Edited version of your written advice

Authorisation Number: 1012872289704

Date of advice: 4 September 2015

Ruling

Subject: Non-resident subsidiary

Question 1

For the purposes of Parent Co calculating any possible entitlement to a reduced capital gain or loss under Subdivision 768-G of the Income Tax Assessment Act 1997 (ITAA 1997), is Offshore Sub Co considered to be a foreign resident as defined by section 995-1 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

January 20XX - December 20XX.

The scheme commences on:

January 20XX.

Relevant facts and circumstances

The ultimate parent entity of Offshore Sub Co is Parent Co, a company incorporated in a state of Australia.

Offshore Sub Co is a company incorporated in a foreign country with its registered office in that foreign country and is a wholly owned subsidiary of Parent Co.

Offshore Sub Co carries on business in a specific industry in the foreign country through its interest in an unincorporated joint venture operated by a large multi-national corporation, known as the Project. The Project consists primarily of plant and processing facilities in the foreign country.

Offshore Sub Co has no income earning activities in Australia and has only one significant operational activity which is the conduct of specific operations through its interest in the Project.

Offshore Sub Co has less than five directors who are based in Australia and one director who is based in the foreign country. The Financial Statements for Offshore Sub Co indicate that the directors of Offshore Sub Co were not paid directly by Offshore Sub Co, and that Offshore Sub Co employs no permanent staff.

The Board meetings are held between the capital of a foreign country and Australia. The Project meetings for the main operating committee generally alternate between the capital of foreign country and Australia.

The major assets of Offshore Sub Co consist of its interest in the Project.

Offshore Sub Co holds an equity interest in a specific licence, and a smaller equity interest in the Project. However, the interest in the Project is also used as security under related financial arrangements.

Whilst Offshore Sub Co has minimal specific obligations, it does have capital expenditure obligations as well as operating and finance lease obligations.

The agreements entered into by Offshore Sub Co govern the joint operations under the Project and unitises Offshore Sub Co's interest in the Project. Another agreement entered into with the Government of the foreign country and the licensees of various other specific licences in the foreign country are also part of the Project. This agreement governs the development of the Project, provides government fiscal stability for the Project and sets out the rights and obligations of land owners whose land is affected by the Project.

A further agreement has been entered into between the Government of the foreign country, a separate entity which is responsible for logistics and sales associated with the Project (Logistics Co) and the joint venture parties in the Project and sets out how Logistics Co markets, sells and arranges for the shipping of output from the Project.

Logistics Co is a company owned by the joint venture parties and operated by a large multi-national company. Logistics Co was incorporated to conduct certain activities relevant to the finance structure of the Project, including the obtaining of external borrowings and on-lending these borrowings to the Operator of the Project to fund the Project on behalf of the joint venturers. Logistics Co is also the sole purchaser of the product produced by the Project from the joint venturers. Logistics Co resells that product, and undertakes the chartering of vessels to transport the product of the Project. Logistics Co has long-term supply agreements to sell the product to major customers in the region.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 subsection 6(1)

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

Income Tax Assessment Act 1997 Subdivision 768-G

Income Tax Assessment Act 1997 subsection 768-505(1)

Income Tax Assessment Act 1997 subsection 995-1

Reasons for decision

Unless stated otherwise, all legislative references are to the Income Tax Assessment Act 1997.

In order to be entitled to a reduced capital gain (or loss) under Subdivision 768-G, Parent Co will need to satisfy subsection 768-505(1). Relevantly, the subsection provides that:

The *capital gain or *capital loss a company (the holding company) that is an Australian resident makes from a *CGT event that happened at a particular time (the time of the CGT event) to a *share in a company (the foreign disposal company) that is a foreign resident is reduced if:

Therefore, satisfaction of subsection 768-505(1) is contingent upon Offshore Sub Co being a foreign resident within the meaning of the subsection. The definition of foreign resident for income tax purposes is set out in subsection 995-1(1). The provision provides:

foreign resident means a person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936.

The term 'resident' in relation to a company is defined within subsection 6(1) of the Income Tax Assessment Act 1936 (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. For a company incorporated in Australia, this is where the inquiry ends.

