Private ruling: Residency and Consolidation
Date of advice: 10 November 2017
Published: April 2018
Ruling period: Period ended 30 June 2010 | Period ended 30 June 2011 | Period ended 30 June 2012 | Period ended 30 June 2013 | Period ended 30 June 2014 | Period ended 30 June 2015

Ruling: Q1: Is Company X a resident under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the period covered by the ruling? | A1: Yes. Company X is a resident under paragraph 6(1)(b) of the ITAA 1936 for the period covered by the ruling. | Q2: If the answer to question 1 is in the affirmative, is Company X eligible to be a ‘subsidiary member’ of the Company Y Australian tax consolidated group, as defined in paragraph 703-15(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997), that satisfies the requirements in item 2 of the table in subsection 703-15(2) for the period covered by the ruling? | A2: Yes.

Relevant facts and circumstances: Company Y Australian tax consolidated group Company Y is the head company of an Australian tax consolidated group focused on delivering personal IT services. Company Y owns and operates, among others, Company Z, an Australian IT company and Company X, an established IT company incorporated in Country X. Company Z Company Z develops applications for consumers in Australia and Country X. Company Z employs all of the staff in the Company Y group of companies (‘Company Y group’) Company Z has all leasing, operational and credit risks associated with the business of the Company Y group. Company X Establishment Company X was established in Country X to enter into contracts with Country X service providers. Company X has not entered into a lease to establish an office space in Country X. It has a registered address at its Country X solicitor’s premises solely for the purpose of receiving correspondence. Company X’s headquarters have been located in Australia since its establishment. The company’s books of account are kept in Australia. Country X business operations Company X’s business operation in Country X is largely automated and does not involve Country X based personnel except for a resident director. Company X does not undertake any development of technology or intellectual property in Country X. Sales Company X relies on Company Z’s Australian technology to derive revenue from its services provided to residents of Country X. Directors Company X has X Australian resident directors who were appointed in their roles when the company was established. The directors are also directors and shareholders of Company Y. In order to fulfil a Country X corporate requirement, one of the directors of Company X has to be a Country X resident. The Country X resident director is not a key decision maker in respect of Company X and merely acts as a liaison between the Australian directors and the Country X third party service providers. To explain further, the Country X director does not have the authority to make decisions on behalf of Company X in their dealings with the Country X service provider representatives without direction or input from the other members of the Australian Executive Team (explained later in this report). Further, the Country X resident director does not have an IT background and does not provide much input while based in Country X on the IT and technology side of the business. Board meetings All board meetings of Company X were held at its Australian headquarters and attended by the company’s Australian resident directors. In particular, resolutions were made to declare payment of dividends and their amounts at these board meetings. All matters directly related to the Country X business also formed part of the discussions in the Company Y board meetings. Company Y –- Business Operations Strategy and vision The board of directors of Company Y make decisions, in Australia, relating to entering new markets, investing in research and development, determining and reviewing product KPIs (key performance indicators) and managing key supply contracts in respect of the Australian and Country X business operations. The shareholding in Company Y is ultimately held by X Australian resident individuals who are also directors of the company. X of Company Y’s major shareholders and directors are also directors of Company X. They are responsible for the overall administration and business strategy of the group as a whole. Individually their roles include: ● Making the strategic decisions for expansion of the business through diversification innovation and IT development; ● overseeing the technical operation of the group’s business activities, including Company X’s business activities, on a day to day basis; and ● building relationships with stakeholders and third parties connected to the business in Australia and Country X Together, the Australian shareholders and directors of Company Y constitute the ‘Australian Executive Team’. Board Meetings The Company Y board meetings held during the period under consideration were attended by all the shareholders and directors of the business. Business discussions, decisions made, and reviews undertaken in the Company Y board meetings include: ● Setting of investment and operational policy, including the policy for acquisition and development of capital assets, and decisions to buy and sell significant assets; ● Appointment of company officers and agents, and the granting of power to carry on business; ● Oversight and control of those