Australia: Corporate residency rules; issues arising under sole-incorporation test
Australia: Corporate residency rules
The Board of Taxation opened a consultation concerning potential reforms to the corporate tax residency rules.
There is general consensus that the current administration of the “central management and control” test to determine Australian corporate tax residency is uncertain and possibly creating practices that are costly. In some cases, key decisions about the operations or investments of foreign companies within Australian multi-national groups are made by the board or management of the Australian controlling company within Australia. The practice of holding a board meeting in a foreign jurisdiction under the current tax administrative practice to consider and approve those decisions could itself be seen as contrived, when a majority of the directors are Australian residents that could attend the meeting from Australia, using modern communication technology. The uncertainty is even greater when the board members of the foreign company are also directors or senior management of the Australian controlling company that made the operational or investment decision that the foreign company is to implement.
Addressing pressure points for a sole-incorporation corporate residency test
The current “central management and control” approach in an environment when businesses have increasingly become more complex with digitisation has meant the test has also become increasingly difficult for taxpayers and the tax administration to apply.
A sole-incorporation test would be a simple solution—one that is easy to comply with and simple to enforce administratively. A number of consultation submissions to the Board of Taxation advocated for this approach.
However, there are “pressure points” and concerns raised in the Board of Taxation’s consultation paper in adopting a sole-incorporation test. These pressure points include the following:
- An incorporation-only test may result in an existing foreign incorporated resident company ceasing to be an Australian resident or even becoming “stateless” or a “resident of nowhere” for tax purposes. The Board highlighted the Singapore corporate tax residency rules that determine residency solely on where the “control and management” of a company is exercised. A company incorporated in Singapore but controlled and managed in Australia would not be a resident of or in either country, or “stateless” if Australia adopts a sole-incorporation test. How will this be mitigated?
- An incorporation-only test is susceptible to residency manipulation given Australia’s relatively high corporate tax rate, potentially encouraging companies to incorporate in a country with a lower headline corporate tax rate.
- Australia’s taxing rights over foreign-incorporated companies will be limited to income and gains generated from Australian sources, regardless of where central management and control is exercised or where they carry on business.
- There may be unpredictable detrimental effects on the operation of a number of tax treaties to which Australia is a party.
Response to the concerns
- The increasing number of integrity rules implemented in Australian tax law since the Organisation for Economic Cooperation and Developments (OECD) base erosion and profit shifting (BEPS) project and the possibility of future changes under BEPS 2.0 Pillar 1 and Pillar 2 place less emphasis on the need for complex corporate residence rules. However, in the event these rules are insufficient to address “stateless” income, Ireland is an example that has implemented specific anti-avoidance rules in 2014-2015. This is to determine that “stateless” income arising from differences in central management and control and residency tests between two countries does not go “untaxed.” The United Kingdom (UK) has had some form of rule of dealing with “nowhere companies” when they were prominently used in the late 1980s and early 1990s. Australia could look into having a similar integrity rule of a sole-incorporation test, and in the event no other integrity measures apply in the tax law, a stateless income integrity rule would apply as a last resort.
- Australia’s controlled foreign company (CFC) rules are anti-tax deferral rules that seek to prevent income from being shifted from a high-tax country like Australia to a low-tax jurisdiction and indefinitely deferring income from taxation in the low-tax jurisdiction. This would largely address the concern of residency manipulation. However, the CFC rules would benefit from being updated and modernised if a sole-incorporation test were adopted to address issues raised in the primary decision of Hua Wang Bank Berhad v. Commissioner of Taxation. The Hua Wang case briefly mentioned Australia’s CFC rules and the use of registered debentures to circumvent the CFC rules. The facts in this case probably highlight gaps in Australia’s current CFC rules (which were also highlighted in the Board of Tax’s review of the Anti-Tax Deferral Regime in 2007) rather than problems associated with adopting a sole-incorporation test.
- On treaties, implementing an incorporation-only test presents some complexities. In particular, a number of Australia’s current tax treaties rely on control and management-based tiebreaker tests to deal with cases of dual residency, which could override the resident status of Australian-incorporated companies under an incorporation-only test. The use of place of incorporation as a treaty tiebreaker is not unprecedented in Australia’s treaties (e.g., it is used in the Australia-Canada income tax treaty), or other global treaties, and the release of the Multilateral Instrument (MLI) provides another example of a non-control and management-based test in the form of the competent authority tiebreaker. The Committee on Fiscal Affairs recognised in 2017 (as noted in the OECD Model Convention Commentary) that although situations of double residence of entities other than individuals were relatively rare, there had been a number of tax-avoidance cases involving dual-resident companies. It therefore concluded that a better solution to the issue of dual residence of entities other than individuals was to deal with such situations on a case-by-case basis.
With international tax rules placing priority on re-establishing the link between taxation and the location of economic activities, there may be less emphasis on issues with residence and source in the long term. A sole incorporation test accompanied by a review of the current international integrity measures or putting in place an additional “stateless” income integrity measure that operates as a last resort is an option worth considering to simplify the Australian corporate tax residency rules.
For more information, contact a KPMG tax professional in Australia:
Jenny Wong | + 61 2 9335 8661 | firstname.lastname@example.org
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