Edited version of your private ruling

Authorisation Number: 1012437471944

Ruling

Subject: Income Tax: residency of Company B

Question 1

Is Company B a resident of Australia for the purposes of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

If the answer to question 1 is 'yes', is Company B a 'prescribed dual resident' for the purposes of subsection 6(1) of the ITAA 1936?

Answer

Unable to rule.

Question 3

If the answer to question 1 is 'yes' and the answer to question 2 is 'no', is Company B a subsidiary member of the Company A tax consolidated group pursuant to paragraph 703-15(2)(b) of the Income Tax Assessment Act 1997 ( ITAA 1997)?

Answer

Unable to rule.

This ruling applies for the following periods:

From the financial year commencing 1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Company A Group originated in Australia and has since expanded its operations into offshore markets.

Company A is listed on the Australian Securities Exchange and is the parent entity of the accounting consolidated group and the head company of the Company A tax consolidated group.

Company B was incorporated outside of Australia and is a wholly-owned subsidiary of Company A.

Current operational activities of Company B

Company B has a significant number of employees in an overseas country (Country Y). The day-to-day operations of Company B include the provision of various services in Country Y.

Company B does not provide any services in Australia.

The day-to-day operational role of Company B employees depends on their functional responsibilities.

Where an employee is part of the service delivery operations, employees may be involved in the process of bidding for new work, negotiating contracts and the delivery of services to clients in respect of those contracts.

The decision making for Company B operations is performed by the Senior Managers for each of the 2 main business units of the Company A Group for the Australia and Country Z region. These individuals are not employees of Company B.

Company B - its business from incorporation to Time A

From incorporation, Company B personnel were responsible for the management of its operations.

Company B had General Managers who were responsible for specific industry sectors.

Senior Managers, who were above the General Managers, were employed by Company B and were located in Country Y.

A CFO and CEO were also employed by Company B for the Country Y operations and were also located in Country Y.

The Senior Managers, CFO and CEO were responsible for making the key business decisions for Company B. These decisions had to be approved by the Country Y Strategic Review Committee (CYSRC) which met weekly in Country Y. The CYSRC purpose was to lead and implement the strategic development of the Company A Group in Country Y.

Company B - its business from Time A

At Time A, a restructure of the management of Company B occurred which was aimed at integrating the Australian and Country Y operations of the Company A Group to ensure greater efficiency, remove cost duplication and improve synergies between the operations. As a result, the management of the Company A Group Australian and Country Y operations were grouped and became more centralised (which included key managerial roles of the Country Y operations of Company B being transferred to Australia) as follows:

· The Company A Group was organised into regions such that each entity within a particular region is managed by the region's executive management team. Therefore geographically, Australia and Country Y formed the Australia and Country Y region.

· Since Time A, the Company A Group has undertaken a number of organisational changes but the overall structure involving the Australia and Country Y region as a defined operational and reporting unit has remained consistent. The Company A Group Australia and Country Y region is now divided into two main business units.

Within both of these two main units there is an Australian and Country Y CEO and CFO, based in Australia, who possess ultimate decision-making authority.

· Senior Managers within each of these regional business units reports to their respective CEO and CFO. General Managers report to these Senior Managers. Other than some of the General Managers located in Country Y, none of these individuals are employees of Company B.

· Effective from Time A, the CYSRC and the Australian Strategic Review Committee (ASRC) amalgamated to form the Australia Country Y Strategic Review Committee (ACYSRC). The ACYSRC committee is comprised of members from both Australia and Country Y, with the majority based in Australia.

· The ACYSRC meets weekly in Australia. It is attended by the directors of Company B as well as other Australian based regional management.

· Since Time A all significant projects, client contracts and financing entered into by Company B have required consideration and approval by the ACYSRC and where required, by a more senior committee within the Country A Group to which the ACYSRC reports, (along with the other regional Strategic Review Committees).

· The centralisation of the Human Resources, Finance, Safety and Information Technology and Legal functions of the Company A Group in Australia. Whilst some employees and some managerial roles for Company B remain in Country Y, all of the employees and managers ultimately report to regional management located in Australia. The holders of these management positions are not employees of Company B.

CFOs and CEOs

Within each Company A Group business unit the CEO has ultimate management authority for, and the CFO has ultimate responsibility for managing the financial position of, each of the entities within the Australia and Country Y region, including Company B.

Senior Managers

Company A Group Senior Managers manage business segments within each of the two main business units and report to their respective CEOs and CFOs. Since Time A the number of Senior Managers and their area of responsibility has varied. Since Time A all Senior Managers have been based in Australia and have responsibility for business undertaken within their respective business segment, including by Company B.

