Australian International Tax - Residence Of Companies - Essay Example

Esquire Nominee Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Lecture Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Taxation disputes between tax authorities and incorporation are surrounded by a lot of controversies. In most cases incorporations contend the right of tax authorities to tax them. Residency and source arguments are some of the arguments advanced by incorporation when they challenge the right of tax authority to charge them withholding tax. In Australia, resident companies are charged a withholding tax on all the income they make all over the world while non-resident companies are charged only on the income they derive from Australia. It is apparent from this taxing policy that non-resident companies are at an advantage over residential companies. In most cases, companies that are entirely owned by Australian residents are incorporated in other nations to avoid the unfavorable tax in Australia. Some of the companies have complex ownership structures that make the resolution of residency and source issues for taxation very difficult. In this paper the effects of the residency of a company on whether the company should pay tax for income derived from Australia is tackled. The paper starts from analyzing the case of "Esquire Nominees Ltd v FCT which has been a leading authority on the Australian international taxation matters. The paper continues to analyze the development in the Australian taxation laws relating the issues of residency tackled in "Esquire Nominees Ltd v FCT. The developments are both analyzed in terms of statutory and common law changes since the ruling in the case was made. Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 Facts of the Case1: Esquire Nominee was a resident company in Norfolk Island with two resident directors. The shares that had full voting rights were owned by Norfolk residents While shares with partial voting rights were owned by an Australian Accountants firm (Messrs, Wilson, Bishop, Bowes & Craig) The firm was established on behalf of Australian residents. The accountancy firm controlled the directors through specific advice and draft minutes Esquire also held shares in Mitchell Credits Ltd another Norfolk Island resident, albeit as a trustee. Mitchell Credits in turn owned shares in Pharmaceutical Investment Ltd also incorporated in Norfolk Island Pharmaceutical Investment Ltd in-turn owned shares in Manolas Pharmacy Pty LTD Manolas Pharmacy limited was incorporated in the Northern territory, Australia Manolas derived its income from business conducted in Australia Manolas made a profit and paid dividends worth $31,503.57 to Pharmacetical Investment LTD Pharmacetical Ltd paid the same amount to Mitchells Credit and at last Esquire Nominee was paid the full amount. The FCT sought to have Esquire nominee pay a withholding tax on the amount. The taxman’s argument The taxpayer argued that Esquiree Nominee was a resident of Australia under Section 6 (1) of the Income Tax Assessment Act 1936 (ITAA 1936)2. The taxman held that under section 99 of the Act it had the authority to assess the dividend paid to Esquire nominee by Mitchell Credits LTD. According to the Commissioner by virtue of the company being controlled by an Australian resident accounting firm, Esquire was an Australian resident for taxation purposes3. However, Esquire nominees maintained it was a resident of Norfolk Island as its two directors were both residents on the Island. Furthermore, the central management met in Norfolk Islands. In response, the Commissioner argued that residents of Norfolk Island were required to pay withholding tax for income sourced from Australia. The commissioner quoted section 7 of the Act to support his claims arguing that since Manolas Pharmacy Pty Ltd operated in Australia the income was taxable as it had been derived from Australian business4. Esquire held that since it received the dividend from another Norfolk Island Company it was not liable to pay Australian withholding tax5. Esquire argued that the commissioner acted inappropriately by tracing the income through the whole corporate chain. Issues for resolution The case brings about two issues that are concerned with the two principles of taxation; residency and source. The question to be resolved by the court was whether Esquire Nominee was a resident of Australia under Section 6 (1) of the Australian Income Assessment Act 1936 and whether the dividend received from esquire were derived from Australian sources. This paper concentrates on the issues of residency raised in the case. Decision The decision of the High Court was delivered by Justice Gibbs who held that the mere fact that the directors of Esquire Nominees took the advice of the Australian accounting Firm in administering the company did not make the Taxpayer an Australian resident under section 6 (1) of the Income Assessment Act 19366. Gibbs J went on to explain that the advice of the accounting firm did not mean they had full control over the company and it did not also give them control over the voting