The impact of COVID-19 on corporate tax residency – What is the risk?

The worldwide impact of COVID-19, which has resulted in countries around the world shutting down their borders and international travel being banned, requires companies to operate online whenever possible.

The need to adapt to these changed circumstances has triggered specific tax risks for foreign companies, particularly where Australian-based directors attend foreign board meetings online rather than travelling overseas, as is customarily the case. Where this occurs, foreign companies are at risk of being considered Australian tax residents.

Further, if a foreign company has employees stranded in Australia due to travel restrictions or has temporarily sent Australian expatriates back to Australia before its borders were closed, there is the risk that the foreign company may be deemed to have an Australian permanent establishment.

Corporate tax residency – Central Management and Control

Under Australia’s tax regime, Australian resident companies are subject to tax on their worldwide income from all sources, whether in or out of Australia. In contrast, generally, foreign companies are liable to Australian tax on their income from Australian sources only.

Under Australia’s tax regime, a foreign incorporated company will be an Australian tax resident if:

• it carries on business in Australia; and
• it has its ‘central management and control’ (CMC) in Australia.

Broadly, CMC refers to the control and direction of a company’s operations – with the key element being the making of high-level decisions setting the company’s general policies. Typically, a company will have its CMC at the location where its directors attend board meetings. The Australian Taxation Office (ATO) considers that, where board meetings are conducted via electronic facilities, CMC will depend on where the directors participating in the meeting are located. *

The above residency test has been understood traditionally to be a two-tier test, with the need to satisfy both conditions – the company must both carry on business in Australia and have its CMC in Australia. In 2018, however, the ATO issued Taxation Ruling TR 2018/5 which controversially states that if a company carries on business anywhere in the world, and has its CMC in Australia, it will be an Australian tax resident.

It is therefore no longer necessary for any part of the foreign company’s actual trading or investment operations to take place in Australia in order to trigger Australian residency.

For example, if the Australian-based directors of a corporate group make decisions regarding its non-Australian subsidiaries, the fact that those decisions are made in Australia will trigger the risk that those subsidiaries will be Australian tax residents. This is irrespective of the fact that all business operations are conducted overseas.

Another consequence of an offshore subsidiary constituting an Australian tax resident is that dividends repatriated to its Australian parent will become fully taxable, where they would otherwise be exempt from Australian taxation.

In the present COVID-19 crisis, boards of many foreign incorporated companies have temporarily suspended their normal board meeting procedures and made alternative arrangements where those meetings are conducted via online platforms. Australian-based directors of foreign companies located in Australia are attending board meetings through online platforms such as Zoom, Cisco Webex and Skype.

This would normally give rise to a residency risk for foreign corporates, as their CMC could be considered by the ATO as being conducted in Australia.

However, the ATO has recently provided some assurance on this issue, stating:

If the only reason for holding board meetings in Australia or directors attending board meetings from Australia is because of the effects of COVID-19, then we will not apply compliance resources to determine if your central management and control is in Australia.

The ATO has advised that it will continue to monitor the evolving effects on businesses in these circumstances. As a result, when travel restrictions start to ease, the ATO may revisit its position. We will monitor any developments on this issue.

In the meantime, where directors of foreign corporates are attending board meetings in Australia because of the impact of COVID-19, we recommend this be expressly stated in the board minutes.

Permanent establishment risks – Employees present in Australia

In certain circumstances, a foreign company may be deemed to have an Australian permanent establishment or branch, if it has even one employee present in Australia. In this case, the profits attributable to that permanent establishment are taxed in Australia.

A permanent establishment arises typically where a foreign company carries on business in Australia through a ‘dependent agent’ who has a general authority to negotiate and conclude contracts on behalf of the company, and habitually exercises that authority. An employee of a foreign company would generally constitute a dependent agent for these purposes.

In seeking to provide assurance on this issue, the ATO has advised that the effect of COVID 19 alone will not, in itself, result in a foreign incorporated company having an Australian permanent establishment if it meets all the following criteria:

• the foreign incorporated company did not have a permanent establishment in Australia before the effects of COVID-19;
• there are no other changes in the company’s circumstances; and
• the unplanned presence of employees in Australia is the short-term result of these employees being temporarily relocated or restricted in their travel as a consequence of COVID-19.

While the ATO position provides some clarity for businesses, it is only an interim solution and we expect the ATO view to change once travel restrictions are eased.

How can Rigby Cooke help?

Rigby Cooke can advise foreign companies about how to mitigate the risk of inadvertently triggering Australian residency or a deemed Australian permanent establishment.

Where directors of foreign corporates are present in Australia during the conduct of board meetings or other high-level meetings due to the effects of COVID-19, or staff are currently based in Australia for the same reason, it will be critical that the company holds contemporaneous documentation which actually states that COVID-19 has necessitated the need to temporarily alter business operations.

Given that many businesses have transitioned to an online presence with relative ease, it may be common for workplaces to continue operating online to some degree beyond the impact of COVID-19. The risk here is that, Australian-based directors may prefer to embrace the online environment on an ongoing basis, rather than travelling overseas and potentially exposing themselves to risk in order to attend board meetings. The unintended consequence of choosing this modern approach is that the foreign company is at high risk of being considered by the ATO as an Australian resident for tax purposes.

*Practical Compliance Guideline PCG 2018/9 – Central management and control test of residency: identifying where a company’s central management and control is located