ATO draft risk assessment framework for residency of foreign-incorporated companies

27 July 2023

In brief

On 28 June 2023, the Australian Taxation Office (ATO) issued a draft update to its Practical Compliance Guideline PCG 2018/9 (PCG 2018/9DC1), which deals with the central management and control (CMC) test of residency for foreign-incorporated companies. The draft update confirms that the ATO’s transitional compliance approach ended on 30 June 2023 and provides a draft risk assessment framework against which companies can self-assess to understand the likelihood of the ATO applying compliance resources to review their residency.

In detail

The residency of foreign-incorporated companies has been an issue of concern for many multinational groups since the ATO withdrew its taxation ruling (TR 2004/15) dealing with this issue, and issued TR 2018/5 in its place. This followed the High Court’s 2016 decision in Bywater Investments Ltd v Federal Commissioner of Taxation.

Broadly, the ATO’s current view in TR 2018/5 is that it is not necessary for any part of the actual trading or investment operations of the business of the company to take place in Australia because the central management and control of a business is factually part of carrying on that business. This represented a departure from the long-held position that the CMC test of residency had two distinct limbs - one requiring the actual business to be carried on in Australia, and one requiring CMC to be exercised in Australia.

The ATO issued PCG 2018/9 at the same time as TR 2018/5, setting out its compliance approach with regards to the CMC test of residency. This included a ‘transitional compliance approach’ under which the ATO would not apply resources to review or seek to disturb a foreign-incorporated company’s status as a non-resident during a transitional period if it meets certain criteria. This transitional compliance approach was broadly seen as intended to cover a period during which the law might be amended to restore the two limb test for foreign-incorporated companies (see further below regarding the status of this amendment).

The transitional compliance approach was originally intended to cover the period 15 March 2017 to 30 June 2019. This was subsequently extended multiple times until 30 June 2023, with the ATO now indicating it will not be extended beyond 30 June 2023.

With the transitional compliance approach having now ended, the ATO has released a draft update to PCG 2018/9 to confirm its ongoing compliance approach applies to public groups only, and to provide a risk assessment framework for groups that do not meet the conditions to access the ongoing compliance approach.

Ongoing compliance approach for public groups

Acknowledging that there may be unintended consequences arising from the views set out in TR 2018/5, the ATO has provided an ongoing compliance approach for public groups. A public group for this purpose is a group whose head entity or ultimate parent is listed on an approved stock exchange set out in Schedule 3 to the Income Tax Assessment (1997 Act) Regulations 2021, including a listed holding company of a foreign public group or a wholly-owned subsidiary of a foreign public group.

Broadly, under this approach, the ATO will not normally apply resources to review or seek to treat a foreign-incorporated company as a resident applying the CMC test of corporate residency for Australian tax purposes merely because part of the company’s CMC is exercised in Australia, because directors regularly participate in board meetings from Australia using modern communications technology, where all of the criteria set out below are satisfied on an ongoing basis.

The company is
- a subsidiary of an Australian public group that is an ordinary company incorporated under a foreign equivalent to the Corporations Act 2001 and is not a foreign hybrid (as defined in Australian tax law), and treated in the group’s Australian income tax returns and financial statements as non-resident for Australian taxation purposes and is disclosed as a controlled foreign company, or
- a listed holding company of a foreign public group, or
- a wholly-owned subsidiary of a foreign public group that is an ordinary company incorporated under a foreign equivalent to the Corporations Act 2001 and is not a foreign hybrid, and treated in the group’s income tax returns and financial statements as a resident of a listed country.
A substantial majority of the company’s CMC is exercised in a foreign jurisdiction (that is not a tax haven*) where it is treated as a resident for tax purposes under that jurisdiction’s law through:
- board meetings that are held outside Australia, or
- board meetings (including meetings via the use of modern communications technologies) 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.
The company has not undertaken or entered:
- any artificial or contrived arrangement affecting the location of its central management and control, including previous or subsequent ‘migration’ of residency
- a tax avoidance scheme whose outcome depends, in whole or part, on the location of its residence
- arrangements to conceal ultimate beneficial or economic ownership, or
- arrangements involving abuse of board processes including backdating of documents or the board not truly executing its functions.

