Edited version of your written advice

Authorisation Number: 1012762762254

Ruling

Subject: Permanent Establishment

Question 1

Does G have a permanent establishment in Australia in accordance with Article 5 of the Agreement between the Commonwealth of Australia and the Federal Republic of X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes (the Foreign Agreement)?

Answer

Yes.

This ruling applies for the following period:

1 January 20xx to 31 December 20xx

The scheme commences on:

1 January 20xx

Relevant facts and circumstances

Entities involved in the transaction

G is a Foreign resident entity and is a 100% owned subsidiary of Foreign Parent. Foreign Parent is also a resident of X.

G is a service provider to the Foreign group and is proposing to supply services to Australian Co and other group entities in the Asia Pacific region.

G has entered into agreements to purchase, install and operate the equipment with Third Party Co (Third party), an unrelated third party.

Features of the transaction

• Third Party purchases equipment in Australia on behalf of G.

• Foreign Parent and Third Party enter into an agreement for the operation and maintenance of the equipment.

• Third Party delegates work to deliver the services in the Australian locations to its subsidiary in Australia.

• G provides services to Australian Co. The ownership of the assets remains with G.

• Third Party X charges Foreign Parent for services provided.

• Foreign Co Parent passes on the cost to Australian Co.

Purchase of Equipment

G purchased equipment from Third Party, a service provider based in Australia. The equipment has been installed by Third Party at the premises of Australian Co subsidiaries.

The equipment is located in Australian sites.

Internal IT services G provides to Australian Co

G will use the equipment to provide internal services to Australian Co. These services are necessary for the day to day operations of Australian Co and Foreign Parent.

G will retain ownership of the equipment. All equipment will be operated by Third Party. Third Party is responsible for operating, administrating, coordinating maintaining, monitoring, updating, securing and controlling the equipment.

The costs from Third Party are charged to G who then charges Australian Co.

G does not have employees located in Australia. Maintenance of all equipment will be performed by Third Party.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA of the ITAA 1936

Income Tax Assessment Act 1997 section 6-5

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

International Tax Agreements Act 1953

International Tax Agreements Act 1953 section 4

International Tax Agreements Act 1953 subsection 11(1)

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax befit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement that are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box at the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Issue 1

Question 1

Does G have a permanent establishment in Australia in accordance with Article 5 of the Agreement between the Commonwealth of Australia and the Federal Republic of X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes (the Foreign Agreement)?

Summary

Yes. G, a Foreign resident company, will have a permanent establishment in Australia under Article 5 of the Foreign Agreement where it provides ongoing services to the Australian Co group through equipment located in Australia which constitutes a fixed place of business.

G is considered to be in a contractual relationship with Third Party to carry on the installation, operation and maintenance of the equipment such that Third Party is a subcontractor during this period.

Notwithstanding the contractual relationship, G as head contractor will satisfy the three requirements in Article 5 of the Foreign Agreement required for a permanent establishment.

Detailed reasoning

Assessable income of foreign residents

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides:

6-5(3) 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.

The assessable income of the Foreign non-resident taxpayer will include ordinary income derived directly or indirectly from all Australian sources during the income year.

The International Tax Agreements Act 1953 (Agreements Act) must be considered in order to determine whether Australia has a taxing right in respect of the income derived directly or indirectly by the Foreign resident company from an Australian source.

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except when Part IVA of the ITAA 1936 applies).

Subsection 11(1) of the Agreements Act gives the Agreement between the Commonwealth of Australia and the Federal Republic of X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes (the Foreign Agreement) the force of law in Australia.

Article 7 of the Foreign Agreement governs the taxation of business profits derived from Australia by a resident of X. Under Article 7 of the Foreign Agreement, the business profits of a Foreign enterprise can only be taxed in Australia if the enterprise carries on business through a permanent establishment in Australia.

Article 5(1) of the Foreign Agreement defines the term 'permanent establishment' to mean:

…a fixed place of business in which the business of the enterprise is wholly or partly carried on.

Article 5(2) of the Foreign Agreement provides that the term permanent establishment includes:

(a) a place of management;

(b) a branch;

(c) an office;

(d) a factory;

(e) a workshop;

(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources;

(g) land used for agricultural, pastoral or forestry purposes;

(h) a building site or construction, installation or assembly project which exists for more than six months.

Does G have a permanent establishment?

In this case the equipment is located in the Australian Co premises. The Australian Co premises is not of the type specifically recognised as being a permanent establishments in the inclusive list contained in Article 5(2) of the Foreign Agreement. That is the space could not be said to be an office or a branch in itself.

Further guidance on the meaning of permanent establishment can be gained from the OECD commentaries.

In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4714; (1990) 21 ATR 531, the High Court accepted that the OECD Commentaries may be referred to when interpreting tax treaties in accordance with Article 32 of the Vienna Convention (see paragraph 90 of Taxation Ruling TR 2001/13). Taxation Ruling TR 2001/13 at paragraphs 101 to 105 explains the Commissioner's view that the OECD Commentaries are relevant to interpreting Australia's tax treaties.