General Managers

General Managers report to Senior Managers and are responsible for managing specific areas of the business. Since Time A, the majority of these General Managers for the Australia and Country Y region have been based in Australia but some have been based in Country Y.

The restructuring of certain managerial roles as described in the preceding facts did not result in any operational changes - the location of the service provision of Company B remains solely in Country Y.

No operational profit is attributable to Australia.

Company B Contracts

According to Matrix A (see below), contracts that are less than $XX million are bid for, negotiated and executed in Country Y without further approval in Australia by the ACYSRC unless there are certain risks indentified with the contract.

For contracts in excess of $XX million the vast majority of such contracts are bid, negotiated and executed in Country Y by Company B employees in Country Y. Where such contracts are approved in Australia the contractual process is predominantly performed by Country Y employees, subject to approval in Australia.

Contracts are executed by a director or a number of directors of Company B or an appropriate person authorised by way of power of attorney to execute contracts on behalf of the directors of Company B. Some of these contracts are executed by a Country Y based director of Company B, others are executed by an Australian based director of Company B or both.

On occasion, a client will require that a Country Y based director execute the contract on behalf of Company B irrespective of the contract requiring approval in Australia in accordance with Matrix A by the ACYSRC or other level of authority (as the matter requires).

The contract process can be summarised as follows:

· where new work is 'offered' in Country Y and a bid is required, Company B employees would undertake the initial bidding process in respect of the services to be performed. This would involve evaluating the required services to be performed, the ability of Company B to perform those services and preparation of a bid document.

· The level of approval required for a particular contract tender is set by Matrix A. In limited circumstances Australian staff, are required to help in bid preparation for a Company B tender.

· Where a bid is accepted, Company B employees formally undertake contract negotiations with the client regarding the service to be performed. As part of this negotiation process, and where the contract is large in monetary terms or risky enough, approval would need to be obtained from the ACYSRC (or other authority) for the significant contractual points. Where appropriate, and in limited circumstances, Australian management will assist with the contract negotiations.

· Where a negotiation is successful the final approval for the contract is provided by the relevant authority, which may or not be the ACYSRC, in line with Matrix A and the contract is signed by the appropriate Company A Group or Company B representative. The signing of a contract normally involves the Executive Director of Company B.

Matrix A

Matrix A is an internal approval procedure used throughout the Company A Group which determines the appropriate level of authority required for all material business activity.

With respect to client contracts or projects, Matrix A determines the level of authority required for a client opportunity to be approved as an opportunity, for a formal bid to be submitted and for the contract to be executed.

Matrix A contains both qualitative and quantitative factors which effectively determine the level of risk of any particular contract and thereby the appropriate level of authority. The quantitative factor is the overall contract value. The qualitative factors include such issues as whether the opportunity is aligned with the approved business plan, whether the opportunity is a fixed price project or whether the opportunity involves uncapped liability exposure.

Depending on these quantitative and qualitative factors, Matrix A assigns one or more of the following levels of authority for approval:

1) Board of Directors of Company A;

2) Chief Legal Counsel;

3) Senior Strategic Review Committee;

4) Regional SRC (which for the Australia and Country Y business is the ACYSRC);

5) Business Unit SRC;

6) Business Unit in accordance with the Business Unit matrix.

Company B is not included in the list.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(b)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Subsection 995-1(1) of the ITAA 1997 provides that a person (which includes a company) is an 'Australian resident' if that person is a resident of Australia for the purposes of the ITAA 1936.

Paragraph (b) of the definition of 'resident or resident of Australia' in subsection 6(1) of the ITAA 1936 (the definition) means that a company is a resident of Australia if it is:

· incorporated in Australia; or

· if it is not incorporated in Australia, it carries on business in Australia and has either:

o its central management and control in Australia; or

o its voting power controlled by shareholders who are residents of Australia.

Company B is a company incorporated in Country Y, therefore the first statutory test is not satisfied by Company B.

Analysis in relation to the second statutory test of the definition is set out below.

