Edited version of private advice

Authorisation Number: 1052129957419

Date of advice: 19 June 2023

Ruling

Subject: Foreign income tax offset

Question 1

Is Entity A, a Foreign Hybrid Limited Partnership (FHLP) for the purposes of subsection 830-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is Entity B, a FHLP for the purposes of subsection 830-10(1) of the ITAA 1997?

Answer

No

Question 3

Is Entity A an Australian resident for the purposes of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) due to the application of section 94T of the ITAA 1936 and therefore assessable to tax on its worldwide income and required to lodge an income tax return in Australia?

Answer

Yes

Question 4

Is Entity B an Australian resident for the purposes of subsection 6(1) of the ITAA 1936 due to the application of section 94T of the ITAA 1936 and therefore assessable to tax on their worldwide income and required to lodge an income tax return in Australia?

Answer

Yes

Question 5

Is the income received by Entity A assessable in Australia?

Answer

Yes.

Question 6

Are amounts received by you from Entity A assessable in Australia under sections 6-5 and 6-10 of the ITAA 1997?

Answer

Yes.

Question 7

Would the income derived by Entity B that is taxed in Country X as business profits derived from a permanent establishment in Country X under Article 7 of the Agreement between Australia and Country X for the Elimination of Double Taxation with respect to taxes on income and capital and the prevention of fiscal evasion and avoidance (DTA) be non-assessable non-exempt income under section 23AH of the ITAA 1936?

Answer

Yes.

Question 8

Are you entitled to a Foreign Income Tax Offset (FITO) under section 770-10 of the ITAA 1997 for corporate tax and additional tax, less trade tax, paid in Country X in respect of your share of the profits of Entity A (which includes the profits of Entity B) in the XXX years where the amounts of income earned on which Foreign tax is paid are included in your assessable income in Australia?

Answer

Yes.

Question 9

Are you entitled to a FITO under section 770-10 of the ITAA 1997 for trade tax assessed and paid in Country X by Entity B and credited to you in XXX income years?

Answer

Yes.

This private ruling applies for the following period:

Year ended 30 June XXX

The scheme commenced on:

XXXX

Relevant facts and circumstances

Background

You are a Foreign citizen born and raised in Country X.

You moved to Australia with your family on XXX.

Your wife and children are Foreign citizens.

You obtained a TFN in 20XX and backdated your registration to earlier that financial year.

You became an Australian resident for tax purposes when you moved to Australia on X XXX 20XX.

You receive income from your related entities and business operations located and conducted in Country X.

None of your related entities have an office or any business operation in Australia.

Formal decisions like shareholder resolutions of any of the four entities are being exercised at your home address in Suburb X in Australia.

Any shareholder approvals under the Matrix of Approval like payment of bonuses or bank financing are done by you as the sole shareholder at your home in Australia.

Company A

Company A is a limited liability Company.

You are the sole shareholder and Managing Director of Company A.

The Company's registered office is in Country X.

Business activities

The Company is involved with the possession, management and marketing of its own real estate and assets.

Entity A

Entity A is a limited partnership under the Foreign law with the limited liability company Company A as a general partner and you as the second and sole limited partner.

You are the Managing Director of Entity A in your role as Managing Director of Company A.

You founded the partnership in 20XX.

There are no business premises located in Australia.

You provided Articles of Partnership of Entity A.

Business activities

The partnership Entity A is the owner of the factory premises located in Country X used by Company B in the manufacturing business.

The only purpose of Entity A is to hold shares in Company B and being owner of the premises in Country X, rented out to Company B on behalf of Entity B. Under Foreign tax legislation all Entity A income and expenses, which are directly linked to Entity B are to be neutralised.

Besides being the partner and asset holding company for the operations of Entity B, Entity A has no other business activities.

Management and Operations

Company A is the managing company of Entity A and has the top authority in making high level decisions.

Company A has full rights to represent and to take decisions on behalf of Entity A.

Entity A does not have a managing body of its own.

Roles and responsibilities

You have the following roles in Entity A with different rights associated:

a)            In your role as the sole Shareholder of Company A you have:

•                    the right to request information and to review financial statements;

•                    the right to a share of the profit according to the ownership ratio (being 100%).

b)            In your role as the Managing Director of Company A you have the right:

•                    to participate in the day-to-day finance and operations decisions of Entity A;

•                    to participate in making the high-level decisions;

•                    to represent the business in external relations.

c)            In your role as the Individual partner, you are liable with your deposit of XXX.