appointed to carry out the day-to-day business including setting and monitoring performance against Key Performance Indicators (KPIs); ● Financial policies including the review of financial performance, setting of budgets and dividend policies; ● Compliance and regulatory matters; ● Research and Development activities; ● Decisions to apply for audit exemption in Country X; ● Decisions to pay dividends and the amount of such dividends; ● Decisions regarding hiring, firing and reviewing remuneration packages of personnel; ● Decisions surrounding R&D expenditure, incentives received; ● Discussion of current Country X debtors, pricing policy and any changes required; ● Discussion of strategic direction of the business as a whole, including lines of reporting and responsibility, and expansion opportunities; ● Discussion of Country X tax compliance matters; ● Review of marketing KPIs such as return on advertising; ● Review of financial activity including, revenue, Net Profit after Tax and cash flow; and ● Comparison of service agreements held in Country X and Australia Research and Development Company Z undertakes all research and development activities in Australia for the Company Y Group to ensure that its technology remains relevant to the market and to guard against risks of the business becoming extinct or obsolete given the significant advancements made in technology. Supply Chain In order to enter the market, licence agreements and agreements with service providers are required. Company Y and Company X enter into agreements with local service providers. These agreements are negotiated and executed by the Australian Executive Team in Australia. IT support The Company Y group‘s business is predominantly IT-based. This is reflected in the day to day IT activities carried out to ensure that the business operates smoothly. These activities are carried out by the Australian based IT team to support both the Company Y and Company X businesses. The IT team is overseen by an Australian resident director of Company Y. In this regard, Company Y employs IT specialists to take care of maintenance and troubleshooting to ensure that the business continues to function smoothly. Technical support Company Y hires full time as well as part time personnel working solely from the head office in Australia to provide customer service and support in Australia and Country X. Marketing The strategy, performance tracking, and IT facilitation activities that enable successful marketing are only undertaken in Australia.

Relevant legislative provisions: Subsection 6(1) : Income Tax Assessment Act 1936 | Section 6-5: Income Tax Assessment Act 1997 | Subsection 703-15(2): Income Tax Assessment Act 1997 | Subsection 703-20(2): Income Tax Assessment Act 1997 | Subsection 703-45(2): Income Tax Assessment Act 1997 | Subsection 995-1(1): Income Tax Assessment Act 1997 | Convention between the Government of the Commonwealth of Australia and the Government of Country X for the avoidance of Double taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains (‘the Country X Convention’).

Reasons for decision: Detailed Reasoning - Residence of companies: The issue under consideration is whether, Company X, a Country X incorporated company is an Australian resident within the meaning of subsection 6(1) of the ITAA 1936, and therefore, subject to Australian income tax on its ordinary income under subsection 6-5(2) of the ITAA 1997 . An 'Australian resident' is defined in subsection 995-1(1) of the ITAA 1997 to have the same meaning it bears in the ITAA 1936. Subsection 6(1) of the ITAA 1936 provides: '6 Interpretation ... (1) In this Act, unless the contrary intention appears: resident or resident of Australia means: ... (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' (emphasis added). Section 6-5(2) of the ITAA 1997 provides: '(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.' | Detailed Reasoning - Carry on business: Factually, the substantive day-to-day business activities of Company X that produce income for Company X are conducted by or on behalf of Company X in Australia and in Country X. | Detailed Reasoning - Central management and control: This test was recently considered in the case of Bywater Investments Ltd & Ors v Commissioner of Taxation; Hua Wang Bank Berhad v Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589 ( Bywater Investments ). Each of the X taxpayer companies involved in Bywater Investments made profits from the acquisition and sale of securities in entities listed on the Australian Stock Exchange. Each taxpayer was incorporated overseas and the board meetings were held overseas by foreign resident directors. However, the directors mechanically carried out the directions and wishes of a resident individual in regards to all transactions. The High Court of Australia held that, where a board of directors relinquished its decision-making power in favour of an outsider, effectively doing no more than implementing decisions made by the outsider, there was a usurpation of the functions of the board so that the place of central management and control of each taxpayer company was found to be with the resident individual in Australia. In summary, central management and control: ● is the control and direction of a company’s operations; ● has as its key feature the making of high level decisions that set the company’s general policies and determines the directions of its operations and the type of