The Federal Budget flagged a number of changes to the corporate residency test with ‘significant economic connection to Australia’ and central management and control key parts of the review.

When the Government handed down its Federal Budget in October 2020, it signalled a shift in how the residency of non-Australian incorporated companies, trusts, and limited partnerships would be treated. The changes focus on whether the foreign companies have central management and control over a subsidiary and whether there are significant economic connections to Australia.

Australian tax rules and how a company is determined to be Australian for tax residency have been stable for some time, however as organisations increasingly operate across borders there is a need to clarify what constitutes Australian residency for tax purposes.

However as COVID continues to create issues for residency of individuals and companies, a shift towards considering the economic connection to Australia is set to replace a stalwart test for residency.

Carrying on a business in Australia … or not?

Companies that have been incorporated off-shore will often exercise central management and control (CM&C) over Australian operations, however may not conduct its day-to-day operations. However a ruling after the Bywater Investments Limited case from the Tax Commissioner flagged that carrying on a business in Australia would be a trigger for it to be resident under the second statutory test.

Until now, a foreign company that has its central management and control within Australia, is effectively carrying on business according to the 2016 High Court decision, even if it is only CM&C in Australia and other operations occur offshore. This created considerable uncertainty for Australian controlled foreign companies about whether they would be deemed residents for tax purposes.

The implication for foreign companies was a risk of being considered Australian resident for tax purposes across their global operations. The ruling flagged the risk that companies could be exposed to different outcomes relating to dividends, capital gains tax exemptions and the significant global entity rules. Other potential residency triggers included the corporate board composition, travel movements of its directors, and the number of Australian directors.

Legislative change to consider ‘Significant economic connection’ to Australia

The Federal Government sought to quell the uncertainty with legislative changes by adopting the key elements of the review, which was to ensure that a company or the entities mentioned above will only trigger the residency test where it has significant economic connection to Australia. 

This effectively means:

• The company has central management and control in Australia
• It has core commercial activities in Australia

The review pointed to the need to distinguish between the definition of carrying on a business test and the definition of central control and management – a definition that was blurred in the ruling mentioned above.

The challenge for the legislation will be to clearly define what core commercial activities actually means and how it may be interpreted as well as whether the rules can be applied to different types of entities.

Place of effective management

The COVID crisis has also flagged concerns about a potential change in the ‘place of effective management’, as senior company executives have been stranded by border closures or the inability to travel. Of particular concern is the question of whether the relocation of management will in fact trigger a change of a company’s residence under domestic tax law and whether the executive’s location will result in being considered a resident for tax purposes.

Given the extraordinary circumstances ushered in by COVID and that they are likely to be considered temporary, the OECD has signalled that the residency changes of its executives should not result in a change of residency for companies or the executives under the tax treaties that exist between Australia and other tax jurisdictions. Tie breaker rules are likely to apply.

However, we suggest seeking experienced international tax guidance to ensure that any pre-COVID arrangements are reviewed so that that companies and executives do not unwittingly trigger residency questions by either the ATO or foreign tax agencies.

Residency rules for certain entities

How will this impact or resolve COVID-related activity? COVID-19 has raised numerous issues for cross-border residency and tax, particularly the spectre of permanent residency for companies with employees caught in Australia as a result of border closures. 

Cross-border taxation is inherently complex and the legislation still has some gaps in clarifying exactly what might trigger a residency review. Please contact our team on 02 9957 4033 for further guidance on the traps and triggers that are likely to arise with the corporate residency tests.

Last updated July 2021. This factsheet is provided for information purposes only and is correct at the time of publishing. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.