•                    You have taken over financial guarantees in the amount of XXX.

•                    You make the decisions about the Articles of the Partnership such as:

-        the purpose of the Company

-        the amount of the liable capital

-        the distributions of results

•                    Once a year you approve the annual accounts.

Company B

Entity A is the sole shareholder of Company B.

Business activities

Manufacturing business and currently employs XX staff.

Management and Operations

Company B is managed by an employed Managing Director, Mr Y.

You receive monthly reports such as profit and loss, balance sheets, and hours worked, and on that basis, you prepare a budget and calculate productivity and employee bonuses.

You have not been involved in the daily operational management of the Company since you stepped down from the Director's position and moved to Australia.

You are involved in the key financing decisions. You are a personal guarantor for the financing of the business premises.

100% of the voting rights rest with the limited partner in accordance with Article 7(3) of the Articles of Partnership provided for Entity A and Entity B.

You provided minutes from a shareholders meeting of Company B held on XXX at your home in Suburb X Australia. You were the sole representative as the sole shareholder for Entity A.

Entity B

Entity B is a limited partnership between:

•                     the limited liability company Company B represented by the Managing Director with sole power of representation Mr X as a general partner and

•                     Entity A as the sole limited partner represented by Company A.

You provided Articles of the Partnership for Entity B.

Business activities

Manufacturing business and currently employs XX staff.

Management and Operations

You provided a Matrix of Approval, which shows your responsibilities as well as those of the various Managers and the Managing Director.

Entity B has an appointed Managing Director located in Country X.

The Managing Director is responsible for:

•                     Overseeing and controlling the remaining managers who are appointed to carry out the day-to-day business operations

•                     Tender and Quotes with margin of less than 5%

•                     Changes to the Terms and Conditions of the contracts

•                     Procurement of materials and subcontractor purchases

•                     Any kind of consultancy agreements

•                     Obtaining legal advice

•                     Hiring and termination of staff including directors

•                     Paying adjustments of less than 5% p.a.

•                     Payment of one-off payments like bonuses and gratuities

•                     Waving receivables of less than 5%

•                     Day-to-day business operations and management decisions

Your roles and responsibilities

You are responsible for overseeing and controlling the work of the Managing Director in your role as the Managing Director of Entity A. You do this by regular phone calls (every week or two), frequent e-mails and VPN access to the server of Entity B.

You are responsible for approximately 100 requests for approval per year for job quotes with volumes exceeding XXX.

As the main shareholder and owner, you receive monthly reports, which you use to prepare a follow up on the budget and do the calculations of the productivity and employee bonuses.

You are involved with financing and communication with banks as well as the tax advisor.

You provided a guarantee/security for financing the business premises and currently are negotiating obtaining further working capital.

You are also responsible for decisions involving liquidation or commencement of new business ventures.

You do the monthly calculation of bonus provisions based on the monthly reporting.

Entity A and Entity B Partnership specific terms:

You provided copies of the partnership agreements dated in the year of XXX between:

•                     Company A and Mr X for the Entity A partnership; and

•                     Company B and Entity A for the Entity B partnership.

The partnerships do not have a fixed end date.

100% of voting rights with regards to any decision to include additional partners and assignment of partnership interest rest with the limited partner.

There is no limitation of liability for the general partners Company A and Company B.

You as the limited partner of Entity A formally are liable up to the amount of your capital contribution being XXX deposit.

Profit distribution

The profit shares are to be attributed to the loan accounts of the shareholders (at the end of each accounting period), unless otherwise resolved by the shareholders.

Similarly, shareholders participate in the losses in proportion to their capital shares.

Taxation obligations in Country X

Taxation of the companies Company A and Company B

Company A and Company B are subject to corporate tax (X%), trade tax (X%) and additional tax (X%).

In XX the total profit from Company A and Company B was XXX and displayed as the relevant amount in your personal income tax assessment.

Taxation of Entity A and Entity B

Entity A and Entity B are partnerships under the Foreign tax legislation and flow through vehicles not taxed in their own right.

