Highway to the 'low-risk zone': a new approach for foreign companies and Australian tax residency

The ATO has recently updated its Practical Compliance Guideline PCG 2018/9, which deals with the ‘central management and control test’ of residency for foreign-incorporated companies. 
The update introduces a risk assessment framework to allow companies to self-assess the likelihood of the ATO applying compliance resources to review their residency status. 
This article provides an overview of the central management and control test, with a focus on the new risk assessment framework and how companies can ensure they fall within the 'low-risk zone'.

Matthew D'Angelo, Maddocks Lawyers

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What is the central management and control test of company residency?

The central management and control test of company residency (CMC Test) is an assessment used to determine whether a company is a resident of Australia for income tax purposes. 
Under the CMC Test, a company is a resident if it is incorporated in Australia or, if not incorporated in Australia, either:

• its voting power is controlled by shareholders who are residents of Australia; or 
• its central management and control are in Australia.

Taxation Ruling TR 2018/5 sets out the matters which are relevant in determining whether a company meets these criteria. For companies that carry on business in Australia, the focus is on determining who exercises central management and control and where the decisions are made.
Where the ATO establishes that a foreign-incorporated company is an Australian resident, the company will be liable to pay income tax in Australia. The CMC Test therefore has significant tax implications and merits close attention as to how corporate actions are likely to be construed by the ATO.

What does the ATO look for when reviewing a company's residency?

In determining whether a foreign-incorporated company is a resident under the CMC Test, the ATO draws a distinction between central management and control and day-to-day management, and focuses on evidence of where a company's central management and control is located.

Exercising central management and control vs. day-to-day management of a company's operations

The control and direction of a company is different from the day-to-day conduct and management of its activities and operations. It is often the case that employees are responsible for the day-to-day management of a company's business under the authority and supervision of the board, while the board still retains central management and control for the purposes of the CMC Test. The CMC Test will not focus on the day-to-day management.

Evidence of central management and control

Evidence, in particular board minutes and related records, is critical to establishing where a company's central management and control is located. If board minutes have not been kept, or are not a true indication of where decisions have been made, it will be necessary to look at other evidence, including documents identifying who has the formal power to make high-level decisions, such as a company's constitution. 

What is the new risk assessment framework?

The ATO's new risk assessment framework guides foreign-incorporated companies to self-assess the likelihood of the ATO applying compliance resources to review their residency status. 
In particular, the framework sets out 3 risk zones and the corresponding level of ATO engagement expected for companies falling in each zone.  

• For companies in the 'low-risk zone', the ATO will not normally allocate resources to review the company's position on the CMC Test.
• A company that falls within the 'moderate-risk zone' is more likely to be subject to compliance activity. The ATO may conduct further analysis to understand the company's residency position and taxation outcomes through its ordinary engagement and assurance activities.
• A company that falls within the 'high-risk zone' will likely be subject to compliance activity and need to provide analysis for the ATO to understand the relevant facts and circumstances. Depending on the outcome of engagement, the ATO may proceed to audit the company where appropriate. 

How can non-resident companies ensure they fall within the ‘low-risk zone’? 

With the risk-assessment framework in mind, it is in the interest of foreign-incorporated companies to proactively monitor the likelihood of having their residency status reviewed by the ATO.  In particular, companies that do not assess as tax residents of Australia should consider how their circumstances apply to the risk allocations in the framework.
To fall within the ‘low-risk’ zone, a company that self-assesses as a non-resident and is a resident of a foreign jurisdiction (that is not a tax haven) would exhibit one or more of the following factors:

• Meetings in Australia are once-off or temporary: The company usually has its central management and control in that foreign jurisdiction, but one-off or temporary changes to governance practices mean that either meetings are held in Australia or directors attend meetings remotely from Australia. 
• Subsidiary of Australian company with independent, high-level decision making:  The company is a subsidiary incorporated in that foreign jurisdiction, but whose parent company is incorporated in Australia, and there is evidence of independent high-level decision making in the foreign jurisdiction in relation to the control and direction of the foreign company.
• Wholly offshore businesses: The company is incorporated in a foreign jurisdiction in which it operates a wholly offshore business, and the taxation treatment in Australia of the profits and losses of the foreign company's offshore business is sufficiently similar to what it would be if the company was an Australian resident.

It is unlikely that the ATO would apply resources to review the residence of such a foreign company provided that a substantial majority of the company's central management and control is exercised in that foreign jurisdiction through established governance practices, including through:

• board meetings that are held outside Australia, or
• board meetings (including online meetings and teleconferences) where the majority of directors are not present in Australia when such meetings take place, or
• decisions by the board undertaken by circular resolution where the majority of directors are not present in Australia when such decisions are made.

Companies can increase the chance of falling in the ‘low-risk zone’ by maintaining effective governance practices when exercising central management and control in foreign jurisdictions, to avoid repeated or sustained lapses in directorial standards or corporate governance.
One of the best ways to uphold corporate governance is to keep contemporaneous board minutes and governance documents to demonstrate where high-level decision-making occurred as a matter of fact and substance. This could include contemporaneous records that document:

• any high-level decisions;
• who made those decisions; and 
• the location where such decisions were made, including any decisions made outside the ordinary board process.

More Information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Tax and Structuring team.

More Cleardocs information on related topics.

You can read earlier Clear Law articles on a range of topics, such as:

• Meeting basics: why are board minutes so important?
• Changes to the SMSF Residency Trap
• Crackdown! ATO ramps up pursuit of unpaid taxes

Other document packages:

• Superannuation (SMSF) Documents
• Trusts Documents
• Company Documents