Edited version of administratively binding advice

Authorisation Number: 1052095534735

Date of advice: 14 March 2023

Subject: Controlled foreign company

Relevant facts and circumstances

You are a dual citizen of Australia and Country A.

You are a resident of Australia for Australian tax purposes and will continue to reside in Australia.

You propose to incorporate a company in Country A (the Company) to operate the business.

The business, to be located in Country A, will employ a manager, bookkeeper and accountant who will be responsible for the day-to-day operation of the business.

You will be a director and shareholder of the Company.

You propose that all key investment decisions and board meetings will be held in Country A and that each of the Directors will travel to Country A to attend meetings. Where any major business or financial meetings are required outside of scheduled meetings you and the directors will attend board meetings in Country A. Monthly meetings with management will take place via an online service.

You have advised that the Company will be liable to pay tax in Country A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 770-135

Income Tax Assessment Act 1936 section 6-1

Income Tax Assessment Act 1936 section 340

Income Tax Assessment Act 1936 section 393

Question 1

Will the Company be a resident of Australia pursuant to section 6(1) of the Income Tax Assessment Act 1936?

Summary

No.

Detailed reasoning

Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) defines an Australian company resident for taxation purposes as 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.

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 central management and control tests for company residency.

The first requirement is that the company carries on business in Australia. Paragraph 8 of TR 2018/5 states:

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. This is because the central management and control of a business is factually part of carrying on that business. A company carrying on business does so both where its trading and investment activities take place, and where the central management and control of those activities occurs.

Paragraphs 10 to 13 of TR 2018/5 outlines what central management and control means:

10. Central management and control refers to the control and direction of a company's operations.9 It does not refer to a physical location in which the control and direction of a company is located, and may ultimately be exercised in more than one location.

11. 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.

12. The control and direction of a company is different from the day-to-day conduct and management of its activities and operations.12 The day-to-day conduct and management of a company's activities and operations is not ordinarily an act of central management and control. Nor is the management of day-to-day activities under the authority and supervision of higher-level managers or controllers.

13. The day-to-day conduct and management of a company's operations might be an exercise of central management and control in circumstances where they are effectively the same. For example, for a small passive investment company with a very small number of investments, the decisions to make, hold and dispose of those investments, would be both the day-to-day management and the central management and control of the company.

Application to your Circumstances

Central management and control will not be located in Australia for the following reasons:

-       The Company will be registered in Country A.

-       The Company will carry on its business operations in Country A.

-       The day-to-day operations will be managed by staff in Country A.

-       All high-level decision making will be carried out in Country A.

Question 2

Will the proposed Company be a Controlled Foreign Company (CFC) pursuant to section 340 of the Income Tax Assessment Act 1936?

Summary

Yes

Detailed reasoning

The controlled foreign company (CFC) provisions are contained in Part X of the Income Tax Assessment Act 1936 (ITAA 1936). The accruals system applies to Australian residents who have a substantial interest in a foreign company controlled by Australians. The system operates to include a taxpayer's share of specified income and gains of a CFC in the taxpayer's assessable income: this is called attribution. This is achieved by attributing tainted income to the Australian resident controllers of the CFC.

There are modifications to the attributable income where the CFC is located in a country that taxes income in a similar way to Australia. The attributable income is also modified where the CFC has significant income from actively carrying on business.

Section 340 of the ITAA 1936 contains the definition of CFC. The determination of the status of a foreign company as a CFC arises from a consideration of the direct and indirect control interests held by Australian entities in the company.

The following factors need to be established in order for a company to be a CFC:

1. Is the entity a company?
2. Is the company a resident of either a listed country or an unlisted country?
3. Is there a group of five or fewer Australian 1% entities, the aggregate of whose associate inclusive control interests in the company, is not less than 50%? (strict control test)

Application to your Circumstances

The Company will be a CFC for the following reasons:

-       The Company will meet the definition of a company as it will be a body corporate and will not be a partnership or a ^* non-entity joint venture pursuant to section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

-       The Company will be a resident of Country A which is a listed country.

-       There will be 5 Australian resident shareholders which together will have an associate inclusive control interest in the company of greater than 50%.

Question 3

Where the CFC pays tax in Country A, will you be eligible to claim a foreign tax offset?

Summary

No.

Detailed reasoning

In calculating attributable income, section 393 of the ITAA 1936 allows a deduction for foreign tax and Australian tax paid by a CFC that relates to the eligible period, whether paid before, during or after the eligible period.

A foreign income tax offset (FITO) may also apply to a company (other than a CFC) that is an attributable taxpayer which is assessed under the CFC rules, in order to prevent double taxation. Section 770-135 of the ITAA 1997 deals with foreign tax paid by a CFC and allows a FITO only when the attributed entity is a company.

Your attributable income is reduced by the tax paid by the proposed Company, however as you are an individual and not a company, you will not be entitled to a foreign income tax offset to apply against your attributable income.

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