Entity A receives rental income from renting out the factory premises to Company B acting for Entity B, and incurs relevant expenses for maintenance of the factory premises. For Foreign tax purposes, this is not recognized as an expense to Entity B or income to Entity A.

Entity A and Entity B are subject to Foreign trade tax. The assessment is raised on the entities and paid by the entities, but any trade tax paid is credited to your personal income tax via the tax assessment of Entity A.

In XX, only minor administrative expenses of XX not directly (but indirectly) linked to Company B remained on the profit and loss statements of Entity A. Therefore, Entity A had a negative taxable income and did not pay any trade tax.

You provided an assessment for trade tax for Entity A, which was XX since there was no income but a small amount of administrative expenses in 20XX year.

You provided an assessment for trade tax for the 20XX year for Entity B, which showed a total amount of trade tax paid XXX.

The entire income (before trade tax) of both partnerships is taxed at your level as the sole shareholder.

Taxation of Mr X

You are personally liable for the Foreign income tax on the profits made by Entity A and in receipt of a tax offset for Foreign trade tax levied on the respective partnerships.

Besides the income from Entity A and Entity B, you have not received any other income from Country X since you became a resident of Australia for tax purposes.

DETAILED REASONING

Question 1

You are the sole shareholder and Managing Director of Company A, which is a Company with limited liability involved with the possession, management and marketing of its own real estate and assets. The Company was incorporated in Country X and has its registered office in Foreign country, Country X.

You are also the sole limited partner in Entity A, and have been partnered together with Company A.

Entity A is regarded as a limited partnership in Country X.

Limited partnership

First, we need to consider whether Entity A meets the definition of a limited partnership for Australian purposes.

Subsection 6(1) of the ITAA 1936 states:

'limited partnership' has the same meaning as in the ITAA 1997.

Subsection 995-1(1) of the ITAA 1997 states:

limited partnership means:

a)            an association of persons (other than a Company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited; or

b)            an association of persons (other than one referred to in paragraph (a)) with legal personality separate from those persons that was formed solely for the purpose of becoming a VCLP, an ESVCLP, an AFOF or a VCMP and to carry on activities that are carried on by a body of that kind.

Company or partnership requirement

As a limited partnership will not include an association of persons that is a Company (under paragraph (a) of the definition), it is important to consider what is a Company for the purposes of the income tax law.

A Company is defined in subsection 995-1(1) of the ITAA 1997 to mean:

a)            a body corporate, or

b)            any other unincorporated association or body of persons, but does not include a partnership or a non-entity joint venture.

A person includes a Company according to subsection 995-1(1) of the ITAA 1997.

A partnership is defined in subsection 995-1(1) of the ITAA 1997 to mean:

a)            an association of persons (other than a Company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly, or

b)            a limited partnership.

Miscellaneous Tax Ruling MT 2006/1: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business number (at paragraphs 30 to 31) sets out guidance on the definition of body corporate - taking into account the common law meaning:

30. 'Body corporate' is not a defined term. The term takes its meaning from the general law. 'Body corporate' is a general term to describe an artificial entity having a separate legal existence. A body corporate has the ability to continue in existence indefinitely and to keep its identity regardless of changes to its membership. It also has the power to act, hold property, enter into legal contracts, sue and be sued in its own name, just as a natural person can.

Entity A exhibits the following features to establish that it should be regarded as a limited partnership rather than as a company:

•                     The partnership is formed under the laws of Country X governing limited partnerships.

•                     The relationship of the partners is formalised through and governed by Articles of Partnership as opposed to a memorandum of association.

•                     Entity A does not have its own managing body.

•                     Company A as the general partner and managing Company of Entity A has full rights to represent and make decisions on behalf of the partners.

•                     From Entity A perspective, there is no limitation of liability of the general partner Company A.

•                     You as the limited partner of Entity A formally are liable up to the amount of your capital contribution.

•                     The Entity A does not have perpetual succession in the same manner as a Company, insofar as the partnership will be dissolved upon withdrawal of the general partner.

Based on the above, it is considered that the individual limited partner and the general partner of the partnership are "an association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly".

A partner with a limited liability requirement

Under paragraph (a) of the definition of 'limited partnership', there is also the requirement establishing whether the liability of at least one of the persons in the association is limited.

