Edited version of your written advice

Authorisation Number: 1051465026165

Date of advice: 13 December 2018

Ruling

Subject: Residency status of foreign incorporated company and distribution of the shares

Legislative references in this Ruling are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936), or to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Question 1

Is X Co a ‘resident of Australia’ within the meaning of section 6?

Answer

No

Question 2

Will the distribution of the shares in AUS Co occurring in connection with the liquidation of Y Co under the Proposed Reorganisation result in an amount being included in Y Co’s assessable income as either ordinary income under section 6–5 or statutory income under section 6–10?

Answer

No

Question 3

Will the distribution of the shares in AUS Co occurring in connection with the liquidation of Y Co under the Proposed Reorganisation result in an amount being included in X Co’s assessable income as either ordinary income under section 6–5 or statutory income under section 6–10?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

April 2018

Relevant facts and circumstances

Relevant Group entities

1. X Co

X Co is a limited company, incorporated in X and wholly owned by a company situated in the Y. X Co was incorporated in order to serve as the foreign holding company for the Taxpayer’s non-Y operations, consolidate and rationalise certain operations currently carried out by four existing X entities and to serve as future strategic, non-Y acquisitions.

The decision to incorporate X Co in the X was driven, in part, by the availability of X management talent, which is necessary to leverage as the relevant market expands.

2. Y Co

Y Co is a Y incorporated company. Y Co is disregarded (i.e. treated as part of its parent company) for Y tax purposes. Y Co’s sole function is to operate as a holding company for a number of the Group’s subsidiaries in Europe, the UK, Asia Pacific and other non-US jurisdictions.

Y CO is controlled exclusively by employees and directors who meet and do business outside of Australia and its business activities (which comprise of holding shares, receiving dividends and distributing dividends to its shareholders) are carried on outside of Australia. The high-level decisions that set Y CO’s general policies and determine its strategic direction and the types of transactions it will enter into are made by Y CO’s directors (all based in the Y) in meetings held outside of Australia.

Y CO has no employees or tangible assets located in Australia.

Y CO has no permanent establishment in Australia.

3. AUS Co

AUS CO is a public limited company incorporated in Australia and wholly owned by Y CO since December 2010.

AUS CO is the head company of an Australian tax consolidated group. AUS CO is an Australian resident for tax purposes.

The shares in AUS CO (and one other foreign entity) constitute the only property held by Y CO.

Y CO holds the shares in AUS CO on capital account.

Land and buildings represent the majority of the value of the Australian real property held indirectly by AUS CO. The most recent audited financial statements prepared for AUS CO and its controlled entities as at 30 June 2017 indicate that the aggregate value of AUS CO’s assets (not including off balance sheet assets, such as goodwill) and the subsidiaries with which it is consolidated for accounting purposes vastly exceeds (i.e. is far more than double) the value of its indirectly held Australian real property assets.

Proposed Reorganisation

4. The Group is proposing to undertake an internal reorganisation consisting of:

a) the transfer of shares in Y CO from its ultimate parent company to a subsidiary of the ultimate parent company

b) the transfer of shares in Y CO from the subsidiary of the ultimate parent company to X Co, and

c) the transfer of shares in AUS CO from Y CO to X Co in connection with the liquidation of Y CO.

The above steps are collectively called the Proposed Reorganisation.

5. The Proposed Reorganisation, which forms part of a broader rationalisation of the Group’s global operations, is being undertaken with the objective of streamlining the Group’s non–Y operations under X Co.

6. X CO will have oversight over the Group’s European operations and will perfom (exclusively from the X) legal and financial functions in relation to non–Y Group entities. Additionally, the Group intends to transfer certain functions and operations of its existing X entities to X CO.

X CO’s Board of Directors (the Board)

7. The Board consists of two directors – a X based director and a Y based director.

8. The Board reports to the personnel located outside Australia (generally, the Y) and rely on an immediate team of advisors who are also situated outside of Australia.

9. Under its constitution, the directors of X CO are empowered to undertake the kinds of strategic decision making such as:

● the setting of X CO’s investment and operational policy

● appointing company officers and agents and granting them the power to act on behalf of X CO as well as overseeing and controlling such appointees, and

● matters of finance, for example, determining how X CO’s profits are to be used, when to declare dividends, borrow money and mortgage property.