* The term ‘tax haven’ for the purposes of PCG 2018/9 refers to the definition developed by the Organisation for Economic Cooperation and Development (OECD) in its 1998 publication ‘Harmful Tax Competition: An Emerging Global Issue’.

Additionally, where a company that satisfies the criteria above fails to lodge a return as a result of an honest but mistaken belief that the company was a non-resident, the ATO will not apply resources to pursue penalties for failing to lodge the return.

Risk assessment framework

The intention of the risk assessment framework is to allow companies to self-assess the likelihood of the ATO applying compliance resources to review their residency. This would generally be relevant where the ongoing compliance approach for public groups, as outlined above, does not apply, and there is uncertainty about the location of CMC based on the views outlined in TR 2018/5.

Table 1 below summarises the risk zones and level of ATO engagement expected for companies falling into these zones.

Table 1: Likely ATO level of engagement based on risk zones

Risk Zone	ATO treatment
Low	The Commissioner will not normally allocate resources to review a company’s position on the CMC test of residency.
Medium	A company that falls within the moderate-risk zone is more likely to be subject to compliance activity. The Commissioner may conduct further analysis to understand the company’s residency position and taxation outcomes through ordinary engagement and assurance activities. Where multiple moderate-risk factors identified below apply to a company, it is more likely that compliance activity will be considered.
High	A company that falls within the high-risk zone will likely be subject to compliance activity and need to provide analysis for the Commissioner to understand the relevant facts and circumstances. If further review confirms the company’s residency position remains high-risk, the Commissioner may proceed to audit where appropriate.

Table 2 summarises the key criteria for companies to fall within each risk zone. Refer to PCG 2018/9DC1 for further information and examples relating to each risk zone.

Table 2: Risk zone criteria

Risk Zone	Companies that fall within this zone
Low	This includes a company that self-assesses as non-resident and is a resident of a foreign jurisdiction (that is not a tax haven), where one or more of the following apply. The company ordinarily has its CMC in that foreign jurisdiction, but has one-off or temporary changes to its established governance practices that result in either meetings being held in Australia or directors attending meetings from Australia via modern communications technology. The company is a subsidiary incorporated in that foreign jurisdiction and is subject to an Australian parent’s policies, proposals or approval processes and there is evidence demonstrating independent consideration and judgement by directors in making high-level decisions in that foreign jurisdiction. The company has a wholly offshore operating business in that foreign jurisdiction, the company’s tax position in Australia is substantially similar to what it would be if the company was an Australian resident, and a substantial majority of the company’s CMC is exercised in that jurisdiction through board meetings that are held outside Australia, or board meetings and/or board decisions undertaken by circular resolution where the majority of directors are not present in Australia when the meetings take place or decisions are made.
Medium	This includes a company that self-assesses as non-resident, is a resident of a foreign jurisdiction, and one or more of the following apply. The company has a repeated or sustained lapse in directorial standards or corporate governance. The majority of directors of the company spend most of their time in Australia but are stated to make all high-level decisions in a foreign jurisdiction. However, the company’s business or directors’ circumstances and roles indicate that high-level decisions appear to be made more regularly or outside of board meetings in Australia. There are circumstances relating to the exercise of CMC of the company that appear to lack a clear commercial basis. For example, the foreign jurisdiction where high level decisions are ordinarily made may not appear to be compatible with the company’s economic presence and operations or there appears to be no clear commercial rationale for incorporation in the relevant foreign jurisdiction. There are unusual circumstances, such as the director's role or roles appearing to be undertaken by outsiders in Australia who appear to make high-level decisions, or where one or more of the company’s directors are employed by its Australian parent and it is unclear to what extent the company’s high-level decision making is being dictated by the Australian parent. There appears to be some mismatch between legal form arrangements relating to residency outcomes and high-level decision making in substance. The company’s residency position relates to a broader set of taxation issues being reviewed by the Commissioner. The company purports to have satisfied the criteria of the transitional compliance approach within the transitional period up until 30 June 2023, however, is unable to adequately demonstrate satisfaction of all of the requisite criteria.
High	This includes a company that self-assesses as non-resident and one or more of the following apply. The company appears to not be a resident of any foreign jurisdiction. There are facts suggesting that central management and control is not exercised in any foreign jurisdiction. Tax and profit outcomes in Australia do not appear to be commensurate with Australian operations. There is an artificial or contrived arrangement affecting the location of central management and control, including previous or subsequent ‘migration’ of residency. This does not include where there are genuine, commercial purposes for the migration. A tax avoidance scheme exists whose outcome depends, in whole or part, on the location of a company’s residence, including any arrangement identified in a Taxpayer Alert. There are arrangements to conceal ultimate beneficial or economic ownership. There are arrangements involving abuse of board processes such as backdating of documents or the board not truly executing its functions. This also includes where the details of board minutes are shown to be false or misleading. Evidence indicates that there is no substantive high-level decision making in the jurisdiction in which the company is a resident (or in the foreign jurisdiction where it is asserted that central management and control is exercised), including evidence of mere implementation, or rubber stamping, of decisions made by others or by directors without the exercise of independent consideration or judgement.

