The High Court has revisited the concept of corporate residence for tax purposes and challenged the conventional wisdom that previous authorities had applied a form over substance approach to determining residency

Dabner, Justin

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"It's the vibe of the thing": Esquire Nominees (re) considered by the High Court

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© CCH1[¶859] “It’s the vibe of the thing”: Esquire Nominees(re)considered by the High Court, 25 November 2016Click to open document in a browserContributed by Associate Professor Justin Dabner, Law School, James Cook University, Cairns,Australia; Adjunct research fellow in Business Law and Taxation, Faculty of Business andEconomics, Monash University, AustraliaIntroductionThe High Court in Bywater Investments Limited v Commissioner of Taxation; Hua Wang Bank Berhad vCommissioner of Taxation 2016 ATC ¶20-589 has affirmed the decision of the Full Federal Court (2015 ATC¶20-549) in holding that the taxpayers could not rely on Esquire Nominees Limited as Trustee of ManolasTrust v FCT 73 ATC 4114 to assert that they were non-residents where the boards of the taxpayers wereacting in accordance with the wishes of an Australian resident. In “Is Esquire Nominees under assault?”Australian Tax Week (24 March 2016), the author suggested that the Full Federal Court, by distinguishingEsquire Nominees, had cast doubt on the ability to rely on Esquire Nominees in denying that a company wasan Australian resident. The High Court decision, while not going so far as rejecting the decision in EsquireNominees, has interpreted the case in such a way as to provide little opportunity to structure “tax havencompanies” to avoid the Australian residency rules.Corporate residency and Esquire NomineesThe test for corporate residency contained in s 6(1) of ITAA 1936 provides for three alternative scenarios.Incorporation in Australia is the first test. A company that is not incorporated in Australia may, nevertheless,be an Australian resident if it carries on business in Australia and has its central management and controlhere. Should a foreign incorporated company (such as one incorporated in a tax haven) have its board meetoutside Australia then it might avoid being treated as an Australian resident under this second test. The thirdtest focuses on whether the majority of the shareholders are Australian residents. The decision in PatcorpInvestments Limited (formerly Patrick Corporation Limited) & Ors v FCT 76 ATC 4225 means that in theapplication of this test reference is made solely to a company’s register and the ultimate beneficial ownership(where the shares are held in trust) is irrelevant.For companies seeking to avoid the second test it is common to appoint foreign directors who meetoverseas. Of course, the ultimate (Australian resident) owners of the company will want these directorsto act according to their wishes. However, to avoid central management and control being sheeted backto Australia the directors must be seen to be independently minded, although focused on the Australianinterests. This creates a tension traditionally resolved by ensuring that there is no legal control over the boardof directors vested in the domestic interests and couching any communications between the two in termsconsistent with this state of affairs.Esquire Nominees is viewed as the authority underpinning this approach. In a much quoted paragraph inthe judgment of Gibbs J at first instance (72 ATC 4076, at 4085; and endorsed by the Full Court) his Honouropined that although an Australian accounting firm sent “instructions” to the overseas directors the firm“had no power to control the directors.” Although the firm may have had power to exert strong influence thedirectors simply complied because they accepted that it was in the interest of the beneficiaries and had theaccountants instructed the directors to do something which they considered improper or inadvisable theywould not have acted on the instruction.Viewed as a victory of form over substance many have been heralding that, given the chance, the High Courtwould revisit this decision (for example see Cindy Chan, “Corporate Residence: has Esquire Nominees stoodthe test of time?” 49(5) Taxation in Australia 253) if not to reverse it, at least to ensure that the precedent wasrestricted to circumstances where directors really do exercise independent judgment in contrast to the mere“rubber stamping” of instructions from Australia. Bywater Investments is exactly that case.Bywater Investments© CCH2The taxpayers in Bywater Investments had structured their offshore corporations to have local directors andmeetings. “Instructions” came from Australia from a Sydney based accountant, a Mr Gould. Squarely atissue was as to whether the taxpayers could rely on the authority of Esquire Nominees to avoid Australianresidency.At first instance it was held that notwithstanding the overseas location of the directors the real business ofthe entities was conducted by Gould from Sydney without the involvement of the directors. Thus