10. The directors of X CO will meet (via online means) from the X and the Y.

11. X CO’s books, share register and registered office are all located in the X (or otherwise outside of Australia).

Voting power

12. X CO’s sole shareholder is a Y domestic corporation which operates exclusively in the Y and its books and share register are held in the Y.

13. The X CO’s shareholder is not a resident of Australia.

14. The high level decisions that set up the X CO’s shareholder general policies and determine the direction of its operations and the type of transactions it will enter into are carried out from the Y. None of X CO shareholder’s directors, or otherwise the persons that materially influence its decision making, are situated in Australia.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1936 paragraph 44(1)(b)

Income Tax Assessment Act 1997 subsection 6–5(3)

Income Tax Assessment Act 1997 section 6–10

Income Tax Assessment Act 1997 Subdivision 855–A

Income Tax Assessment Act 1997 paragraph 855–10(1)

Income Tax Assessment Act 1997 subsection 855–15

Income Tax Assessment Act 1997 subsection 855–20

Income Tax Assessment Act 1997 subsection 855–25

Income Tax Assessment Act 1997 subsection 855–30

Income Tax Assessment Act 1997 subsection 960–195

Reasons for decision

Legislative references in this Ruling are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936), or to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Question 1

Is X CO a ‘resident of Australia’ within the meaning of section 6?

Summary

X CO is not a ‘resident of Australia’ within the meaning of section 6.

Detailed reasoning

The term ‘resident’ in relation to a company is defined within subsection 6(1), (paragraph (b) of the definition 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

X CO is incorporated in the X. Therefore, X CO is not a resident of Australia under the incorporation test within subsection 6(1).

CM&C Test

Taxation Ruling TR 2018/5 Income tax: central management and control test of residency (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).

Carrying on business in Australia

Paragraphs 7 and 8 of TR 2018/5 state that:

7. If a company carries on business and has its central management and control in Australia, it will carry on business in Australia within the meaning of the central management and control test of residency.

8. 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.

The trading operations of X CO are performed exclusively outside of Australia. Nevertheless, X CO may carry on a business in Australia if the central management and control is in Australia as per the Commissioner’s view set out in paragraphs 7 and 8 of TR 2018/5.

Paragraph 10 and 11 of TR 2018/5 state that:

Central management and control refers to the control and direction of a company’s operations.

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 into.

Paragraph 16 of TR 2018/5 sets out examples of the high-level decisions which would normally be made in exercising central management and control, for example:

● setting investment and operational policy

● appointing company officers and agents

● 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.

Paragraph 20 of TR 2018/5 states that:

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.

That is, normally, the high-level decisions of the company will be made by its directors in accordance with the constitution and the company law rules which apply to the company. It follows that ordinarily, it is the company’s directors who exercise its central management and control.

In this case, X CO’s constitution empowers the directors to undertake the strategic decision making such as:

● the setting of X CO’s investment and operational policy

● appointing company officers and agents and granting them the power to act on behalf of X CO as well as overseeing and controlling such appointees, and

● matters of finance, for example, determining how X CO’s profits are to be used, when to declare dividends, borrow money and mortgage property.

Under X CO’s written resolution of the board of directors, the directors of X CO approved a number of matters relating to X CO’s incorporation including to dispense with the need for a company seal and to issue a share certificate to its parent company. In addition, the directors established X CO’s accounting period and approved appointment its auditor as well as the storage of X CO’s accounting records with in the X.

Additionally, under cover of this resolution and following consideration of the relevant documents and arrangements, the directors of X CO resolved to incorporate a new subsidiary, and to enter into a power of attorney in respect of this subsidiary.

A written resolution was passed under which the directors of X CO approved receipt of money as a contribution from its sole parent, in return for the issuance of certain ordinary shares (Contribution). The resolution notes that the Contribution was approved by the directors of X CO following detailed review of the documents affecting the Contribution.

X CO has two directors and both of them are based outside of Australia. They will meet (via online means) from the X and the Y, respectively. They rely on an immediate team of advisors who are also situated outside of Australia.

X CO’s books, share register and registered office are all located in the X (or otherwise outside of Australia).

Based on the facts, we consider that it is X CO’s directors who control and direct its operations. As such, it is X CO’s directors who exercise its CM&C from locations outside of Australia.