Paragraph 2 of the OECD Commentary on Article 5: Concerning the definition of permanent establishment (OECD Commentary) explains that the general definition of a permanent establishment contains the following conditions:

• the existence of a 'place of business', that is, a facility such as premises or in certain instances, machinery or equipment;

• this place of business must be 'fixed', that is, must be established at a distinct place with a certain degree of permanence; and

• the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.

Each of these three requirements will be considered below.

Does G have a 'place of business'?

The question that arises is whether G can be considered to have a place of business. It has been submitted that the contract entered into with Third Party means that there is no place of business as the equipment is not at the disposal of G, being fully operated, maintained and controlled by Third Party.

The OECD Commentary at paragraph 4 states that the term 'place of business' covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. Further, in relation to having a space at its disposal rather than a branch or an office in the traditional sense:

A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise…

… Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise.

Paragraph 4.1 of the OECD Commentary notes that

…the mere fact an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business…

Paragraphs 42.5 and 42.6 of the OECD Commentary relevantly provides that:

Another issue is whether the business of an enterprise may be said to be wholly or partly carried on at a location where the enterprise has equipment such as a server at its disposal. The question of whether the business of an enterprise is wholly or partly carried on through such equipment needs to be examined on a case-by-case basis, having regard to whether it can be said that, because of such equipment, the enterprise has facilities at its disposal where business functions of the enterprise are performed.

Where an enterprise operates computer equipment at a particular location, a permanent establishment may exist even though no personnel of that enterprise is required at that location for the operation of the equipment. The presence of personnel is not necessary to consider that an enterprise wholly or partly carries on its business at a location when no personnel are in fact required to carry on business activities at that location.

Therefore, it is necessary to determine whether G has a certain amount of space "at its disposal" which constitutes a "place of business" in relation to the equipment which will be at the Australian Co premises.

The commentary provides guidance that it is not necessary for the premises to be used exclusively for G's purposes, or that they pay rent. So the location of the equipment in the premises of Australian Co is sufficient to establish a space in which the equipment is located. In this sense the Commissioner takes the commentary to mean that this place may be in an office or premises that G has at its disposal. That is, in this case it would extend to a foreign enterprise locating equipment in the office of an Australian subsidiary of the Group.

As to whether the equipment is at the disposal of G the Commissioner does not believe that it is fatal that the administration, control and monitoring is performed by Third Party. The Commissioner has considered the contracts and is of the view that the performance of all functions by Third Party has been contracted to Third Party by G as head contractor. Therefore, Third Party is a sub-contractor of G. In this case Third Party needs to meet the specific conditions of G in its service delivery.

At all times under the contract G retains the ultimate right to set standards and/or change the service provider. That is they can subcontract to another provider.

Given the factors above the Commissioner considers that G does have a space in the premises of Australian Co at its disposal and on which it is able to locate equipment required to perform its business functions. Therefore, the location of the IT equipment will constitute a place of business for the purposes of Article 5(1) of the Foreign Agreement.

Is G's place of business fixed?

It is than necessary to consider whether G has a fixed place of business. This requires us to consider the degree of permanency of the spaces where the equipment is located.

The OECD Commentary explains at paragraph 5 that in order for the place of business to be fixed, there has to be a link between the place of business and a specific geographical point. Paragraph 6 states that since the place of business must be fixed, it follows that a certain degree of permanency is required to deem a permanent establishment to exist - i.e. it is not of a purely temporary nature. The Commentary notes that a permanent establishment would not normally exist where a business is carried on in a country through a place of business for less than six months. However, there are exceptions to this general rule.

Specifically in relation to computer equipment, as in this case, Paragraph 42.4 of the OECD Commentary provides that:

Computer equipment at a given location may only constitute a permanent establishment if it meets the requirement of being fixed. In order to constitute a fixed place of business, a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1.

In Taxation Determination TD 2005/2, the Commissioner discussed the distinction between computer equipment and the data and software used by, or stored on, that equipment. The Commissioner considered that the server on which a website is stored is a piece of equipment with a physical location and may constitute a 'fixed place of business' of an enterprise which has that server at its disposal.

In this case, G's place of business being the location of the equipment will remain fixed in a geographical point (i.e. The Australian Co premises) for the relevant period of this ruling.

Further, this arrangement is expected to continue on an on-going basis and therefore establishes a certain degree of permanency. Accordingly, the physical location of the equipment is a "fixed" place of business for the purposes of Article 5(1) of the Foreign Agreement.

Is G's business carried on through the fixed place of business?

In addition to having a place of business that is fixed, the enterprise must carry on its business through this fixed place of business to establish a permanent establishment under Article 5(1).

In this case the business of G, being the provision of services, is conducted through a fixed place of business being the equipment. G will enter into a subcontracting arrangement with Third Party whereby Third Party exclusively operates and maintains the equipment located in the Australian Co group premises.

The equipment are required so that staff can work.