Carrying on business in Australia

Taxation Ruling TR 2004/15 Income tax: residence of companies not incorporated in Australia - carrying on business in Australia and central management and control (TR 2004/15) provides the Commissioner's views on whether a company, not incorporated in Australia, is a resident of Australia under the second statutory test in paragraph (b) of the definition. Paragraph 6 of TR 2004/15 provides:

If no business is carried on in Australia, the company cannot meet the requirements of the second statutory test and, in these circumstances, it is not a resident of Australia under the second statutory test. In these situations there is no need to determine the location of the company's CM&C, separate from its consideration of whether the company carries on business in Australia. [Emphasis added]

Paragraph 9 of TR 2004/15 states that the question of where business is carried on is one of fact. It requires a consideration of where the activities of the company are carried on and is dependent on the facts and circumstances of a case. The Commissioner's approach to this factual determination is to draw a distinction between a company with operational activities which include trading, service provision, manufacturing or mining activities and a company which is more passive in its dealings. For example, the Commissioner considers that a large industrial concern with substantial operational activities carries on business wherever its offices, factories or mines are situated (see paragraph 10 of TR 2004/15) but that on the other hand '…a company whose income earning outcomes are largely dependent on the investment decisions made in respect of its assets, carries on its business where these decisions are made...' (see paragraph 11 of TR 2004/15). Accordingly, the Commissioner considers at paragraphs 25 and 41 of TR 2004/15 that:

25. A practical approach which provides a starting point for determining the location of the business is to draw a distinction between a company with operational activities (for example, major trading, service provision, manufacturing, or mining activities relative to the whole of its business) and a company that is more passive in its operations……[Emphasis added]

41......it is considered that major operational activities which are the essence of a company's income earning activities and which are carried out with a high degree of autonomy would be sufficient to constitute the carrying on of business in Australia where those activities occur in Australia. [Emphasis added]

It is clear from the facts that it is the substantial operational activities (the provision of services) being carried on by Company B, with its significant number of employees in Country Y, which is the essence of Company B's income earning activities. These significant operational activities are carried out on a daily basis by Company B operational staff at ground-level with a very high degree of autonomy. As such, Company B's operational activities, carried on in Country Y, would constitute the carrying on of business by Company B in Country Y, and not in Australia. That is, Company B is a large industrial concern carrying on substantial operational activities in Country Y where it has offices and where it provides its services i.e. where the clients of its two main business units for which it provides services are located. There are no comparable major operational activities being carried on in Australia which could indicate that a business was also being carried on in Australia.

Therefore, in accordance with paragraph 6 of TR 2004/15, as Company B does not carry on business in Australia as explained immediately above, it cannot meet the requirements of the second statutory test and, in these circumstances, the Commissioner's view is that Company B is not a resident of Australia under the second statutory test. Accordingly, the Commissioner considers that there is no need to determine the location of the company's central management and control (CM&C) or to consider any further application of TR 2004/15, separate from its consideration of whether the company carries on business in Australia. Notwithstanding this however, as the applicant has addressed specific aspects of TR 2004/15 in its private ruling application the Commissioner will, for completeness and transparency, address those aspects of TR 2004/15 that he considers are relevant to the applicant's view that Company B carries on business in Australia.

Does Company B also carry on business in Australia?

The applicant states at page 7 of its private ruling application that:

Importantly, the test for carrying on business does not require business to be carried on in only one location; rather, an entity can carry on business in a number of locations.

The Commissioner agrees with this submission (but disagrees with the proposition that there is a business being carried on in Australia by Company B based on the facts presented in the private ruling application).

The applicant then submits at page 9 of its private ruling application that:

We are of the view that the management of a company which undertakes operational activities will often comprise a key component of the business activities of the company and we are of the view that with respect to Company B the management activities undertaken in Australia should be characterized as the carrying on of business in Australia." [Emphasis added]

Finally, the applicant concludes at page 9 of its ruling application by stating that:

Company B's business is carried on in both Country Y and Australia. As the element conducted in Australia is more than incidental, we consider the above case law and ATO rulings support the proposition that Company B carries on business in Australia, notwithstanding that it also carries on business in Country Y.

(NB - This conclusion, the essence of the applicant's view, is referred to and reiterated in similar wording by the applicant in both of its responses, RFI response 1 and RFI response 2.

It is the view of the Commissioner that the management activities the applicant wishes to characterize as amounting to '... the carrying on of business in Australia' should be more correctly characterized as part of CM&C for the reasons described below. They are not activities that amount to Company B also carrying on business in Australia.

Central Management and Control

Paragraphs 48 and 49 of TR 2004/15 provide:

48. Determining CM&C involves a focus on the who, when and where of the strategic decision making of a company. CM&C includes the setting of directions and goals, and the evaluation of the company's performance measured against these benchmarks and emerging market risks and opportunities. Accordingly, the second statutory test focuses on management and control decisions made at the highest levels in the company. [Emphasis added]

49. Usually these high level decisions are made by the company's board of directors and therefore the place where the board meets is highly relevant in determining where CM&C is located. However, the place where the board meets is not the sole factor for consideration (Lord Radcliffe in Unit Construction v. Bullock [1959] 3 All ER 831 (Unit Construction)), although it provides a prima facie indicator of where the CM&C is located. However, there may be cases where the company's board is not in fact the high level decision maker …..[Emphasis added]

The circumstances of Company B in this ruling can be considered to be commensurate with example 2 in TR 2004/15 in the context of CM&C activities (with Company B being the equivalent of Trade Co in the example):

Example 2 - CM&C in Australia with trading outside Australia

71. Trade Co is incorporated in Papua New Guinea, but its board of directors holds the majority of its meetings in Australia where decisions on the major contracts entered into by Trade Co, its finance, major policies and strategic directions are made. Trade Co undertakes all its trading activities in Papua New Guinea.