the “centralmanagement and control” was situated in Australia. On appeal, the Full Court of the Federal Court endorsedthis conclusion. Critical to the outcome in Esquire Nominees had been that the compliance of the directorswith the wishes of others was only because the directors accepted those wishes to be in the interests of thebeneficiaries. This situation was to be contrasted with the facts of the instant case. The taxpayers’ urging togive weight to factors such as the place of incorporation, the shareholding of each company and the place ofincorporation of corporate shareholders, the location of the directors, the minutes of meetings of the boardsof directors, the place at which the meetings were held, and the place at which the transactions were enteredinto as constituting the businesses of each of the taxpayers did not alter the conclusion. The taxpayers’ casewas compounded by the lack of probity in the evidence given by their chief witness nor did the nature ofcommunications between Gould and the directors assist.The taxpayers’ subsequent appeal to the High Court was dismissed by unanimous decision (Gordon Jissuing a separate judgment differing from the rest of the Court in her Honour’s focus on the relevant doubletax treaties). The Court emphasized that, as a matter of long-established principle, the residence of acompany is a question of fact and degree to be determined according to where the central managementand control of the company actually abides, and that is to be determined by reference to the course of thecompany’s business and trading, rather than by reference to the documents establishing its formal structure.The Court held that the fact that the directors were located abroad was insufficient to locate the residence ofthe companies’ abroad in circumstances where the directors had abrogated their decision-making in favourof Gould and only met to rubber-stamp decisions made by him in Australia.The Policy ArgumentsIt is easy to characterize the decision as one that simply distinguished Esquire Nominees on the facts anddid not vacate any of the reasoning in that case. However that would lead to an understatement of thesignificance of the decision. After all the High Court rarely grants special leave to hear tax matters. Althoughnot rejecting Esquire Nominees, borrowing from Dennis Denuto, Darryl Kerrigan’s frazzled lawyer in TheCastle, the High Court has established a new “vibe”.The author’s earlier consideration of the Full Federal Court decision concluded with the observation thatthe decision was a warning that blind faith reliance on the authority of Esquire Nominees was now a riskyproposition. Certainly the wording of communications from Australia to foreign directors needed to bereviewed but also Australian corporate groups with overseas subsidiaries urgently needed to undertake a riskanalysis. The uncertainty in departing from the entrenched view that the assertion of some authority over anoverseas subsidiary’s board by its holding company does not, on its own, render the subsidiary an Australianresident is point that was, in fact, expressly alluded to by counsel for the taxpayers (see para 34). The Courtrejected this argument as exaggerated (at para 80).Taxpayers’ counsel had also sought to support a “form over substance” approach to ascertaining centralmanagement and control by reference to where the board meets by citing the approach adopted in Patcorpto the third residency test. This argument was given swift treatment (at para 79). Similarly a suggestion thatthe enactment of the controlled foreign company rules in lieu of a change to the control test to a “habituallyresponds to instructions formulated in Australia” test, as support for a general understanding of EsquireNominees, was also rejected. The Court stated that nothing in Esquire Nominees, in the recommendationsof the Asprey Committee or the subsequent enactment of the CFC rules implied that a company should beregarded as a non-resident where its board acted upon the dictates of an Australian resident (at para 82 and83).Conclusion© CCH3The proposition that central management and control is where the board meets in the absence of a legalpower over the board residing in someone else has now been comprehensively rejected (see for examplepara 68). Apparently this never was the law; the enquiry has always been where control exists as a matterof fact. Many advisers might be forgiven for viewing the High Court decision in Bywater Investments as arevision of history. Regardless, the (new) vibe is clear — and maybe as it should have always been — andAustralian taxpayers with “connections” to foreign companies would do well to review the residency statusof these entities. Mere reliance on the location of the formal constituents of a company to satisfy a factualenquiry as to the location of the central management and control will not be decisive.

https://researchonline.jcu.edu.au/46531/2/46531_Dabner_2016.pdf

"It's the vibe of the thing": Esquire Nominees (re) considered by the High Court

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