Bywater Investments – Reconsidering Central Management and Control

On 16 November 2016, the High Court unanimously dismissed appeals by four companies (the appellants), ruling that they were Australian residents for income tax purposes.

Under s 6(1) ITAA 1936 a company, not incorporated in Australia, is resident if it carries on business in Australia and has either its central management and control in Australia or its voting power controlled by Australian resident shareholders. The focus of Bywater was on where the central management and control of the company was located.

The appellants sought to rely on the precedent set by Esquire Nominees[1]. In Esquire, a firm of Australian accountants exerted significant influence over the company. Nevertheless, it was found that central management and control of the company resided with the Board of Directors who met outside of Australia.

In Bywater (as in Esquire) the meetings of the directors were held abroad and the appellants argued that the court was bound to find that the central management and control was therefore exercised abroad. The High Court rejected this approach and held that, as a matter of long-established principal, the location of central management and control of a company was not to be determined by its formal structure, but was rather a question of fact.

In Esquire the court found that the accountants, while influential, had no power to control the directors as, had the accountants instructed he directors to do something that was improper or inadvisable, the directors would not have acted on the instruction. This is to be contrasted with the situation in Bywater. While the appellants characterised the role of Mr Vander Gould, a Sydney accountant, as an adviser, the court accepted that the real business of the appellants was conducted by Mr Gould from Sydney, without the involvement of the directors. The fact that the directors were located abroad was insufficient where the directors had abrogated their decision making in favour of Gould and only met to rubber-stamp decisions made by him in Australia.

Bywater is a reminder that courts will generally emphasise substance over form. It also holds a lesson for companies that seek to avoid the second test of residency by appointing foreign directors and for Australian parent companies that exercise influence over offshore subsidiaries – while parties in Australia may exert significant influence, if central management and control is to be situated abroad, the overseas directors must be seen to be independent and not merely rubber stamps.

[1] Bywater Investments & Ors v FCT (2016) HCA 45

 

The view expressed in this article are mine alone and do not represent my employer or anyone else. The article is intended only to provide a summary and general overview on matters of interest. It is not intended to be comprehensive nor does it constitute legal advice. You should seek legal or other professional advice before acting or relying on the article.

 

Tax residency for companies – part 2

In part one I wrote about the central management and control test and whether or not it had two requirements. For now let’s assume it does – carrying on a business in Australia and having central management and control in Australia.

Carries on a business in Australia

For the purposes of this test the Commissioner will consider virtually all companies (other than dormant companies) to be carrying on a business. Where that business is carried on depends on what it does. A company with operational activities (e.g. a trading, service, manufacturing or mining business) will be resident in Australia if those activities take place in Australia i.e. if their offices, factories or mines are situated in Australia. Conversely, where a company earns its income through passive investments, the company will be resident in Australia if the investment decisions are made in Australia.

Central management and control

Central management and control does not refer to the day-to-day running of the company but rather to high-level decision making processes. That includes things like reviewing strategic directions, major agreements, significant financial matters and overall performance. Typically (but not always) these powers will be vested in the board of directors of a company. If the directors do in fact manage and control the company then central management and control will generally be located where the directors meet. The Commissioner says that if the majority of board meetings are held in Australia, the central management and control of a company will be taken to be in Australia, unless that situation is artificial or contrived. The courts too have tended to focus on formal acts (which has opened the door for manipulation) though they have sometimes shown a willingness to consider a wider number of factors.

Central management and control will not always be exercised by the board of directors of a company. This can be illustrated by the contrasting cases of Union Construction v Bullock and Esquire Nominees. In Unit Construction the parent company (located in the United Kingdom) effectively took over management of the company from its board of directors. Therefore the court found that central management and control was in the UK, despite the constitution expressly provided that the director’s meetings were not to take place in the United Kingdom. In Esquire Nominees the director’s meetings were held in Norfolk Island but the agenda was prepared in Australia by accountants acting on behalf of the beneficial owners. The Norfolk Island directors would invariably follow the advice of the accountants but the court ruled that central management and control remained with the Norfolk Island directors. Justice Gibb explained that although the accountants were influential, the final decision lay in Norfolk Island and the directors would not agree to any recommendation that was improper or inadvisable.  From this we get the principle that a director can delegate some of his or her decision making power and still retain central management and control, provided they at least review and consider the actions of the delegated decision-maker.