72. Trade Co is not a resident of Australia under the second statutory test. Although Trade Co has its CM&C in Australia, it is not carrying on business in Australia.

73. The fact that Trade Co has Board related, administrative support in Australia does not change this outcome, as such activity is considered to be part of the activities of the Board, and not the carrying on of a business of the company. [Emphasis added]

Accordingly, the Commissioner considers that all the management activities the applicant refers to in its private ruling application and RFI responses are broader activities of the CM&C function of Company B being undertaken in Australia.

The applicant states at page 11 of RFI response 2 that these management business activities:

…..go towards the strategic direction, senior assessment of operational activity, assessment of new or continuing business, and the identification and employment of executives and staff working in Country Y.

The Commissioner considers these activities amount to CM&C functions and activities - high level decisions that are akin to '…the setting of directions and goals, and the evaluation of the company's performance measured against these benchmarks and emerging market risks and opportunities…' referred to by the Commissioner in paragraph 48 of TR 2004/15 (see above).

The above conclusion by the applicant makes it clear that the CFO, CEO, Senior Manager and General Manager functions the applicant refers to in its application and RFI responses (and in particular the sign-off required by senior management/personnel residing in Australia for major contracts) are inextricably linked to the CM&C function of Company B. As paragraph 49 of TR 2004/15 makes it clear, just because these activities are not being carried on solely by the Board does not then automatically relegate these activities to non CM&C activities - these activities can be undertaken by others (i.e. the CFOs, CEOS, Senior Managers and General Managers and higher senior staff) and still maintain their CM&C nature. That is, the Board is not in fact the daily operational high level decision maker (reflected in the fact that only two director meetings have been held for Company B (since the change in 200X), although no doubt it will be involved in relevant decisions where and when required Statements at pages 4 and 5 of the private ruling application clearly highlight the significant influence the Senior Managers ultimately have on CM&C activities and the strategic direction of Company B. That this is so on the facts is also evidenced by the applicant's submission at page 5 of its private ruling application:

The decision making for the operations is performed by the Senior Managers of the two divisions of the combined Australia and Country Y business. [Emphasis added]

And also at page 10 of the private ruling application:

In addition to the role of the Board of Directors, the restructure in 200X, resulted in the key management decisions taking place in Australia. [Emphasis added]

Case Law

Contrary to contentions by the applicant, the Commissioner does not consider that Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 156; (1946) 8 ATD 75; (1946) 3 AITR 256 (Malayan Shipping)) applies such that it can be considered that the business carried on by Company B consisted of or included its CM&C being undertaken in Australia. As noted by the Commissioner at paragraph 39 of TR 2004/15:

In Malayan Shipping his Honour considered that the business carried on by the company consisted of or included its CM&C. However, the comments are explicable by the facts of the case in which both elements of the second statutory test were satisfied because of the nature of the particular business. [Emphasis added]

The facts of this case are clearly distinguishable from the Malayan Shipping case.

Finally, as already stated above, the applicant stated at page 10 of RFI response 1:

The managerial roles and functions that remained in Country Y were those below the level of General Manager as well as some of the General Managers as noted in the response to question 4.

This evinces an intention on the part of Company B to separate those management functions that it considered integral to the daily operational activities of Company B in Country Y from those management functions allocated to the broader Company A Group for the Australian and Country Y region. For the reasons given above these management functions are considered to be CM&C activities. The restructure (which included the centralisation of some Company B management activities and subsuming of what were originally Company B functions only into broader Company A Group Australia and Country Y region functions) reflects changes made at the broader Company A Group and CM&C level, rather than any radical change deliberately made to the normal operational activities of Company B in Country Y. As even highlighted in the facts, a majority of the work in relation to Company B's contracts (both up to and in excess of $XX million) takes place in Country Y (excepting what can be considered to be the CM&C aspects of contracts that take place in Australia).