Therefore, as its CM&C is not in Australia, X CO is not a resident of Australia under the CM&C test within subsection 6(1).

Voting power test

As both X CO’s business activities and its CM&C are located outside Australia, X CO does not carry on business in Australia. Therefore, X CO will not satisfy the voting power test within subsection 6(1).

Furthermore, the sole shareholder of X CO is not a resident of Australia.

Conclusion

X CO does not satisfy the incorporation test, the CM&C test and the voting power test. Therefore, X CO is not a resident of Australia under subsection 6(1).

Question 2

Will the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO under the Proposed Reorganisation result in an amount being included in Y CO’s assessable income as either ordinary income under section 6–5 or statutory income under section 6–10?

Summary

As Y CO is a foreign resident, any capital gain or capital loss from the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO is disregarded under Subdivision 855A unless the shares are taxable Australian property. Based on the assumption that the market value of the taxable Australian real property assets of AUS CO does not exceed the market value of the non-taxable Australian real property asset, Y CO’s membership interest consisting of its shares in AUS CO do not pass the principal asset test in section 855–30, and consequently are not an indirect Australian real property interest under section 855–25. Further, the interest is not any other form of taxable Australian property under section 855–15. Any capital gain or capital loss from the distribution of the shares in AUS CO is therefore disregarded under subsection 855–10(1).

The facts provided in this case do not indicate that that Y CO derived any ordinary income from the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO under the Proposed Reorganisation.

Detailed reasoning

Statutory income under section 6–10

Subsection 855–10(1) entitles foreign residents to disregard a capital gain or loss from a CGT event if the CGT event happens in relation to a CGT asset that is not taxable Australian property.

Section 855–15 defines five categories of CGT assets that are taxable Australian property. Relevantly, these include:

1. Taxable Australian real property (see section 855–20)

2. A *CGT asset that:

(a) is an *indirect Australian real property interest (see section 855–25); and

(b) is not covered by item 5 of this table

…

Section 855-20 explains that a CGT asset is ‘taxable Australian real property’ if it is:

● real property situated in Australia (including a lease of land, if the land is situated in Australia); or

● a *mining, quarrying or prospecting right (to the extent that the right is not real property), if the *minerals, *petroleum or quarry materials are situated in Australia.

Section 855–25 broadly provides that an indirect Australian real property interest will exist if the membership interest that they hold passes:

● the non-portfolio interest test (per section 960–195), and

● the principal asset test in section 855–30.

In this circumstance, for the purpose of section 855–25, Y CO is the holding entity and AUS CO the test entity, and the shares held by Y CO in AUS CO constitute a membership interest.

The non-portfolio test

Section 960–195 describes the non-portfolio interest test as follows:

An interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the *direct participation interests held by the holding entity and its *associates in the test entity at that time is 10% or more.

As Y CO owns 100% of the shares in AUS CO, it will pass the non-portfolio test.

The principal asset test

According to subsection 855–30(2) the principal asset test will be satisfied if the sum of market values of the test entity’s assets that are taxable Australian real property exceeds the market value of the test entity’s assets that are not attributable to taxable Australian real property.

In applying the principal asset test in section 855–30, again Y CO is the holding entity and AUS CO is the test entity. Therefore, the enquiry under subsection 855–30(2) is to establish whether the sum of the market values of AUS CO’s assets that are taxable Australian real property exceeds the sum of the market values of its assets that are not taxable Australian real property.

Under subsection 855–30(3), Y CO’s membership interest in AUS CO is treated as if it were two assets, one being taxable Australian real property (the TARP asset) and the other not (the non-TARP asset).

The market value of the TARP asset is, according to subsection 855–30(4), the sum of the market values of AUS CO’s assets that are taxable Australian real property, while the market value of the non-TARP assets is the sum of the market values of AUS CO’s assets that are not taxable Australian real property (Y CO has 100% direct participation interest in AUS CO).

According to the most recent audited financial statements prepared for AUS CO and its controlled entities as at 30 June 2017, the value of the TARP assets (approximately 10.15% of the total asset) does not exceed the value of the non-TARP assets (approximately 89.85% of the total asset).