rights of the seven “A “class shareholders. Gibbs J argument was based on the premises that the strength of control exerted by the firm was strong but could not be passed as total control of the company. Gibbs closing remarks in the judgment were “If on the other hand, Messrts, Wilson, Bishop, Bowes and Craig had instructed the directors to do something which they considered improper or inadvisable, I do not believe that they would have acted on the instruction”7 Gibbs J concluded that Esquire Nominees was a resident of Norfolk Island despite the presence of strong management control by the Australian firm. Would the Judgement be Different Today? The decision on residency made in Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 has wide ranging implications when it comes to determining whether a company incorporated elsewhere can come under the Australian tax regime. To answer whether the judgement in Esquire Nominee v FC of T (1973) 129 CLR 177 would be different today, one needs to analyze the various tests courts use to determine the residency a non Australian incorporated company8. To effectively assess these development one needs to look at the changes both in common and legislative law. Secondly, once needs to trace how courts determined corporate residency issues before the case and how they determine it nowadays. Present Corporate Residency Tests There are three statutory tests used to determine whether a company is a resident of Australia. The Incorporation test constitutes the first test of residency; under this test the concept of Incorporation is decisive in determining the residency of a company a contradiction with the common law. Under section 6 of the Income Tax Assessment Acts 1936 the three statutory tests are set out as follows; a company is considered a resident if it is incorporated in Australia, or if it is not incorporated in Australia, it operates in Australia and it Central management and Control are in Australia. Alternatively, the company voting powers are entirely controlled by residents of Australia9. Under the first statutory test a Company can only be considered an Australian resident if its central management and control is in Australia. Under the second statutory test a company is required to operate in Australia, and have its central management in Australia. These two limbs of the test must be fulfilled to arrive at a conclusion that a company operates in Australia10. The second test calls for the separation of the concepts of Control and management. FCT v Commonwealth aluminium Co Ltd distinguishes management and control and further notes control are the paramount consideration while determining residency of a company11. FCT v Commonwealth Aluminiun Co Ltd agrees with the judgement in Esquire Nominees that control must be the actual control of a company rather than the capacity to control. According to House of Lords in Unit Construction co Ltd v Bullock (1959) 38 TC 712 actual control is usually exercised by directors and management therefore making management and control the same concept while resolving issues of corporate residency12. Todd v Egyptian Delta Land Investment Co Ltd (1929) AC 1 it was held that the mere fact that an entity has the power to control the decision of a corporation does not constitute Central management and Control of an Incorporation13. Similarly, Mitchell v. Egyptian Hotels Ltd [1915] AC 1022 at 1039-1040 had held that the right to legally interfere in the decision making process did not mean full control of the company14. In Unit Construction companies that were subsidiaries of a UK company were ruled to be residents of the UK as they directors of the parent company were domiciled in the UK and they made controlling decisions in the subsidiary companies15. The third test requires that, first a company carries its business in Australia and that its voting power be controlled by Australian residents. The Third test departs from historical judgments on the concept of control by referring to control by voting power. In Malayan shipping Co Ltd v FCT where Australian residents had the power to hire or fire directors the company was considered an Australian resident. Additionally, the judgement held that veto power over resolution and control over finance and business decisions where necessary conditions for a company to be considered a resident for tax purposes despite its directors being non-residents. The reference to capacity to control shows that the second test refers to the actual control of the company rather than capacity to control. It can be concluded, that for a company to pass the second residency test the company should be actually located in Australia. Sometimes dual residency may be found where a company is controlled or managed in different jurisdictions. According to Peter J Gilles central management can be said to reside where most physical activities take place, the directors meet and where major decisions are arrived at16. This second statutory test has been faulted as it exposes some corporations to double taxation as it allows for dual residency of subsidiary