Applicant's view - other key points

We note that the applicant has referred to 'Private Ruling 1011291194581' in support of its view. It is important to note that records on the Register of private binding rulings (the source of the applicant's referral) cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

In any event, that case is clearly distinguishable on its facts from this case. Company X in that case was (like Company B) incorporated in a country outside Australia, Country Z. It was a subsidiary of Company Y which was incorporated in and a resident of Australia. Company X, unlike Company B:

· never had a physical office in country Z

· only ever had one employee (involved primarily in sales support) who was employed for less than a year

· relied on Company Y for the provision of staff

· only ever became part of a transaction after a sale was confirmed by Company Y

· had its central management and control functions carried out as part of the business of Company Y in Australia

· had all Board of Directors meetings and shareholders meetings in Australia

· had all its administration managed by staff employed by Company Y

· could only conduct operations in Country Z using Company Y resources.

· Carried out very few activities in Country Z

Accordingly, in Private Ruling 1011291194581 it was correct for the Commissioner to conclude that Company X was a resident of Australia because '...as Company X does not carry out significant operational activities…it…carries out its business at the place where its central management and control is based, namely Australia'. The decision was consistent with the Commissioner's approach in TR 2004/15 and an example of what the Commissioner refers to in TR 2004/15 as '...a company which is more passive in its dealings…' (as opposed to a company with significant operational activities being undertaken) with the consequence that Company X as '...a company whose income earning outcomes are largely dependent on the investment decisions made in respect of its assets, carries on its business where these decisions are made. This is often where its CM&C is located.'

To strengthen support for its argument that Company B carries on business in Australia by virtue of the significant management activities being undertaken in Australia by Senior Managers, the applicant advises that in addition, all of the directors of Company B except for one, reside in Australia and that (see page 11 of RFI response 2):

All of the Senior Managers responsible for the operations of Company B are located in Australia (refer to previous correspondence for a description of their roles and other key management roles). The CEOS and CFOS of the Country Y business units reside in Australia.

In negation of this submission it is sufficient to quote the Commissioner pursuant to paragraph 52 of TR 2004/15:

The place where most of the company's high level decision makers are resident, does not of itself determine where the company is resident but may indicate the place where the CM&C of the company is likely to be located: John Hood and Company Ltd v. Magee (1918) 7 TC 327[Emphasis added]

Accordingly, the Commissioner considers that the fact that the higher level management responsible for Company B reside in Australia (as opposed to ground-level operational staff in Country Y) coupled with the nature of the activities they undertake, supports the view that it is the CM&C only of Company B that is being carried on in Australia and nothing else.

Conclusion

The Commissioner's position can best be summarised by paragraphs 10 and 26 of TR 2004/15. Paragraph 26 states:

It is arguable that an industrial company carries on business wherever its major operational activities relative to the whole of its business take place, notwithstanding that its CM&C may be located elsewhere. However, operational activities alone are not sufficient to make a company resident in Australia under the second statutory test, the company's CM&C must also be in Australia. [Emphasis added]

The importance of relativity is stressed by the Commissioner earlier at paragraph 10 of TR 2004/15 wherein he states:

For the purposes of the second statutory test, a company that has major operational activities relative to the whole of its business carries on business wherever those activities take place and not necessarily where its CM&C is likely to be located. Operational activities include major trading, service provision, manufacturing or mining activities. For example, the place of business of a large industrial concern is wherever its offices, factories or mines are situated. [Emphasis added]

The applicant submits at page 11 of RFI response 2 that:

It is the case that the physical and direct interaction with clients takes place in Country Z and that a significant part of Company B's business is carried on in Country Z. [Emphasis added]

Accordingly, in the context of paragraphs 10 and 26 of TR 2004/15, even if the Commissioner considered that these activities were not CM&C activities, the Commissioner would conclude that they were still not significant enough operational business activities relative to the whole business of Company B so as to suggest that Company B carried on business in Australia in addition to Country Y.

Alternatively, and in any event, the Commissioner considers that if these management activities did amount to operational business activities, then they would be activities which other entities within the broader Country A Group are carrying out on behalf of Company B, but which are not being carried out by Company B itself. The senior personnel responsible for undertaking the activities in Australia which the applicant submits form the basis of Company B carrying on business in Australia are undertaken by people residing in Australia and employed by other entities within the Company A Group and not Company B. The Commissioner considers this situation to be analogous to that of Company B contracting out certain business functions to third parties. These functions may be necessary in order that Company B can actually carry on its business, but they are no longer a part of that business carried on by Company B itself.

Question 2

As the answer to question 1 is no, we are unable to rule on question 2.

Question 3

As the answer to question 1 is no and we are unable to rule on question 2, we are unable to rule on question 3.

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