Paragraph 13 of Taxation Determination TD 2008/15 Income tax: Can an unincorporated association of persons acting only in Australia who do not carry on a business in common with a view to profit be a corporate limited partnership within the meaning of section 94D of the Income Tax Assessment Act 1936? states:

The reference to the liability of at least one of the 'partners' being limited is a reference to a limitation (applying under the legal system applicable to the association) of their liability to third parties for, or to contribute to, the debts, obligations or other liabilities of the 'partnership'. Those debts, obligations or other liabilities will be those arising from the partners carrying on business as partners, or from their joint receipt of income, whichever character their association has.

Under the Article of the partnership, the liability of the limited partner is limited to the capital they contribute. You have invested in the partnership XXX and your liability is limited to the amount of your contribution. Entity A, therefore, satisfies the definition of a limited partnership because the liability of at least one of the partners is limited.

Therefore, Entity A satisfies paragraph (a) of the definition of 'limited partnership' in subsection 995-1(1) of the ITAA 1997. Entity A is, therefore, considered a limited partnership for the purposes of applying subsection 830-10(1) of the ITAA 1997.

Foreign Hybrid Limited Partnership (FHLP)

Subsection 830-10(1) of the ITAA 1997 provides that a limited partnership is a foreign hybrid limited partnership in relation to an income year if all of the following criteria are satisfied:

a)            it was formed in a foreign country; and

b)            foreign income tax[1] is imposed under the law of the foreign country on the partners, not the limited partnership, in respect of the income or profits of the partnership for the income year; and

c)            at no time during the income year is the limited partnership, for the purposes of a law of any foreign country that imposes foreign tax on entities because they are residents of the foreign country, a resident of that country; and

d)            disregarding subsection 94D(5) of the ITAA 1936, at no time during the income year is it an Australian resident; and

e)            disregarding that subsection, in relation to the same income year of another taxpayer:

                             i.                the limited partnership is a controlled foreign Company (CFC) at the end of a statutory accounting period that ends in the income year; and

                            ii.                at the end of the statutory accounting period, the taxpayer is an attributable taxpayer in relation to the CFC with an attribution percentage greater than nil.

Paragraph 830-10(1)(a) of the ITAA 1997

In the present case, paragraph 830-10(1)(a) of the ITAA 1997 is satisfied because Entity A is a limited partnership which was formed in Country X.

Paragraph 830-10(1)(b) of the ITAA 1997

Paragraph 830-10(1)(b) requires foreign income tax to be imposed at the level of the partners and not the limited partnership in respect of any income or profit derived by the partnership.

Taxation Determination TD 2009/2 'Income tax: when is 'foreign income tax... imposed...on the partners, not the partnership' under paragraph 830-10(1)(b) of the Income Tax Assessment Act 1997 for the purpose of determining whether a foreign limited partnership is a foreign hybrid limited partnership under Division 830 of that Act?' (TD 2009/2) sets out the ATO's view of the circumstances in the following paragraphs:

1. Paragraph 830-10(1)(b) of theITAA 1997 contains two requirements: that foreign income tax is imposed on the partners of the limited partnership in respect of the income or profits of the limited partnership; and that foreign income tax in respect of the income or profits is not imposed on the limited partnership itself.

2. In determining whether foreign income tax is imposed on the partnership or the partners for these purposes, consideration must be given to characteristics specific to the limited partnership in question where they affect its status, and/or the status of the partners, as taxpayers. For example, whether the limited partnership has elected corporate or entity tax treatment which affects how the income or profits of the partnership are taxed, and/or whether it engages in activities that result in the partnership being a taxpayer, will be relevant.

3. The tests do not require the limited partnership or the partners to have earned actual taxable income or profits in the income year: it is only necessary to consider whether the limited partnership or the partners would be the taxpayer(s), were there such income or profits. Therefore, the requirement that income tax is imposed on the partners can still be satisfied in an income year in which the partnership has a loss for tax purposes, or only earns income that is exempt from tax. The provision does not require the partners to have an actual foreign income tax liability. It simply requires that, were the limited partnership to have income or profits that would have been taxable in the foreign jurisdiction, the tax liability would have been incurred by the partners.

...

6. The requirement that income tax is not imposed on the limited partnership will not be satisfied merely by virtue of the partnership not having an actual tax liability in the particular income year, for example, because it had a loss for tax purposes. It is necessary to consider what the tax treatment of the limited partnership would have been if it had derived income or profits that would have been taxable in the foreign jurisdiction......

