In order to provide certainty for foreign incorporated businesses conducting operations in Australia, the government announced in the 2020 Budget that it will be seeking to make changes to clarify the corporate residency test. While details have not been forthcoming in the days since the Budget, the Board of Taxation has recently released its review on that same topic, potentially providing a glimpse of what the amending legislation may contain, including what constitutes “sufficient economic connection” and “core commercial activities”.

In the 2020 Federal Budget, the government announced that it intended to make technical amendments to clarify the corporate residency test. While the government has not provided further details, the Board of Taxation has recently released its review of corporate tax residency, the details of which appear to be consistent with the government’s intentions. This report contains more information on various aspect of the government’s announcement including the concept of sufficient economic connection.

Under the current rules, a company will be an Australian tax resident if:

• the company is incorporated in Australia; or
• the company “carries on business” in Australia and has either it’s central management and control in Australia OR its voting power controlled by shareholders who are residents of Australia.

However, in Bywater Investments Ltd & Ors v FCT; Hua Wang Bank Berhad v FCT [2016] HCA 45, the High Court decided that having boards of directors of various companies located in overseas countries were insufficient to make the companies “foreign residents”. This overturned much of the accepted understanding of corporate residency of a foreign incorporated company and caused confusion and red tape for many in the business community.

In its review, the Board indicated that a majority of submissions supported its proposal to modify the “central management and control test” to ensure that a foreign incorporated company will only be an Australian tax resident if it has sufficient economic connection with Australia.

According to the report, “sufficient economic connection” could be determined using a two-step process. Firstly, to determine whether core commercial activities of a foreign incorporated company are undertaken in Australia. Only if the answer if affirmative, does it move to step 2 which involves looking at the central management and control of the foreign incorporated company.

The Board considers that overarching guidance on the meaning of “core commercial activity” should be provided in either the legislation or an explanatory memorandum and be supplemented by accompanying ATO practical compliance guidance. Further, it notes that additional ATO administrative guidance may be required on the meaning of the term “central management and control in Australia” in the context of modern corporate board practices.

Factors considered by the Board to be relevant when assessing whether the core commercial activities of a foreign incorporate company include:

• the nature of the business carried on by the company;
• the location of staff  and  assets  employed  in the conduct  of  the  core business activity of the company in both Australia and abroad;
• the size of the company;
• the sophistication of the company’s corporate governance practices;
• any separation between strategic management and operational control of the business;
• the composition of the company’s board and any additional roles held by directors; and
• the distinction between activities that are core to the conduct of the business and those that are preliminary or ancillary, such as general support functions.

In the Budget, the government announced the measure will have effect from the first income year after the date of the enabling legislation receives assent, but taxpayers will have the option of applying the new law from 15 March 2017 (the date on which the ATO withdrew Ruling TR 2004/15: residence of companies not incorporated in Australia — carrying on a business in Australia and central management and control).