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Who Controls the Company?

Tax Ruling 2018/5 and the central management and control test of residency

What’s the ruling and what’s it about?

Tax Ruling 2018/5 (‘TR 2018/5’) relates to the ‘central management and control’ test of company residency, and how the test should be applied. TR 2018/5 follows the decision held in Bywater Investments Limited & Ors v Commissioner of Taxation; Hua Wang Bank Berhad v Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589 (‘Bywater Investments’).

What is Bywater Investments about?

Bywater Investments concerned a number of companies incorporated outside of Australia, in countries such as Switzerland and Samoa, that carried on business in Australia. Each company derived ordinary income from trading on the Australian Stock Exchange. The board of directors of each company was based in the country in which they were incorporated. This is also where board of director’s meetings took place. Based on these facts alone, this would mean that the central management and control of each company was located outside of Australia. As per the central management and control test, this would have meant that all of the companies were foreign residents of Australia. Section 6-5(3) of the Income Tax Assessment Act 1936 (Cth) (‘ITAA’) provides that:

If you are a foreign resident, your assessable income includes:

  • The ordinary income you derived directly or indirectly from all Australian sources during the income year

However, this case also involved an individual, ‘G’, who made decisions, and provided instructions to each board of directors from Australia. In this sense the board of directors for each company did not maintain any independence from G. The issue on appeal to the High Court was therefore whether the central management and control of each company was located in Australia or overseas. This would determine whether the companies were considered to be foreign or Australian residents under Australian tax law. Importantly, s 6-5(2) of the ITAA states:

If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Given this, if the companies were considered to be foreign residents, it would reduce their tax liabilities incurred in Australia.

In Bywater Investments, the High Court ruled against the companies, finding that in each case ‘the constitutional organs of the company do not, and are not intended to, exercise central management and control of the company’. The High Court held that ‘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’.

What are the implications of Bywater Investments? – TR 2018/5

Following this ruling made by the High Court, the Australian Taxation Office (ATO) released a draft determination regarding the central management and control test. This determination was recently finalised in TR 2018/5. The determination addresses four main questions concerning the central management and control test.

What does central management and control mean?

Central management and control does not refer to command of a company’s day-to-day conduct and operations. Rather, as stated in TR 2018/5, central management and control refers to ‘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.’ TR 2018/5 provides a number of examples of tasks that are considered to be the exercise of central management and control. The list includes:

  • Financial matters such as ruling how profits are used
  • Declaration of dividends
  • Decisions relating to acquiring and selling significant company assets

Does the company carry on business in Australia?

Whether a company does or does not carry on business in Australia is a question of fact. If a company does not carry on business in Australia, it is not subject to the central management and control test of residency. The carrying on of business includes the location of trading and investing and/or central management and control.

Who exercises central management and control?

The question of who exercises central management and control is also a question of fact. As made evident in Bywater Investments, although a company’s directors will generally be those who exercise central management and control, this is not always the case. TR 2018/5 explains that there is a difference between an outsider that is only influential on a board of directors, as opposed to one that actually makes the decisions for directors. As already noted, in Bywater Investments, each company was in fact controlled by G. The board of directors for each company essentially rubber-stamped G’s directions. They did not actually consider whether the instructions provided to them by G were in the best interest of the company.

Where is central management and control exercised?

The location of a company’s central management and control is a matter of where high-level decisions are made. This does not concern the residence of the directors, the company or an outside individual. Rather, as explained in TR 2018/5, what matters is where those who control the company ‘actually perform the activities to control and direct the company.’ For example, in Bywater Investments G was providing instructions to the boards of directors from Australia. This meant that the effective place of management for each company was exercised in Australia.

Conclusion

The central management and control test of residency is a question of fact and substance. As demonstrated in both Bywater Investments and TR 2018/5, companies that carry on business in Australia must be genuine foreign companies in order to be treated as such for tax purposes.

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