Risk Zone

Companies that fall within this zone

Low

This includes a company that self-assesses as non-resident and is a resident of a foreign jurisdiction (that is not a tax haven), where one or more of the following apply.

The company ordinarily has its CMC in that foreign jurisdiction, but has one-off or temporary changes to its established governance practices that result in either meetings being held in Australia or directors attending meetings from Australia via modern communications technology.
The company is a subsidiary incorporated in that foreign jurisdiction and is subject to an Australian parent’s policies, proposals or approval processes and there is evidence demonstrating independent consideration and judgement by directors in making high-level decisions in that foreign jurisdiction.
The company has a wholly offshore operating business in that foreign jurisdiction, the company’s tax position in Australia is substantially similar to what it would be if the company was an Australian resident, and a substantial majority of the company’s CMC is exercised in that jurisdiction through board meetings that are held outside Australia, or board meetings and/or board decisions undertaken by circular resolution where the majority of directors are not present in Australia when the meetings take place or decisions are made.

Medium

This includes a company that self-assesses as non-resident, is a resident of a foreign jurisdiction, and one or more of the following apply.

The company has a repeated or sustained lapse in directorial standards or corporate governance.
The majority of directors of the company spend most of their time in Australia but are stated to make all high-level decisions in a foreign jurisdiction. However, the company’s business or directors’ circumstances and roles indicate that high-level decisions appear to be made more regularly or outside of board meetings in Australia.
There are circumstances relating to the exercise of CMC of the company that appear to lack a clear commercial basis. For example, the foreign jurisdiction where high level decisions are ordinarily made may not appear to be compatible with the company’s economic presence and operations or there appears to be no clear commercial rationale for incorporation in the relevant foreign jurisdiction.
There are unusual circumstances, such as the director's role or roles appearing to be undertaken by outsiders in Australia who appear to make high-level decisions, or where one or more of the company’s directors are employed by its Australian parent and it is unclear to what extent the company’s high-level decision making is being dictated by the Australian parent.
There appears to be some mismatch between legal form arrangements relating to residency outcomes and high-level decision making in substance.
The company’s residency position relates to a broader set of taxation issues being reviewed by the Commissioner.
The company purports to have satisfied the criteria of the transitional compliance approach within the transitional period up until 30 June 2023, however, is unable to adequately demonstrate satisfaction of all of the requisite criteria.

