Edited version of private advice

Authorisation Number: 1051840967136

Date of advice: 20 May 2021

Ruling

Subject: Residency

Question 1

Was ABC Co (ABC) a resident of Australia under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the period from 1 January 20XX to 31 December 20XX?

Answer

Yes.

Question 2

Was ABC deemed to be a resident solely of Country B under the Treaty between Australia and Country B (the Treaty) for the period from 1 January 20XX to 31 December 20XX?

Answer

Yes.

Question 3

Is interest income derived by ABC from its Country B bank accounts during the period 1 January 20XX to 31 December 20XX assessable income under subsection 6-5(2) of the ITAA 1997?

Answer

Yes.

Question 4

Will ABC be a resident of Australia under subsection 6(1) of the ITAA 1936 from 1 January 20YY?

Answer

Yes.

Question 5

Will ABC be deemed to be a resident solely of Country B under the Treaty (as modified by Article 4(1) of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI)) from 1 January 20YY?

Answer

No.

Question 6

Is interest income derived by ABC from its Country B bank accounts from 1 January 20YY assessable income under subsection 6-5(2) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods

Questions 1 to 3: 1 January 20XX to 31 December 20XX

Questions 4 to 6: 1 January 20YY to 31 December 20YY

Relevant facts and circumstances

ABC

X Co is a Country B incorporated company listed on the Stock Exchange and parent entity of the global group.

Within the group structure, the widget business is headed by ABC Parent Co, a Country B incorporated company.

ABC is owned by ABC Parent Co and carries on the group's widget business in Australia. ABC does not carry out these activities in Country B.

ABC is an entity incorporated in Country B under Country B law. It is a resident of Country B for Country B tax purposes.

All of ABC's shares have at all relevant times been owned by companies that are Country B resident and not Australian resident.

ABC has a substituted accounting period such that its income year ends on 31 December each year.

ABC has carried out its Australian widget business since 20TT. Prior to that, ABC carried on a different business and was dormant for a period between ceasing that business and commencing the Australian widget business.

ABC's Board of Directors

ABC's board has at all relevant times been comprised of three directors.

In 20TT, when ABC commenced carrying on its widget business in Australia, the board was comprised of two Country B resident directors and one Australian resident director.

On 1 January 20XX, there was a change in the composition of the board with the appointment of an additional Australian resident director and the retirement of a Country B resident director at that time. The Australian resident director was also appointed to be the managing director of ABC at that time. A board meeting was held on 1 January 20XX to approve these appointments. This meeting was held in Australia, with two directors present in Australia and one dialling in from Country B.

From 1 January 20XX, board meetings were generally held in Australia, with a majority of directors participating in the meetings from Australia.

In some cases, board meetings were nominally held in Country B, with one director physically present in Country B, however, in these cases the two Australian resident directors would participate by telephone from Australia. Board meetings were held in this manner throughout the period up to and including the year ended 31 December 20XX.

The directors of ABC exercised the following functions at board meetings:

(a) setting investment and operational policy by:

(i) setting the policy on the use and development of capital assets; and

(ii) deciding to buy and sell significant assets of the company;

(b) appointing company officers and agents and granting them power to carry on the company's business (and the revocation of such appointments and powers);

(c) overseeing and controlling those appointed to carry out the day-to-day business of the company; and

(d) determining matters of finance, including determining how profits are used and the declaration of dividends.

During the relevant income years, it is not the case that any particular board member dictated or controlled the decisions made by the directors to the exclusion of the other directors. Neither was it the case that any person outside of the board dictated or controlled the decisions made by the directors.

ABC's activities in Australia give rise to a permanent establishment in Australia.

During the income year 1 January 20XX to 31 December 20XX, ABC earned interest on an intra-company cash pool account and a bank deposit located in Country B (the Country B Interest).

The relevant bank accounts in Country B existed before ABC commenced its widget business in Australia. The funds in the accounts were sourced from activities prior to the commencement of ABC's widget business. The funds did not arise from ABC's widget business in Australia. The accounts are not operated from Australia, but are instead operated from Country B, whereby personnel employed by ABC's parent and located in Country B operate the account. The monies in the accounts are used to pay miscellaneous expenses of ABC.