transactions it will enter; ● can involve: ● setting investment and operational policy; ● appointing company officers and agents and granting them power to carry on the company’s business; ● 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. The decision in Bywater Investments clarified, among others, the following key matters relevant to determining whether a foreign incorporated company is resident under the central management and control test of residency contained in paragraph (b) of subsection 6(1) of the ITAA 1936: ● Where a company's central management and control is located is a question of fact to be determined by the reality of what happens. It is not determined by reference to legal formalities, or restrictions on who may exercise it or where it may be exercised, and may be exercised by persons without any legal authority to manage or control a company. ● The High Court decision in Esquire Nominees Ltd v Federal Commissioner of Taxation [1973] HCA 67; (1973) 129 CLR 177 is not authority for the proposition that a foreign incorporated company will have its central management and control outside Australia if it has a local board which rubberstamps and implements decisions that are made in Australia. If a company's directors merely rubberstamp decisions made by others they do not exercise central management and control, rather it is those who actually make the decisions as a matter of fact As such, consistent with Bywater Investments , a company will be controlled and directed where those making its decisions do so as a matter of fact and substance. It is not where decisions are merely recorded and formalised or where the company's constitution, bylaws or articles of association require it to be controlled and directed, if in reality it occurs elsewhere. The following is a non-exhaustive list of factors that courts have considered in identifying where those who control and direct the operations of a company do so, depending on the facts and circumstances of each case: ● where the governing body of the company meets ● where the company declares and pays dividends ● where the shareholder's meetings are held ● where the company's register of shareholders is kept ● where the company's books are kept ● where its registered office is located ● where those who control and direct the company's operations live ● where its shareholders reside ● the nature of the business and whether it dictates where control and management decisions are made in practice ● minutes or other documents recording where high-level decisions are made None of the above factors alone determine where central management and control of a company is exercised as ultimately the nature of a company's activities may dictate where key decisions of a company must be made as a matter of practice. In North Australian Pastoral ( North Australian Pastoral Co Ltd v FCT (1946) 71 CLR 623) the need to make essential decisions on the company's business activities where those activities took place, was relevant to the court's conclusion that the central management and control was located where the company's business activities took place. North Australian Pastoral The business of the company was the breeding, purchasing, de-pasturing and selling of cattle upon and from an extensive cattle station in the Northern Territory and a large part of its income was derived from that source. In determining that the company’s central management and control was in the Northern Territory, Dixon J considered as follows: ‘The undertaking, for the carrying on of which the company came into existence, is wholly within the Territory. The company takes its corporate life from registration in the Territory... It was not to facilitate the conduct of the company's affairs that the directors met in Brisbane, but because that was for their common convenience the most convenient course... The station manager necessarily took the initial responsibility in everything that most really affected the success or failure of the company's undertaking and the visits of the directors were an acknowledgment of the necessity of reaching the more important decisions of policy in or after consultation with him and of forming an opinion about them on the place where the business was conducted... The company's enterprise was not a financial or trading business the control and management of which might be considered to depend on decisions of policy...independently of the locality...’ Accordingly, in the present circumstances, the central management and control of Company X will reside in the place where the operations giving rise to the profits and gains of the company are controlled from, having regard to the nature of its business activity. | Detailed Reasoning - Company X’s business circumstances: Registration Company X is incorporated in Country X. The following elements of Company X’s business are associated with its place of incorporation: ● the service providers that enable Company X’s provision of services are based in Country X ● automated business equipment is held by Company X at third party office premises in Country X ● one of the directors of Company X resides in Country X ● the service requests originate from Country X and are provided to customers in Country X To explain further in regards to each of the above elements: Company X’s agreements with service providers for their services are negotiated and executed by the Australian Executive Team. The business