Assuming that the market value of the TARP assets does not exceed the market value of the non-TARP assets, Y CO’s membership interest consisting of its shares in AUS CO fails the principal asset test, and therefore the condition in paragraph 855–25(1)(b) is not satisfied. That interest is therefore not an indirect Australian real property interest. Further, the interest is not any other form of taxable Australian property under section 855–15. Hence the shares in AUS CO are not taxable Australian property, and so the condition in paragraph 855–10(1)(b) is satisfied.

Therefore, any capital gain or capital loss from the distribution of the shares in AUS CO is disregarded under subsection 855–10(1).

Ordinary income under section 6–5

Subsection 6–5(3) provides:

If you are a foreign resident, your assessable income includes:

(a) the ^*ordinary income you ^*derived directly or indirectly from all ^*Australian sources during the income year; and

(b) other ^*ordinary income that a provision includes in your assessable income for the income year on some basis other than having an ^*Australian source.

As such, to the extent there is a gain in the nature of ordinary income made on the disposal of the shares in AUS CO, Y CO could only be required to include the gain in its assessable income if the gain is Australian-sourced (not foreign sourced). Even if the gain is Australian-sourced, where the Convention between the Government of Australia and the Government of the Relevant Country for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (‘the Y DTA’) applies to Y CO and does not allow Australia to tax the gain, the gain will not form part of Y CO’s assessable income.

Based on the facts provided, the liquidation of Y CO and distribution of its shares in AUS CO does not result in a gain accruing to Y CO. As such there is no amount of income which could be subject to the operation of section 6–5 or the Y DTA.

Question 3

Will the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO under the Proposed Reorganisation result in an amount being included in X CO’s assessable income as either ordinary income under section 6–5 or statutory income under section 6–10?

Summary

No amount will be included in the assessable income of X CO either under section 6–5 or section 6–10 as a result of the distribution to it of the shares in AUS CO.

Detailed reasoning

The term 'dividend' is defined in subsection 6(1) and includes a distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of 'dividend' excludes a distribution that is debited against an amount standing to the credit of the share capital account of the company.

Subsection 47(1) provides that distributions to shareholders of a company by a liquidator in the course of winding up the company to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Paragraph 44(1)(b) provides that dividends (other than non-share dividends) paid to a shareholder that is a non-resident by the company to the extent to which they are paid out of profit derived by it from sources in Australia will be included in the shareholder’s assessable income. In addition, subsection 44(1A) provides that a dividend paid out of an amount other than profits is taken to be a dividend paid out of profits.

As such the distribution of the shares in AUS CO to X CO will be treated as a dividend.

The source of the distribution (being in the nature of investment income) should be determined by reference to the principles decided by the High Court in Esquire Nominees v FC of T 73 ATC 4114 (Esquire), wherein Menzies J held that:

In considering the source of a dividend the proper enquiry is not to ascertain where the production of wealth, to which it can ultimately be traced through other companies, took place. Nor is the source of a dividend upon a share to be attributed to the place where the share happens to be located. To determine the source of a dividend, it is necessary to examine the situation of the company which pays it out of its profits, rather than by merely looking at the share register. The most material consideration is the place where the profit, out of which the dividend was paid, was made.

The High Court went on to confirm that in the case of a holding company which makes it profit purely by investment, the source of profit should be treated as the place in which it has its central management and control.

Y CO is a holding company which makes it profit purely by investment. Y CO is a non-resident company. It is incorporated in the Y and carries on its business operations outside of Australia. Y CO’s central management and control is situated outside of Australia and Y CO does not have a permanent establishment in Australia.

Therefore, Y CO’s profits is treated as having been derived from sources outside of Australia (specifically, the Y) and any distributions paid by it to X CO will not be included in assessable income under section 6–5.

As X CO is a foreign resident, any capital gain or capital loss from the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO is disregarded under Subdivision 855A for the same reasons as stated in Question 2. The shares in Y CO do not constitute taxable Australian property as the shares in Y CO are not indirect Australian real property interests, nor do they constitute any other form of taxable Australian property under section 855–15.

As such, the distribution of the shares in AUS CO occurring in connection with the liquidation of Y CO under the Proposed Reorganisation will not result in an amount being included in X CO’s assessable income as either ordinary income under section 6–5 or statutory income under section 6–10.