The relevant Country B bank accounts are exclusively designated for use by ABC and for ABC's expenses only. The only expenses that have previously been paid from these bank accounts have been audit fees. The cash in the accounts are treated as assets of the Australian operations for accounting purposes.

There will be no change to ABC's board composition or the manner in which ABC's board meets from 1 January 20YY, i.e. it will continue to have a majority of directors resident in Australia and board meetings will continue to be held in Australia where the relevant activities will be carried out in relation to the high-level decision making.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, opened for signature 31 December 2016, [2016] ATS 23 (entered into force 1 July 2018)

Reasons for decision

Question 1

Was ABC a resident of Australia under subsection 6(1) of the ITAA 1936 for the period from 1 January 20XX to 31 December 20XX?

Detailed reasoning

The term 'resident' in relation to a company is defined within subsection 6(1) of the ITAA 1936, and is defined at paragraph (b) of that term as:

(b) 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.

The definition sets the criteria necessary to establish residency of a company. The first element of the definition states that a company which is incorporated in Australia, is a resident of Australia (the incorporation test). For a company incorporated in Australia, this is where the examination ends to determine if the company is a resident under the definition.

If a company is not incorporated in Australia, a company will be a resident under 'the central management and control (CM&C) test' of company residency in paragraph (b) if it carries on business in Australia and has its CM&C in Australia.

Alternatively, a company which is not incorporated in Australia will be a resident under 'the voting power test' if it carries on business in Australia and has its voting power controlled by shareholders who are residents of Australia.

Incorporation Test

ABC is incorporated in Country B. Therefore, it is not incorporated in Australia and is not a resident company under the incorporation test within subsection 6(1) of the ITAA 1936.

CM&C Test

Taxation Ruling TR 2018/5 Income tax: central management and control test of residency (TR 2018/5) sets out the Commissioner's view on how to apply the CM&C test of company residency following Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589 (Bywater).

As outlined at paragraph 10 of TR 2018/5, CM&C refers to the control and direction of a company's operations. Paragraph 11 of TR 2018/5 states that the key element in the control and direction of a company's operations is the making of high-level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter.

What activities constitute high-level decision-making?

Paragraph 16 of TR 2018/5 provides examples of what acts involve exercising CM&C:

16. Exercising central management and control of a company can involve:

•         setting investment and operational policy including:

o   setting the policy on disposal of trading stock, and/or the use and development of capital assets

o   deciding to buy and sell significant assets of the company

•         appointing company officers and agents and granting them power to carry on the company's business (and the revocation of such appointments and powers)

•         overseeing and controlling those appointed to carry out the day-to-day business of the company, and

•         matters of finance, including determining how profits are used and the declaration of dividends.

Who exercises CM&C?

Paragraph 19 of TR 2018/5 states that identifying who exercises CM&C is a question of fact. Paragraphs 20-22 of TR 2018/5 provide that:

20. Normally, where a company is run by its directors in accordance with its constitution and the company law rules applicable to that company, which give its directors the power to manage the company, the company's directors will control and direct its operations. It follows that ordinarily it is a company's directors who exercise its central management and control.
21. However, the actions of a company's directors, or others with the legal power and authority to control and manage the company, are not the end of the enquiry as to who exercises central management and control. There is no presumption that the directors of a company will always exercise its central management and control.
22. When determining who exercises a company's central management and control, all the relevant facts and circumstances must be considered. Facts and circumstances to be considered in determining who exercises a company's central management and control include the role of anyone who assumes the role of the directors' role in managing and controlling the company's affairs or has a role in the decision-making processes or governance of the company.

Where is the CM&C carried out?

In determining where CM&C of a company is exercised, paragraph 30 of TR 2018/5 provides:

30.   A company will be controlled and directed where those making its high-level decisions do so as a matter of fact and substance. It is not where they are merely recorded and formalised, or where the company's constitution, bylaws or articles of association require it be controlled and directed, if in reality it occurs elsewhere. This will not necessarily be the place where those who control and direct a company live.

Paragraph 34 of TR 2018/5 states that where a company's CM&C is exercised is not determined by where the directors, or other persons, who control and manage it, are resident or live. It states that what matters is where they actually perform the activities to control and direct the company. Relevant considerations in determining where CM&C is exercised are provided in paragraphs 35-38 of TR 2018/5.