equipment held at the third party premises in Country X serves only to transmit data from Country X to the Australian IT system of the Company Y group. Although, services are provided in Country X, it is the Australian IT infrastructure and associated staff who enable the provision of services by Company X and the collection of revenue from the services provided to residents of Country X. Ownership and directors Company X is wholly owned by Company Y, an Australian IT business and head company of the Company Y global group. Company Y in turn is owned by Australian residents who also serve as its directors. The shareholders and directors collectively have a hands-on role in the management and control of the Company Y group’s business and respectively have carriage of roles that are vital to the survival of the business of the group, namely: ● managing relations with service providers and other third parties ● determining business strategy and innovation for business expansion ● overseeing the day to day technical operations of the business Two of the Australian resident directors of Company Y are also directors of Company X. Policy and decision making The board of directors of Company Y make strategic, high level decisions, in Australia, relating to entering new markets, investing in research and development, determining and reviewing product KPIs and managing key services contracts in respect of the Australian and Country X business operations. Company Z, on behalf of Company Y, undertakes all research and development activities for the Company Y group to improve the IT systems that enable the delivery of services by the group in Australia and Country X. All board meetings of Company X are held at its headquarters in Australia where the Australian Executive Team meet regularly to discuss, evaluate and make decisions, in particular, on issues including: ● Pricing policy and any changes required; ● Current Country X debtors; ● Marketing KPIs such as return on advertising ● Financial activity including, revenue, Net Profit after Tax and cash flow; and ● Payment of dividends and the amount of such dividends. Day to day business Company X relies solely upon the Company Y group’s Australian technology to provide its services in Country X. An Australian based team of IT staff provide round the clock technical support and customer service support to ensure that the services of Company X are delivered to Country X residents without disruption. Accordingly, for the majority of factors nominated by the courts as relevant to identifying where those who control and direct the operations of a company do so (such as where the governing body and shareholders meet, where the registers and books are kept, where those who control, direct, decide and manage the company’s operations live, where the shareholders reside, etc.), they point to Australia. | Detailed Reasoning - Conclusion: The Australian Executive Team is responsible for making, and does make, decisions in Australia on everything that most affects Company X’s undertaking such that the success or failure of that undertaking is reliant on the Team’s judgment and capacity to make sound decisions of policy. Company X’s business operations are managed by the IT and customer support teams from Australia; and the control and management of Company X’s business in Australia exercised by the entire Australian Executive Team is independent of its locality in Country X. Consequently, Company X carries on business in Australia and has its central management and control in Australia. Therefore, Company X is a resident of Australia for the purposes of subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Double Tax Agreement: Company X, by virtue of its incorporation in Country X, is a resident of Country X for Country X income tax purposes. In determining liability to Australian tax of a person who is a resident of both Australia and another country with which Australia has a double tax agreement (DTA), it will be necessary to consider the relevant provisions of the DTA concerned. This is because the provisions of the DTA prevail to the extent they may be inconsistent with the provisions of the domestic law of the Contracting States (subsection 4(2) of the International Tax Agreements Act 1953 ). The relevant DTA to be considered in the present circumstances is the Country X Convention. | Detailed Reasoning - The Country X Convention: The Country X Convention stipulates that for the purposes of the Convention, a company that is a resident of both Australia and Country X under their respective domestic tax law will be deemed to be a resident in the country where its place of effective management is situated. As set out in Taxation Ruling TR 2001/13 (refer paragraphs 101-104), the commentary on Article 4 in the Model Tax Convention on Income and on Capital 2014 (OECD Commentary) will be considered in interpreting the term ‘effective management’ for the purposes of the Country X Convention. The OECD Commentary on Article 4 provides at subparagraph 22 of paragraph 3 that it would not be an adequate solution to attach importance to a purely formal criterion like registration and that the Commentary attaches importance to the place where the company is actually managed. Subparagraph 24 of paragraph 3 characterises the place of effective management as the place where key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. Subparagraph 24 further provides that