companies. Dixon J in Koitaki Rubber Estates v FCT cautioned against allowing dual residency while noting it was possible to arrive at this conclusion using the second test17. In contrast to the Second test, the third test is a true two limb test. Under this test an Australian resident corporation carries out business in Australia and is voting power is held by Australian residents. According to Hamilton et al factors like profit motive, repeated transaction and systems of organization are needed to show that a company carries out its business in Australia18. In London Australia Investment Co Ltd v FCT (1977) 77 ATC 4398; FCT v Total Holdings it was ruled that the act of merely investing in Australia could be taken to mean that a company carries out business in Australia19. However, Williams J in Malayan Shipping Co Ltd v FCT argued that control of voting power took precedent over “ mere trading” when deciding the residency of a company20. However, the test of whether a corporation carries out business in Australia remains a substantive test that can be decided on a case-by-case basis. Hill J in Evans v FCT 89 ATC 4540 envisioned the problem that may be caused by relying on preceding cases to decide whether a company’s presence in Australia constitutes carrying out business in Australia21. Hill J went on to note that the business activity in each case is a matter of fact and degree. If a court is satisfied that the company carries out business in Australia, then the second limb of the third test on voting rights must be satisfied. This limb involves showing that the voting power of the company is controlled by Australian residents. For the taxman to prove that a person is an Australian resident he/she must go back to the definition of an Australian resident found in Section 6 (1) of the ITAA 1936 where a resident is one who fulfills the following conditions22: a) They reside in Australia and are not a company meaning: i. They are domiciled in Australia. ii. Have been Australia for more that one year during which they have been earning income. iii. Who 1. Belongs to a Superannuation scheme under the Superannuation Act 1990 2. Are eligible for employance under the Superannuation Act 1976 3. The Spouse, or Child under 16 of an Australian resident Having resolved the issue of who is to be considered resident for this test then the issue of voting power comes into the fore. According to Kolotex Hoisery (Australia) Pty Ltd v FCT (1975) 75 ATC 4028; 132 CLR 535 the voting power extends to power given to holders of office23. In Mendes v Commissioner of Probate Duties (1967) 122 CLR 152 it was noted that voting power needs only be a 50 per cent majority in matters decided by a general meeting of shareholders24. It is clear that; determing the residency of company for taxations issues is very difficult in Australia and may result in the companies being taxed when they are found to belong to dual tax jurisdictions. To deal with this problems Australia has entered into several dual tax arrangements and treaties. Australia has adopted and follow the OECD convention on Taxation that allows it to settle determine matters of taxation where dual residency situations arise25. Under Article 4 of the OECD convention a company can be resident in only one tax jurisdiction. Article 4 of the OECD Convention is meant to deal with the issue of residency asserts that a company is resident where its effective management is located. However, the article fails to explain what it envisioned by the phrase “Effective management”26. The reference to effective management where residency cannot be resolved by Australian domestic law somehow clears the controversy surrounding resolution of residency issues for taxation purposes. Article 4 (3) of the OECD resolves a residency dispute by asserting that; “Where by reason of the provisions of the para 1 a person other than an individual is a resident of both contracting states, then it shall be deemed to be a resident of the State in which its Place of effective management is situated”27. Other Developments on Residency Rules for Taxation Taxation Ruling TR 2004/15 has tried to clear the issues of how a company that is incorporated in Australia can be assessed for Tax using the Statutory test in the Income Tax Assessment Act (ITAA 1936) subsection 6 (1). TR 2004/15 affirms that for a company to be considered an Australian resident for taxation purpose it must meet both conditions of the statutory test separately28. The company must first carry out business in Australia. Secondly it must have its Central Management and Control located there. Where a company does not carry its business in Australia it is not necessary to go to the test of where Central management and control is located at the company automatically becomes a non-resident business. Where the company has business operations in Australia the second limb of the test on whether its management and control is located in Australia. However, TR 2004/15 notes that a company’s CM&C location is sometimes an indicator of where a company carries out business29. But also notes, that by virtue of a