In respect of determining whether a partnership itself is subject to tax for the purposes of paragraph 830-10(1)(b) of the ITAA 1997, TD 2009/2 provides the following:

Example 3: income tax because of activities

19. KG1 is a limited partnership formed in Country X which performs business activities at its fixed base in Country X, such that it is a 'taxpayer' for Foreign trade tax purposes.

20. Foreign trade tax would be imposed on KG1 in respect of its 'trade profits'.

21. As Foreign trade tax is imposed on KG1, the requirement in paragraph 830- 10(1)(b) that foreign income tax is not imposed on the limited partnership is not satisfied, and as a result KG1 is not a foreign hybrid.

22. It is understood that, as well as trade tax being imposed on KG1, Foreign income tax would be imposed on the partners in respect of the income of KG1. However, this does not result in KG1 satisfying the requirements of paragraph 830-10(1)(b).

Example 3A: income tax because of activities - loss year

23. In a subsequent income year, KG1 incurs a loss for trade tax purposes, and therefore does not have any income or profits that result in a trade tax liability for the particular income year.

24. However, because KG1 performs business activities at a fixed base in Country X, if KG1 had had income or profits (instead of a loss), KG1 would have been subject to Foreign trade tax. Therefore, for the purposes of paragraph 830-10(1)(b), foreign income tax is imposed on KG1.

25. Therefore, paragraph 830-10(1)(b) is not satisfied by KG1 in a loss year, and as a result KG1 is not a foreign hybrid.

The above examples demonstrate that where the foreign country imposes trade tax on the partnership even if Foreign income tax is then assessed to the partners, it will still not satisfy the requirement in paragraph 830-10(1)(b) and the entity will not be a foreign hybrid limited partnership as the partnership itself is in part subject to tax. It does not satisfy the criteria even if there is a loss for trade tax purposes and no trade tax liability.

Paragraph 830-10(1)(b) requires that, were the limited partnership to have income or profits that would have been taxable in the foreign jurisdiction, the tax liability would have been incurred by the partners. It does not require the limited partnership or the partners to have earned actual taxable income or profits in the income year. Therefore, the requirement that income tax is imposed on the partners can still be satisfied in an income year in which the partnership has a loss for tax purposes, or only earns income that is exempt from tax.

Therefore, in determining whether the conditions in paragraph 830-10(1)(b) are satisfied, regard should be given to the hypothetical question of where the tax liability would rest if there were income or profits of the partnership of the kind that would have been taxable in the foreign jurisdiction.

First requirement - limited partnership must not be subject to income tax

You stated that Entity A is a partnership under Foreign tax legislation and flow through vehicles are not taxed in their own right.

Entity A receives rental income from renting out the factory premises to Entity B. Due to Entity A being the sole limited partner of Entity B, in accordance with the Foreign tax law, all of Entity A's income and expenses, which are directly linked to Entity B are neutralized.

You stated that Entity A is subject to trade tax.

In 20XX, only minor administrative expenses remained on the profit and loss statements of Entity A. Therefore, Entity A had a negative taxable income and did not pay any trade tax.

As stated above at paragraph 3 of TD 2009/2, paragraph 830-10(1)(b) does not require the limited partnership or the partners to have earned actual taxable income or profits in the income year, it is only necessary to consider whether the tax would be imposed on the limited partnership or the partners if there were such income or profits.

Consequently, since the trade tax would have been imposed on Entity A, even if such tax is subsequently allocated and credited to you in your income tax return, Entity A does not satisfy the first requirement in paragraph 830-10(1)(b). This is consistent with the outcomes as described in Example 3 and Example 3A of TD 2009/2.

Second requirement - partners bear the tax on income or profits of the limited partnership

In terms of the second requirement, paragraph 4 of TD 2009/2 states:

Where the foreign country does not impose any tax on income or profits, or does not impose a tax on income or profits earned by limited partnerships in any circumstances, the requirement that tax is imposed on the partners cannot be satisfied.

In your case, amounts of income or profits earned by Entity A are taxed in your hands as the sole limited partner. As such this second requirement is satisfied.