This is emphasised in Taxation Ruling TR 2004/15 Income tax: residence of companies not incorporated in Australia - carrying on business in Australia and central management and control, where it provides that a company will be a resident under the second statutory test if two separate requirements are met. The first is that the company is carrying on business in Australia, and the second is that the CM&C is located in Australia. If no business is carried on in Australia, satisfaction of the second requirement is irrelevant, as the company will not be a resident. Paragraphs 5 and 6 state:

5. For a company to be a resident under the second statutory test two separate requirements must be met. The first is that the company must carry on business in Australia, and the second is that the company's central management and control (CM&C) must be located in Australia.

6. 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. If the company carries on business in Australia it also has to have its CM&C in Australia to meet the second statutory test.

Carries on business in Australia

In order for Offshore Sub Co to be 'carrying on a business' in Australia, it will be necessary to make a factual determination in relation to Offshore Sub Co's broader activities. In other words, are the predominant activities of Offshore Sub Co 'operational' in nature, or are they more 'passive' such that Offshore Sub Co can be characterised as a mere holding entity?

This is further discussed in TR 2004/15, where it provides that the question of where business is carried on is one of fact. It requires a consideration of where the major operational activities of the company are carried on. Paragraph 9 and 10 state:

9. 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. However, the Commissioner's approach to this factual determination is to draw a distinction between a company with operational activities (for example trading, service provision, manufacturing or mining activities) and a company which is more passive in its dealings. It is appreciated that there will be some overlap in any particular situation.

10. 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.

In considering the notion of 'carrying on business' in Australia, paragraph 12 of TR 2004/15 states:

12. It is considered that for the purposes of paragraph 6(1)(b), the concept of carrying on a business may be wider than its ordinary meaning and extends to undertakings of a business or a commercial character. For example, for the purposes of the second statutory test, a company may be carrying on business even if its only activity is the management of its investment assets.

Paragraphs 22-27 of TR 2004/15, explain that in determining whether or not an entity is 'carrying on a business' it is necessary to examine all the relevant facts and circumstances of the entity's activities to determine whether it carries on business in Australia.

The reasons for reliance on 'all the relevant facts and circumstances' is consistent with the decision of the Court of Exchequer In Californian Copper Syndicate v Harris (1904) 5 TC 159, which is regarded as authority for the proposition that in determining whether a taxpayer is carrying on a business, the relevant inquiry will be a question of fact.

Similarly, Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number considers the meaning of an entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number. Paragraphs 197-201 of MT 2006/1 consider when holding companies (and other entities) will be carrying on a business, and at paragraph 200 of MT 2006/1 the Commissioner identifies some criteria which may assist in determining when a holding entity is carrying on a business. However, MT 2006/1 goes on to state at paragraph 201 that:

Whil[st] these indicators may give guidance as to whether an entity's activities are sufficient for it to be considered to be carrying on an enterprise, deciding that question is ultimately a matter of fact having regard to the scale of the activities undertaken, the form of operation of the corporate group and the commercial context in which it occurs.

Accordingly, in determining whether or not Offshore Sub Co is 'carrying on business' in Australia, the Commissioner will need to determine what are the relevant facts and circumstances, and this will include considering:

• What are the predominant activities of Offshore Sub Co

• Where are the activities carried out

• What are the assets of Offshore Sub Co

• How is Offshore Sub Co managed

The relevant facts and circumstances

The predominant activities of Offshore Sub Co

The Constitution of Offshore Sub Co does not recite what are the objects of the company. However, a certificate issued to Offshore Sub Co by the Government of the foreign country does authorise Offshore Sub Co to carry on business of the type undertaken in the Project.

These activities are consistent with Offshore Sub Co major activities implicit in its financial statements. These are the activities that Offshore Sub Co has been undertaking.

The Commissioner is satisfied that Offshore Sub Co's predominant activities are its interests in the Project and ancillary activities associated with these.