business carrying business in Australia does not mean CM&C is in Australia. According to the commissioner in TR 2004/15 determination of where a company carries business is a matter of the facts of every case. The commissioner however draws a distinction between operational activities of a company and passive dealings. According to TR 2004/15, a company place of business is where its major operational activities take place and not where it CM&C is. In contrast, a company whose main operation is investment carries its business where investment decisions are made and in most cases this is where it CM&C is. CM& C according to TR 2004/15 In TR 2004/15 for it be concluded a company has its CM&C located in Australia it must hold the majority of its board meeting in Australia. In contrast to Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 15630, paragraph 20 TR 2004/15 rules that the power of a parent company to hire and fire a subsidiary’s board cannot be considered CM&C , for the purpose of the residency test31. In paragraph 20, TR 2004/15 opens the door for dual residency by allowing CM&C to be located in different jurisdictions. Other than providing guidance on the issues of CM&C and where a corporation carries business TR 2004/15 provides guidance on the interpretation of the statutory tests of residence. The TR 2004 noted that the words in the statute should not be treated as superfluous but, instead an act must be interpreted in a way as to give full meaning to its wording. Gibb J in Project Blue Sky Inc v. Australian Broadcasting Authority (1998) 194 CLR 355 ruled that a statute's interpretation should be as close as possible to the words constructing it32. Therefore, TR 2004/15 recommends an interpretation of the statutory test that give “Carries business” its full effect33. Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 if judged today Delivering a decision on the residency of the taxpayer today would require putting the facts of the cases through the statutory test discussed above. Judgement used in deciding the previous common laws cases in taxation would also be useful in deciding how Esquire Nominees would be decided today. The first test that the taxpayer would have to be put through is whether they are incorporated in Australia. From the case it can be gathered that Esquire Nominee the company being targeted for tax assessment is incorporated in the Norfolk Island. Furthermore, the first statutory test requires that Central management and control be entirely located in Australia which is not the case with Esquire nominees. It can thus be settled that Esquire Nominees is not a resident of Australia for tax purposes under the first statutory tests34. Failure of the first statutory test to find Esquire Nominees would mean the case is subject to the two residual tests for residency. Under the second statutory test, the commissioner would have shown that Esquire Nominees are Central management and control is located in Australia. The commissioner may argue that since the Australian firm controlled decisions in Esquire Nominee the company’s Central control is in Australia. However, FCT v Commonwealth Aluminium Corporation Ltd (1980) 80 ATC 4371 it was ruled that the control for the purpose of the second statutory test must be actual control. The taxman may refer to the decision in Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 156; which held that a company’s management and control was in Australian hands as the residents had power to name and replace directors and veto decisions and they controlled financial and business decisions35. However, the powers of the Australian accountancy firm were not as far ranging as those discussed in the Malayan case. Alternatively, the taxman might aim to show that CM&C is located in Australia as set out by TR 2000/15 which seeks to clarify the issue. However, TR 2000/15 requires majority of board meetings to be held in Australia for is to be concluded that CM&C in Australia36. In Comparison all the board meetings of Esquire Nominee were held in the Norfolk Islands. Therefore, the taxman would not be able to show that the court that Esquire nominee central management lay in Australia. Being a two limb test the commissioner would have to show that Esquire Nominees also carried business in Australia. However, it can be gathered that the taxman cannot satisfy the court that the Australian firm had actual control over the operation of Esquire Nominees. It is shown that the accountancy firm offered specific advice and minutes which cannot be equated to actual control of the operations of Esquire Nominees37. Therefore the taxman would fail to fulfil that Esquire nominees is resident for tax purposes under the second statutory test. Failing to satisfy the two previous test the third test would be the one most likely to turn the ruling in favor of the taxman. The third test is a true two-limb test that requires both limbs to be satisfied. First, the taxman must show that Esquire Nominees carries out business in Australia and secondly, that majority voting power of its shareholders is in Australia. The