element’ of CM&C. Further, the Commissioner contrasts high-level decisions with day-to-day conduct and management, which, he states, ‘is not ordinarily an act of central management and control’.
Examples of high-level decisions provided in the PCG include:
- the board of an investment company setting investment policies and strategies
- the directors of a passive investment company reviewing, and dealing with, its investments
- determining a manufacturing company’s sales and trading policies, and production methods and
- decisions made by an Australian parent regarding transactions to be made by its foreign subsidiary company, where foreign directors provided by a corporate services provider merely rubberstamp decisions made by its Australian owners.
Examples of decisions that are not high-level decisions provided in the PCG include:
- administrative staff executing the decisions of management
- employees following policies of a company
- the owner of a company recommending to the board of the company that it make a particular decision and
- the directors of a company ‘rubber stamping’ the high-level decisions of the owner of a company.
The PCG also reflects the importance of contemporaneous and thorough documentation of board minutes. In this regard, the Commissioner states in the PCG that:
- If a company has board minutes showing a complete record of where all its high-level decisions were made and who made them, the Commissioner will accept them as prima facie establishing where the company’s central management and control was located
Where decisions are made in more than one place, the Commissioner will examine whether CM&C is exercised to a ‘substantial degree’ in Australia. This test appears to be drawn, in part, from the decision of the High Court in Koitaki Para Rubber Estates Limited v The Federal Commissioner of Taxation (Koitaki),7] in which the court found that:
[a] company resides in a particular geographical unit if it there conducts an essential and substantial part of its trading operations.
While the term ‘substantial degree’ is not defined more precisely in the Ruling or the PCG, the PCG sets out a number of practical examples.
Ongoing compliance approach
In the PCG, the Commissioner outlines his approach to compliance in light of the Ruling. The PCG states:
- The Commissioner will not normally apply his resources to review or seek to treat a foreign incorporated company as a resident applying the central management and control test of corporate residency for Australian tax purposes merely because part of the company’s central management and control is exercised in Australia, because directors regularly participate in board meetings from Australia using modern communications technology […]
This will be the Commissioner’s approach where the non-resident company is a subsidiary of a public group, and is a controlled foreign company incorporated under a foreign equivalent to the Corporations Act 2001, so long as the company is not a ‘foreign hybrid’.
Additionally, a ‘substantial majority’ of the company’s CM&C must be exercised in a foreign jurisdiction, and the company must not have entered into any contrivance, arrangement, or scheme with respect to its residency, governing processes, ownership, or CM&C.
Transitional compliance approach
Provided that certain criteria are satisfied, and in a relatively limited set of circumstances, where Taxpayer have relied on the Withdrawn Ruling the Commissioner will not apply his resources to review or seek to disturb a foreign-incorporated company’s status as a non-resident during the ‘transition period’.
The transitional period is the period between:
- 15 March 2017 and
- 13 December 2018.
The Ruling and Compendium together provide taxpayers with a detailed analysis of the Commissioner’s views regarding CM&C, while the PCG provides a number of practical examples and sets out the Commissioner’s compliance approach.
Further, there is no doubt that in certain circumstances a company will be carrying on a business in Australia if its CM&C is exercised in Australia, but the actual trading or investment operations of the business take place offshore.
However, the Commissioner’s updated position that CM&C will, by its nature, always amount to the carrying on of a business reflects a significant shift in his interpretation of Malayan Shipping; and the circumstances in which the central management and control of a business is regarded as factually part of carrying on that business.
The fact that this shift comes following Bywater raises questions as to whether the High Court’s limited comments in that case regarding Malayan Shipping justify the shift in the Commissioner’s position.
1 HCA 45.
2Above n 1, 2.
3Above n 1, 77.
4Above n 1, 77.
5Above n 1, 66.
6Taxation Ruling 2004/15, 5.
7 HCA 13.
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