As no single factor alone will necessarily determine where CM&C of a company is exercised, the relevance and weight to be given to each factor will depend on the facts and circumstances of the case and surrounding circumstances.

Application to ABC

The directors of ABC exercise the following functions at board meetings:

(a) setting investment and operational policy by:

(i) setting the policy on the use and development of capital assets; and

(ii) deciding to buy and sell significant assets of the company;

(b) appointing company officers and agents and granting them power to carry on the company's business (and the revocation of such appointments and powers);

(c) overseeing and controlling those appointed to carry out the day-to-day business of the company; and

(d) determining matters of finance, including determining how profits are used and the declaration of dividends.

Based on the above, it is considered that ABC's CM&C is exercised by its directors at board meetings.

ABC's board has at all relevant times been comprised of three directors. During the relevant income years, it is not the case that any particular board member dictated or controlled the decisions made by the directors to the exclusion of the other directors. Neither was it the case that any person outside of the board dictated or controlled the decisions made by the directors.

From 1 January 20XX, there was a change in the composition of the board with the appointment of an additional Australian resident director and the retirement of a Country B resident director at that time. From that time, board meetings were generally held in Australia, with a majority of directors participating in the meetings from Australia.

In some instances, board meetings were nominally held in Country B, with one director physically present in Country B, however, in these cases the two Australian resident directors would participate by telephone from Australia. Board meetings were held in this manner throughout the period up to and including the year ended 31 December 20XX.

Based on the factors discussed in TR 2018/5, it is considered that the board of directors of ABC held its meetings and made decisions in Australia and had its central management and control exercised in Australia from 1 January 20XX.

Carries on business in Australia

The phrase 'carries on business' is not defined in Australia's income tax legislation. Whether business is being carried on is a matter of fact. When the company in question does in fact carry on business, the question to be considered in the context of the voting power test is whether the company carries on that business in Australia.

In FCT v Murray (1998) 193 CLR 605; 39 ATR 129 it was stated that '[a] business is not a thing or things. It is a course of conduct carried on for the purposes of profit and involves notions of continuity and repetition of actions.' It is considered that the phrase 'carries on business' in the definition of 'resident' in subsection 6(1) of the ITAA 1936 should be read in wide context to encompass all activities carried on by a company whether or not those activities are of a passive nature or would be described as 'business' within the common meaning of that word.

ABC carries on a widget business in Australia. It also has its CM&C in Australia. Therefore, it carries on business in Australia for the purposes of the definition of 'resident' in subsection 6(1) of the ITAA 1936.

Therefore, ABC is a resident company under the CM&C test within subsection 6(1) of the ITAA 1936 from 1 January 20XX.

Question 2

Was ABC deemed to be a resident solely of Country B under the Treaty for the period from 1 January 20XX to 31 December 20XX?

Detailed reasoning

For the purposes of the Treaty, ABC is prima facie a resident of both Contracting States and it is necessary to consider the 'tie breaker rule' in Article 4 of the Treaty.

As Article 4 of the Treaty states that a resident of both Country B and Australia should be treated solely as a resident of the place in which it was created, ABC is a resident solely of Country B for the purposes of the Treaty.

Therefore, during the period 1 January 20XX to 31 December 20XX, ABC would be considered solely a Country B resident for the purposes of the Treaty.

Question 3

Is interest income derived by ABC from its Country B bank accounts during the period 1 January 20XX to 31 December 20XX assessable income under subsection 6-5(2) of the ITAA 1997?

Detailed reasoning

As a resident of Australia for Australian income tax purposes, ABC's assessable income for the purposes of subsection 6-5(2) of the ITAA 1997 will include, in the first instance, income from all sources worldwide unless an exception applies.

However, as ABC is solely a resident of Country B for the purposes of the Treaty, ABC is liable to tax in Australia only in certain situations. Therefore, ABC will remain, in relation to each country, a resident for the purposes of its domestic law and subject to each country's tax insofar as the Treaty allows.

During the income year ended 31 December 20XX, ABC earned interest income on an intra-company cash pool account and a bank deposit located in Country B.

The monies in the accounts are used to pay miscellaneous expenses of ABC. The relevant Country B bank accounts are exclusively designated for use by ABC and for ABC's expenses only. The only expenses that have previously been paid from these bank accounts have been audit fees. The cash in the accounts are treated as assets of the Australian operations for accounting purposes.