first limb of this case is decided on a substantive case to case basis where factors such as the profit motive, system of organization and frequency of activities are assessed. In this case Manolas pharmacy a subsidiary of a corporate chain where Esquiree nominee was the trustee carried out business in Australia. This view is supported by the ruling in Koitaki rubber Estates v FCT High Court (1941) 64 CLR 15 which categorizes a company as doing business in Australia if it has merely invested there38. In contrast, the taxman would have a more difficult time proving that the voting power of the company lay with Australian residents. From the facts of the case it can be gathered that seven of the A class voting preference shares were held by Norfolk Island residents while seven class B shares were held by an Australian accountancy firm. However, a distinction must be drawn between shares with partial voting rights like those held by the firm on behalf of Australian residents. The ruling in Mendes V Commissioner of Taxation of Probate Duties (1967) 122 CLR 152 require power of control by voting rights to be only a mere majority of 50 per cent at a general meeting39. In the case of Esquire at first instance it may be thought that Australian firms have the majority share of 50 per cent but considering the power attached to votes as set out by Kolotex Hosiery (Australia) Pty Ltd V FCT (1975) 75 ATC 4028; 132 CLR 535 then voting power does not lay with Australian residents40. Thus the taxman would also fail to satisfy the court that the Esquiree nominee was an Australian resident for taxation purposes even under the lower threshold of the third statutory test. As discussed above it is clear the taxman would not be able to fulfill the statutory conditions in place to determine whether a company is an Australian resident for taxation purposes. First, Esquiree nominees is incorporated in the Norfolk Island and is thus not an Australian incorporated company. Although it can be concluded that activities of Manolas Pharmacy qualify, Esquire as undertaking business in Australian its central management and in extension voting power lays with Norfolk Island residents. Therefore, If Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 was decided today it would not arrive at a different conclusion to that of Gibb J 40 years earlier41. Implications of the Ruling and Present Residency Rules From the facts of the esquire case it is clear under the current tax regime the taxpayer would escape liability for Australian withholding tax. Despite the fact that the income received by Esquire Nominee through the corporate chain is derived from Australian sources the company is able to avoid taxation. The corporate chain through which Esquire controlled Manolas Pharmacy is clearly a sham to misdirect the taxman when trying to assess its taxing rights over Esquire Nominee42. The major weakness in Australia’s current residency rules is the loophole that enables companies to relocate their central management to other countries and thus avoid taxation. In this case the location of Phanolas pharmacy Central management in the Norfolk Island a Tax haven circumvents the Australian residency taxation rules. The scheme used in this case study is commonly applied on the international corporate scene with companies moving their central management to lower tax threshold countries (Tax havens). By moving into management to tax haven’s corporations are able to avoid taxation on passive (capital) income including dividends, capital gains, rent, royalties, and interest. In conclusion, the paper is able to bring to light the need to change Australia’s current international taxation regime to ensure Companies which deliberately aim to avoid their tax responsibility do not do so. It also points to the weakness of the principle of residence in resolving whether taxes are accessible. In this cases, application of the source principle would be much better in ensuring Esquire Nominees does not escape its tax responsibility. Bibliography A. Articles/Books/Reports Peter J Gilles, ‘Understanding Company Residence: Central Management and Control’ (1989) CCH Journal Of Australian Taxation 52, 59 R L Hamilton, RL Deutsch and JC Raneri, Guidebook to Australian International Taxation, (6th Ed 1999) 2-16 B. Cases Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 Evans v FCT 89 ATC 4540 FCT v Commonwealth aluminium Co Ltd FCT v Total Holdings Hosiery (Australia) Pty Ltd V FCT (1975) 75 ATC 4028; 132 CLR 535 Koitaki Rubber Estates v FCT Koitaki rubber Estates v FCT High Court (1941) 64 CLR 15 London Australia Investment Co Ltd v FCT (1977) 77 ATC 4398; Malayan Shipping Co Ltd v. FCT (1946) 71 CLR 156 Mendes V Commissioner of Taxation of Probate Duties (1967) 122 CLR 152 Mitchell v. Egyptian Hotels Ltd [1915] AC 1022 at 1039-1040 Project Blue Sky Inc v. Australian Broadcasting Authority (1998) 194 CLR 355 Todd v Egyptian Delta Land Investment Co Ltd (1929) AC 1 Unit Construction Co Ltd v Bullock (1959) 38 TC 712 C. Legislation Income Tax Assessment Act 1936 (Cth). D. Treaties OECD convention on Taxation Read More