Competent authorities having to apply such a provision to determine the residence of a legal person for purposes of the Convention would be expected to take account of various factors, such as where the meetings of its board of directors or equivalent body are usually held, where the chief executive officer and other senior executives usually carry on their activities, where the senior day-to-day management of the person is carried on, where the person’s headquarters are located, which country’s laws govern the legal status of the person, where its accounting records are kept. Based on the explanation in subparagraph 24 of paragraph 3 the OECD Commentary, the test of ‘place of effective management’ is very similar to the test of ‘central management and control’ and is a question of fact. For the same reasons that Company X has its central management and control in Australia, its place of effective management for the purposes of the Country X Convention is also in Australia. Consequently, Company X is a resident of Australia for the purposes of the Country X Convention. | Detailed Reasoning - Members of a consolidated group: The requirements for an entity to be considered as a subsidiary member of a consolidated group, at a particular time in an income year, are set out in paragraph (b) of subsection 703-15(2) of the ITAA 1997, particularly at item 2 of the table in that subsection (‘the table’). Column 2 of item 2 of the table sets out the income tax treatment requirements as follows: (a) the entity must be a company, trust or partnership (but not one covered by section 703-20); and (b) if the entity is a company - all or some of its taxable income (if any) must be taxable apart from this Part at a rate that is or equals the corporate tax rate; and (c) the entity must not be a non-profit company (as defined in the Income Tax Rates Act 1986 ) With regard to (a) above, there is a table in subsection 703-20(2) ITAA 1997, which lists certain entities that cannot be members of a consolidated group. The entities excluded from being members of a consolidated group include: ● a company that is exempt from income tax under Division 50 of the ITAA 1997; ● a company that is a recognised medium credit union as defined in section 6H of the ITAA 1936; ● a company that is an approved credit union for the purposes of section 23G of the ITAA 1936 for income year in question; and ● a company that is a PDF at the end of the income year in question Column 3 of item 2 of the table in in subsection 703-15(2) of the ITAA 1997 sets out the Australian residence requirements as follows: The entity must: (a) be an Australian resident (but not a prescribed dual resident), if it is a company; or (b) ... or (c) ... Column 4 of item 2 of the table sets out ownership requirements as follows: The entity must be a wholly-owned subsidiary of the head company of the group and, if there are interposed between them any entities, the set of requirements in section 703-45 of the ITAA 1997, must be met. | Detailed Reasoning - 703-45(2) provides: At the test time, each of the interposed entities must either: (a) be a subsidiary member of the group; or (b)... At the test time, each of the interposed entities must either: (a) be a * subsidiary member of the group; or (b)... | Detailed Reasoning - Application of paragraph 703-15(2)(b) of the ITAA 1997 to Company X: Income tax treatment requirements in column 2 of item 2 of the table in subsection 703-15(2) (a) Company X is a company that is not covered by section 703-20, i.e., ● it is not exempt from income tax under Division 50 of the ITAA 1997; ● it is not a credit union for the purposes of 6H or 23G of the ITAA 1936: and ● it is not registered as a pooled development fund (b) all or some of the taxable income of company X (if any) is taxable at a rate that is or equals the corporate tax rate; and (c) Company X is not a non-profit company Therefore, Company X satisfies the income tax treatment requirements in column 2 of item 2 of the table in subsection 703-15(2). Australian residence requirements in column 3 of item 2 of the table in subsection 703-15(2) (a) Company X is an Australian resident, but not a ‘prescribed dual resident’ as it is not solely a resident of Country X for the purposes of the Country X Convention nor does it have its place of central management and control in Country X (see definition of ‘prescribed dual resident’ in subsection 6(1) of the ITAA 1936) (b) n/a (c) n/a Therefore, Company X satisfies the Australian residence requirements in column 3 of item 2 of the table in subsection 703-15(2). Ownership requirements in column 4 of item 2 of the table in subsection 703-15(2) Company X is wholly owned by Company A. Company A is a subsidiary member of the Company Y Australian tax consolidated group and an interposed entity between Company X and Company Y the head entity of the Australian tax consolidated group (‘the interposed entity’). As Company A satisfies the interposed entity requirement in subsection 703-45(2), Company X satisfies the ownership requirements in column 4 of item 2 of the table in subsection 703-15 (2). Consequently, Company X satisfies all the requirements for an entity to be considered a subsidiary member of a tax consolidated group as set out in item 2 of the table in subsection 703-15(2) of the ITAA 1997. | Detailed Reasoning - Conclusion: Company X is eligible to be a subsidiary member of the Company Y Australian tax consolidated group.