In the first instance it needs to be considered whether the interest income is subject to taxation under Article 11 of the Treaty.

In the present circumstances, the payers of the interest are not Australian residents. Therefore, Article 11 of the Treaty will not deem the interest as arising in Australia.

Article 11 of the Treaty also provides that if the derivation of that interest income is 'effectively connected' to the Australian permanent establishment of ABC, the interest income will form part of the business profits of the permanent establishment and will therefore be assessable under the provisions of Article 7 of the Treaty.

Article 7 of the Treaty deals with the taxation, as between Australia and Country B, of the business profits of an enterprise.

Article 7 of the Treaty provides that the business profits of an enterprise of Country B shall be taxable only in Country B unless the enterprise carries on business in Australia through a permanent establishment situated in Australia. Article 7 of the Treaty also provides that the profits to be attributed to the permanent establishment are profits which the permanent establishment might reasonably be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment or with other enterprises with which it deals.

Taxation Ruling TR 2001/11 Income tax: international transfer pricing - operation of Australia's permanent establishment attribution rules (TR 2001/11) deals with the operation of Australia's permanent establishment attribution rules and introduces the permanent establishment concept in the sourcing of income and allocation of expenditure.

Paragraph 3.19 of TR 2001/11 provides that the Interest Articles in Australia's tax treaties and in the OECD Model Tax Convention on Income and Capital (the OECD Model Convention) use the phrase 'effectively connected with' to describe the attribution concept of the Business Profits Article. In this regard the term 'effectively connected with' refers to the property giving rise to the income in question.

In the present circumstances, ABC's activities in Australia give rise to a permanent establishment in Australia for the purposes of the Treaty. Therefore, any income that constitutes business profits of an enterprise carried on by ABC in Australia is not prevented from being taxed in Australia under Article 7 of the Treaty, if the income is 'effectively connected with' the permanent establishment of ABC in Australia.

The term 'effectively connected' used in Article 11 of the Treaty is not defined by the Treaty under the General Definitions Article. It is therefore relevant to consider the interpretation of this term by the Commentaries to the OECD Model Tax Convention on Income and on Capital (the OECD Commentary).

The OECD Commentary on paragraph 4 of Article 11 provides at paragraph 25.1 that a 'debt-claim' (which, at paragraph 18, is defined to include cash deposits) will be effectively connected with a permanent establishment and will therefore form part of its business assets, if the 'economic ownership' of the debt-claim is allocated to that permanent establishment. It is further explained that, in this context the 'economic ownership' of a debt claim means the equivalent of ownership for income tax purposes by a separate enterprise with the right to the interest attributable to the ownership of the debt-claim and the exposure to gains or losses from the appreciation or depreciation of the debt-claim.

In applying Article 7 of the Treaty, the facts and circumstances must, in the first instance, be examined in order to determine the extent to which the assets of the enterprise are economically owned by and/or used in the functions performed by the permanent establishment.

In the present circumstances, the property giving rise to the income in question is the 'debt-claim' or the funds maintained by ABC in the Country B bank accounts which give rise to interest income. The funds held in the bank accounts are maintained for the purposes of expenditure relating to ABC's miscellaneous expenses. Given that there are no relevant activities that ABC undertakes other than the Australian operations undertaken through the Australian permanent establishment, it is appropriate to consider the assets to be allocated to the Australian permanent establishment.

The Australian permanent establishment of ABC is therefore considered to have 'economic ownership' of the funds held in the bank accounts (the debt-claim) as it is involved in the use of the debt-claim and effectively assumes any risks associated with the debt-claim.

As it is considered that the interest income derived from the Country B bank accounts is 'effectively connected' to the permanent establishment in Australia, it will form part of its business profits in Australia for the purposes of Article 7 of the Treaty.

Accordingly, Article 7 of the Treaty allocates Australia the taxing right of the Country B interest income. As such, the interest income derived by ABC from its Country B bank accounts during the period 1 January 20XX to 31 December 20XX is assessable income under subsection 6-5(2) of the ITAA 1997.

Question 4

Will ABC be a resident of Australia under subsection 6(1) of the ITAA 1936 from 1 January 20YY?

Detailed reasoning

It is assumed there will be no change to the arrangements concerning ABC's central management and control, i.e. it will continue to have a majority of directors resident in Australia and board meetings will continue to be held in Australia where the relevant activities are carried out in relation to the high-level decision making.