 Voting power test

The final test of corporate residency sayst that a company, not incorporated in Australia, will be resident if it carries on business in Australia and has its voting power controlled by shareholders who a residents of Australia. Two comments are worth mentioning here. Firstly, a shareholder is somebody who appears on the company’s share register (Patcorp Investments). The test therefore does not look through to the ultimate beneficial owner of the shares. Secondly, shareholders with the capacity to control the company’s general meeting but who do not in fact exercise that control, do not control the voting power (Aluminium Corp Ltd).

Finally, just like a natural person, a company can be resident of two or more countries. This was a finding of the Swedish Central railway case. Just like with individuals, Australia’s double taxation agreements (DTAs) typically contain tie-breaker rules designed to allocate a single place of residence for the purpose of the DTA. I will get to double taxation agreements eventually, but before then I will finish with residency of other entities and then move on to discuss where income is sourced. I hope you stick around.

Cheers,

Simon

All advice in this blog is of a general nature. I’ve done my best to make sure it is accurate but I give no guarantees. Make sure you seek professional advice that is specific to your situation.

Tax residency of corporations – part 1

Now that we have discussed individual residency, it is time to move on to corporate residency. The approach taken to determine the residence of both types of taxpayer is similar in many regards. In the old English case of De Beers Consolidated Mines Ltd v Howe Lord Loreburn said;

“In applying the conception of residence to a company, we ought, I think, to proceed as  nearly as we can upon the analogy of an individual. A company cannot eat or sleep, but it can keep house and do business. We ought, therefore, to see where it really keeps house and does business”

While the early cases remain relevant, we now have a statutory definition of corporate resident. The Income Tax Assessment Act 1997 says that “a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia” is a resident.

This definition is comprised of three tests – the incorporation, central management and control and voting tests. The rest of this post will discuss these in turn.

Incorporation test

If a company is incorporated in Australia it will be a resident of Australia. While this test is very simple to apply, it is open to easy manipulation.

Central management and control test

If a company is not incorporated in Australia it will still be a resident if it “carries on business in Australia, and has…its central management and control in Australia”. Whether this test has two parts (and in my opinion it does) or just one is a matter of great controversy.

In the De Beers case mentioned above Lord Loreburn went on to add that “the real business (of a company) is carried on where the central management and control actually abides”. He regarded that as the “true test”. Later, in the Australian case of Malayan Shipping, Justice William rejected the argument that law could not refer only to the management and control of the business but must also refer to the actual operations themselves. The judge found that the reason for the wording of the Act was “to make it clear that the mere trading in Australia by a company not incorporated in Australia will not of itself be sufficient to cause the company to become a resident of Australia”. Malayan Shipping is thus authority for the proposition that if a company’s central management and control is in Australia then ipso facto it must be carrying on a business in Australia. This appears to be the majority view.

However, the Commissioner takes a differing view. In Tax Ruling TR 2004/15 he asserts that the test does have two requirements, and generally other acts of carrying on a business need to exist before the central management and control test is satisfied. In the Commissioner’s words Lord Loreburn’s analogy of a company keeping house and doing business is replicated in the two requirements of the test. The Commissioner’s position is based on the ideas that the courts should not easily consider any word or sentence used in an Act as superfluous and nor should judicial statements supplant or supersede the words of the law itself. TR 2004/15 argues that only where a company’s business is management of its investment assets and where it undertakes only minor operational activities, will both tests be satisfied by the same set of facts.

So the cases say one thing but the Commissioner says another. What’s a taxpayer to do? Well, tax rulings are binding on the Commsioner but not on taxpayers. Therefore if you like the Ruling you can apply it in the knowledge that the ATO won’t stop you. However, if you disagree (and are willing to argue your position in the courts should it come to that) you can ignore it in the knowledge that you have strong judicial precedent to support you.

There’s still lots more to go through regarding corporate residence so stay tuned for part two.

Cheers,

Simon

All advice in this blog is of a general nature. I’ve done my best to make sure it is accurate but I give no guarantees. Make sure you seek professional advice that is specific to your situation.