Where the activities are carried out

The activities of Offshore Sub Co are predominantly conducted within foreign country. Whilst the Commissioner notes that the central management and control of Offshore Sub Co is likely to be determined to be within Australia, such a factor need only be considered once it has been determined that the company carries on business in Australia.

The assets of Offshore Sub Co

As identified above, the major assets of Offshore Sub Co are those associated with the Project.

Offshore Sub Co holds an equity interest in a specific licence, and an equity interest in the Project. Whilst Offshore Sub Co has minimal specific obligations, it does have capital expenditure obligations as well as operating and finance lease obligations.

The sizeable interest that Offshore Sub Co has in the Project and the specific licence are its only major assets.

The management of Offshore Sub Co

As discussed above, the Project meetings for the main operating committee generally alternate between the capital of the foreign country and Australia. The Board meetings are held between the capital of the foreign country and Australia.

The Commissioner notes that the management of Offshore Sub Co could be regarded as being carried out within Australia, however, such a factor need only be considered once it has been determined that the company carries on business in Australia.

Case law

The circumstances of Offshore Sub Co can be distinguished from the principles discussed in Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 156; (1946) (Malayan Shipping). In Malayan Shipping a single judge of the High Court examined the question of whether or not the Malayan Shipping Company Ltd was a non-resident for tax purposes. It concluded that despite the presence of a Malayan board of directors, the managing director Mr Sleigh effectively controlled the company and that the business of Malayan Shipping was where the central control and management of the company was located and hence was an Australian resident for income tax purposes.

In Malayan Shipping, the business of the company was the chartering of a ship and its subsequent rechartering out to Mr Sleigh. The charter documents were signed in London by shipping agents on behalf of the company, following instructions cabled by Mr Sleigh. Mr Sleigh also prepared and executed all the relevant documents from Australia. Mr Sleigh was also empowered to appoint and remove the other directors. The articles provided that no resolution of the company was effective without his agreement and Mr Sleigh had sole authority to affix the seal of the company.

The powers conferred via the Constitution of Offshore Sub Co results in the board of Offshore Sub Co retaining control of the company, that is, no individual has a right of veto. Further, the seal of Offshore Sub Co can only be affixed by a Director and one other person authorised to attach the seal. These factors support the contention that control remains with the board of directors of Offshore Sub Co.

Similarly, in Case H14 76 ATC 92 (Case H14) the taxpayer was incorporated as a proprietary company in foreign country on 24 June 1966. The subscribers to the memorandum and articles of association and its first directors were A, his wife B, and C, who each took one ordinary share in the capital of the company.

A and B were, at all material times, residents of Australia for the purposes of the Assessment Act 1936 (as amended). C was at all material times a resident of foreign country and was not a resident of Australia. A and B were directors of the company throughout the period under review.

The registered office of the taxpayer under the Companies Ordinance 1963 was, at all material times, located at an accountant's office in X. The taxpayer did not register in Y as a foreign company under the specific Companies Acts.

Whilst the position of Offshore Sub Co may be seen as similar to that of the taxpayer in Case H14, Offshore Sub Co' position is different for the following reasons:

• The shareholders of the taxpayer in Case H14 were three individuals, whereas the ultimate holding company of Offshore Sub Co is a large listed Australian public company

• The investments made by the taxpayer in Case H14 were in Australian companies who derived their income from Australian sources, whereas the investments made by Offshore Sub Co are in the foreign country, and the returns from those investments have a non-Australian source

The taxpayer's argument in Case H14 was that it did not carry on business at all in Australia. The taxpayer simply made investments, and thereafter received dividends from those investments. Consequently, it followed, according to the argument, that it was a non-resident which did not carry on business in Australia during the period in question.

The position of the taxpayer in Case H14 is not consistent with the position of Parent Co relative to Offshore Sub Co. Whilst both were incorporated in foreign country, unlike the taxpayer in Case H14, Offshore Sub Co does not undertake any business in Australia.

Accordingly, Offshore Sub Co is not a resident within the meaning of subsection 6(1) of the ITAA 1936, and accordingly is a foreign resident within the meaning of that term in subsection 995-1 and subsection 768-505(1).