For the period from 1 January 20YY onwards, ABC should continue to be regarded as an Australian resident for the purposes of Australian tax law under subsection 6(1) of the ITAA 1936 for the same reasons as set out in Question 1.

Question 5

Will ABC be deemed to be a resident solely of Country B under Article 4 of the Treaty (as modified by Article 4(1) of the MLI) from 1 January 20YY?

Detailed reasoning

The MLI is a multilateral treaty that enables jurisdictions to swiftly modify their bilateral tax treaties to implement measures designed to better address multinational tax avoidance and more effectively resolve tax disputes. The tax treaties which are covered by the MLI are called 'Covered Tax Agreements' (CTAs).

Country B and Australia entered the MLI into force in accordance with Article 34 of the MLI. Both Country B and Australia have made notifications that they consider the Treaty to be a Covered Tax Agreement and have therefore adopted the MLI's terms in respect of the Treaty subject to their individual notifications.

Articles 4(2) and 4(4) of the MLI provide that Article 4(1) of the MLI (the new dual residence article of the MLI) will replace the existing "tiebreaker" article in a Covered Tax Agreement where the Contracting States notify for this to occur. Both Country B and Australia have made the relevant notifications pursuant to Article 29(1) of the MLI in respect of Article 4(4) of the Treaty.

From 1 January 20YY, the operation of the Treaty is modified by the MLI in respect of Article 4 of the Treaty.

Australia has entered a reservation pursuant to Articles 4(3)(e) and Article 28(3) of the MLI, which modifies the text of Article 4(1) of the MLI. (It is noted Country B has not made this reservation, however, under Article 28 of the MLI, Australia's reservation is sufficient to mean that it applies for Country B as well).

Article 4(1) of the MLI (as modified by Australia's reservation) therefore displaces the operation of Article 4 of the Treaty. The modification to the Treaty due to the accession to the MLI and Australia's reservation has the effect that Article 4(4) of the Treaty is replaced by Article 4(1) of the MLI, which provides:

Where by reason of the provisions of a Covered Tax Agreement a person other than an individual is a resident of more than one Contracting Jurisdiction, the competent authorities of the Contracting Jurisdictions shall endeavour to determine by mutual agreement the Contracting Jurisdiction of which such person shall be deemed to be a resident for the purposes of the Covered Tax Agreement, having regard to its effective place of management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions.

(NB: The struck out wording reflects the modification made by Australia.)

Both Country B and Australia have adopted the provisions of Article 16 of the MLI which governs the procedure for seeking "mutual agreement" between the competent authorities in respect of issues arising under treaties. Any such determination is obtained by way of application with either of the jurisdictions' competent authorities, and will broadly be subject to a mutual process of assessment and determination. This process is not automatic and ABC would need to take proactive steps with either Australian or Country B tax authorities to determine its residence for treaty purposes.

Where no such mutual agreement by the Country B and Australian tax authorities has been sought, ABC is not considered to be deemed a resident solely of Country B (or Australia) for the purposes of the Treaty from 1 January 20YY.

Question 6

Is interest income derived by ABC from its Country B bank accounts from 1 January 20YY assessable income under subsection 6-5(2) of the ITAA 1997?

Detailed reasoning

As a resident of Australia for Australian income tax purposes, ABC's assessable income for the purposes of subsection 6-5(2) of the ITAA 1997 will include, in the first instance, income from all sources worldwide unless an exception applies.

From 1 January 20YY, ABC will not be entitled to rely upon the benefits of the Treaty unless and until there has been mutual agreement between the Country B and Australian competent authorities to determine the residency of ABC.

Therefore, ABC is subject to Australian domestic laws and may be required to include any Country B Interest in its Australian assessable income from 1 January 20YY onwards, regardless of whether these amounts are attributable to a permanent establishment of ABC in Australia.

It is expected that further interest income will be derived by ABC from the Country B bank accounts from 1 January 20YY. The interest earned on these accounts would be considered to be assessable income.

Therefore, as Article 7 of the Treaty does not prevent Australia from taxing the Country B interest, the Country B interest derived by ABC from its Country B bank accounts during the period from 1 January 20YY is assessable income under subsection 6-5(2) of the ITAA 1997.

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