High

This includes a company that self-assesses as non-resident and one or more of the following apply.

The company appears to not be a resident of any foreign jurisdiction.
There are facts suggesting that central management and control is not exercised in any foreign jurisdiction.
Tax and profit outcomes in Australia do not appear to be
commensurate with Australian operations.
There is an artificial or contrived arrangement affecting the location of central management and control, including previous or subsequent ‘migration’ of residency. This does not include where there are genuine, commercial purposes for the migration.
A tax avoidance scheme exists whose outcome depends, in whole or part, on the location of a company’s residence, including any arrangement identified in a Taxpayer Alert.
There are arrangements to conceal ultimate beneficial or economic ownership.
There are arrangements involving abuse of board processes such as backdating of documents or the board not truly executing its functions. This also includes where the details of board minutes are shown to be false or misleading.
Evidence indicates that there is no substantive high-level decision making in the jurisdiction in which the company is a resident (or in the foreign jurisdiction where it is asserted that central management and control is exercised), including evidence of mere implementation, or rubber stamping, of decisions made by others or by directors without the exercise of independent consideration or judgement.

The draft update to the PCG also outlines how companies can evidence their self-assessment of risk zones. This would usually include contemporaneous board minutes and governance documents, records documenting high-level decisions, who made those decisions, and the location where such decisions were made, including any decisions taken outside of ordinary board processes.

For public groups, the Commissioner accepts that they should be able to rely on established controls and practices in relation to foreign-incorporated subsidiaries to demonstrate that local directors exercise independent consideration and judgement for the purposes of this risk assessment framework.

However, where evidence of high-level decision making is not available, inconclusive, or incomplete, a company’s residency position is likely to be considered moderate or high risk, subject to the particular facts and circumstances of the company, and consideration of the risk factors outlined in the PCG. For example, where a closely-held private company’s board minutes do not provide complete, contemporaneous or sufficient evidence of where high-level decision making occurred as a matter of fact and substance, the Commissioner will not accept board minutes as prima facie establishing where the company's central management and control was located. Other supporting documentation to demonstrate high-level decision making and governance controls and processes will be required.

Status of amendments to the residency definition for companies

As part of the 2020-21 Australian Federal Budget, the former Government announced it would legislate a change in line with the Board of Taxation’s key recommendation in its 2020 report, Review of Corporate Tax Residency, to ensure that a company that is incorporated offshore will be treated as an Australian tax resident if it has a ‘significant economic connection to Australia’. This test will be satisfied where both the company’s core commercial activities are undertaken in Australia and its central management and control is in Australia.

The changes were due to take effect from the first income year after Royal Assent of the amending legislation, subject to a transitional rule under which taxpayers were to have the option to apply the new law from 15 March 2017, the date on which the ATO withdrew its previous taxation ruling (TR 2004/15) dealing with the residency of foreign incorporated companies.

It is unclear at this stage whether or not the current Government intends to progress this proposal.

The Takeaway

The draft PCG indicates that the ATO is taking a broad, risk-based approach to dealing with questions of tax residency for foreign-incorporated companies. Companies and groups with well established governance processes and procedures, including in relation to tax matters that extend beyond those directly relevant to the question of residency, will likely be categorised as lower risk under this approach.

Tax residency is now also relevant, not only for determining an entity’s tax obligations, but also for new and proposed transparency requirements that require public companies to disclose the tax residency of their subsidiaries and tenderers for Federal Government contracts worth more than $200,000 to disclose their country of tax residency (including their ultimate parent entity’s country of tax residence). The ATO’s compliance approach and risk zones outlined in this draft PCG will have limited relevance for these purposes.

With the ending of the ATO’s transitional compliance approach, and no indication as to whether the Government intends to progress the Board of Taxation’s proposed changes to the definition of resident for companies, we recommend all groups (particularly outbound groups) with foreign-incorporated companies in their structure, consider self-assessing their risk level in accordance with the draft framework in this PCG.