ATO Interpretative Decision (ATO ID) 2014/29 considered the issue of whether a Y incorporated company has a permanent establishment in Australia where it has subcontracted the construction or installation located in Australia to an Australian resident entity. In making the decision that the Y company does have a permanent establishment in Australia, the Commissioner made specific reference to paragraph 19 of the OECD Commentary on Article 5.

Paragraph 19 of the OECD Commentaries on Article 5 states that:

19. … If an enterprise (general contractor) which has undertaken the performance of a comprehensive project subcontracts parts of such a project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as being time spent by the general contractor on the building project. …

ATO ID 2014/29 makes the following relevant observations on paragraph 19:

Paragraph 19 of the OECD Model Commentary on Article 5 recognises that an enterprise may carry on its business through subcontractors, either acting alone or together with employees of the enterprise. It is irrelevant whether or not the enterprise itself performs activities in Australia in connection with the construction or installation project - or subcontracts the work to others - either wholly or in part. Hence, the time a subcontractor spends on a building site or construction or installation project is considered to be the time the general contractor spends on the building site or project. In the case of a non-resident enterprise undertaking a construction or installation project in Australia, it means that the enterprise cannot subcontract its way out of having a permanent establishment in Australia.

While paragraph 19 of the OECD Commentary is in relation to Article 5(3) of the 2010 OECD Model Tax Convention on Income and on Capital (Model Convention) (Article 5(2)(h) of the Foreign Agreement) regarding construction and installation projects, it highlights the Commissioner's view that an entity cannot subcontract its way out of having a permanent establishment. This view is applicable to all types of permanent establishments. That is it would not only be limited to construction and installation but would extend to subcontracting out services as well.

The operation of the place of business by the subcontractor at the direction of the contractor is considered to be the operation of the place of business by the contractor. That is, the rights of subcontracting parties do not affect the nature of the business carried on by the enterprise and whether the overseas enterprise has a permanent establishment.

Paragraph 42.3 of the OECD Commentary gives the example that where an enterprise owns or leases a computer server, the place that the server is located may constitute a permanent establishment if the other requirements of Article 5 are met:

42.3. …However, if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met.

Third Party as subcontractor has the authority to operate the equipment on behalf of G, all contracts between Australian Co will be concluded with G. As the contractor, G bears the ultimate legal obligation and risk regarding performance of the project work in Australia. In addition, G has the right to sell, lease or otherwise dispose of the equipment.

Looking through this subcontracting arrangement, G will be considered to conduct its business of providing services to Australian Co through a fixed place of business located in Australian Co's premises.

Preparatory and auxiliary activities

Article 5(3)(e) of the Foreign Agreement provides that the following activities would not constitute a permanent establishment:

The maintenance of a fixed place of business solely for the purpose of activities which have a preparatory or auxiliary character for the enterprise, such as advertising or scientific research

Paragraph 42.8 of the OECD Commentary notes that where functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the equipment, these would go beyond the activities that are preparatory and auxiliary for the enterprise.

Here, the core business of G is the provision of services to Australian Co. The services provided by G operate from the equipment and are wholly related to the core business services of G. Therefore, the exclusion in article 5(3)(e) is not applicable.

Substantial equipment

Subsection 6(1) of the ITAA 1936 defines a permanent establishment as:

…permanent establishment, in relation to a person (including the Commonwealth, a State or an authority of the Commonwealth or a State), means a place at or through which the person carries on any business and, without limiting the generality of the foregoing, includes…

(b) a place where the person has, is using or is installing substantial equipment or substantial machinery…

As discussed, G has a permanent establishment under Article 5(1) of the Foreign Agreement. The Foreign Agreement overrides the domestic law and therefore it is unnecessary to consider whether the substantial equipment provision contained in ITAA 1936 is satisfied.

However, if the Commissioner were required to consider if the equipment purchased and installed to operate G's business represents substantial equipment it would be likely that the conclusion would be that it is substantial equipment. This is based on the following factors as outlined in ATO ID 2006/337 Income Tax: Permanent establishment: meaning of 'substantial equipment':

• a consideration of the importance of the equipment in conducting G's business activities, such that the equipment may be considered so valuable that it may be considered substantial in an absolute sense. So in terms of the equipment playing a core or necessary role in the income producing activity.

• The size of the equipment in terms of dimensions and weight, and that size is only one factor alone and will not be decisive without consideration of the other factors.

• The value of the equipment in terms of the cost to purchase, install and maintain.

• The value of the equipment in terms of its value (wealth) creating potential which in this case would include the business of the Australian subsidiaries as well as potentially the business in the Asia pacific region reliant on the equipment.

• That the equipment across the various sites would be viewed as a unified process and taken together when considering the question of whether there is 'substantial equipment'.

Conclusion

G will have a permanent establishment in Australia under Article 5 of the Foreign Agreement for the provision of services to Australian Co. This is because G will maintain a fixed place of business through which it will carry out its business for a period of more than six months. G is considered to have carried on the activities of Third Party, the subcontractor, during this period.

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