In conclusion, with respect to Entity A, even though Entity A did not pay any trade tax due to negative taxable income in the 2020 year, the trade tax would have been imposed and would have been payable if not for the losses. Therefore, it does not satisfy the criteria in paragraph 830-10(1)(b) of the ITAA 1997 and is not a FHLP.

Paragraph 830-10(1)(c) of the ITAA 1997

This paragraph requires that at no time during the income year is the limited partnership, for the purposes of a law of any foreign country that imposes foreign income tax on entities because they are residents of the foreign country, a resident of that country.

This condition ensures that if there is another foreign country (apart from the country of formation) which taxes the limited partnership as a resident entity, it will not qualify as a foreign hybrid limited partnership.

There is no other foreign country that has taxed Entity A partnership on the basis of it being a resident of that country.

Therefore, paragraph 830-10(1)(c) of the ITAA 1997 is satisfied.

Paragraph 830-10(1)(d) of the ITAA 1997

This paragraph requires that disregarding subsection 94D(5) of the ITAA 1936, the limited partnership is not an Australian resident at any time during the relevant income year.

In other words, when subsection 94D(5), which deals with corporate limited partnership, is disregarded, the residency rules in section 94T of the ITAA 1936 generally apply to determine the residency of the limited partnership. In brief terms, subsection 94T(1) treats corporate limited partnerships as resident in Australia if and only if:

a)            the partnership was formed in Australia (paragraph 94T(1)(e)); or

b)            either the partnership carries on business in Australia or the partnership's central management and control is in Australia (paragraph 94T(1)(f)).

Accordingly, if a limited partnership carries on business in Australia or has its central management and control in Australia during an income year it will be a resident of Australia and therefore will not qualify as a foreign hybrid limited partnership for that year.

Relevantly, under paragraph 94T(1)(f) of the ITAA 1936, Entity A will be an Australian resident if its central management and control is in Australia.

The Partnership's central management and control is in Australia

Whether Entity A is an Australian resident or not is a question of fact. The main condition that is relevant in the current case is whether its central management and control is in Australia.

Taxation Ruling TR 2018/5 Income tax: central management and control test of residency (TR 2018/5) provides guidance on the central management and control test of residency.

Paragraph 10 of TR 2018/5 states that central management and control refers to the control and direction of a Company's operations. It does not refer to a physical location in which the control and direction of a Company is located and may ultimately be exercised in more than one location.

Paragraph 11 then states that the key element in the control and direction of a Company's operations is the making of high-level decisions that set the Company's general policies and determine the direction of its operations and the type of transactions it will enter. Paragraph 12 specifically distinguishes decision involving the control and direction of a Company from the day-to-day conduct and management of its activities and operations.

In summary, the central management and control of a Company is generally exercised by the Board of Directors.

In the case of a corporate limited partnership, a limited partner may not take part in the management of the business of the partnership. Therefore, the central management and control of the partnership should be found in the general partner, who is subject to unlimited liability and has a role similar to that of the Board of Directors of a Company as it sets the strategy and direction of the business.

As such, the question of where the central management and control is exercised will be determined by where the general partner makes the key decisions in respect of the business. The general partner in Entity A is the company Company A. Company A has full rights to represent and take decisions on behalf of Entity A. Therefore, central management and control will be determined by where Company A 's Board of Directors makes decisions in respect of Entity A's activities specifically.

You are the major shareholder and Managing Director of Company A, and subsequently make all of the high-level decisions in respect of not only Company A, but Entity A. In your role as the Managing director of Company A, in respect of Entity A, you:

•                     participate in the day-to-day finance and operations decisions of Entity A;

•                     participate in making the high-level decisions;

•                     represent the business in all external relations.

•                     make the decisions about the Articles of Entity A partnership such as:

-        the purpose of the Company

-        the amount of the liable capital

-        the distributions of results

•                     have the right to object to decisions of the management of Company A in the event that an action goes beyond the ordinary course of business of the Company (in accordance with s164 of the Foreign Commercial Code).

More specifically, in your role as the Managing Director of Entity A:

•                     You are responsible for overseeing and controlling the work of the Managing director of the main operating entity Entity B. You do this by regular phone calls (every week or two), frequent e-mails and VPN access to the server of Entity B.

•                     You are responsible for approximately 100 requests for approval per year for job quotes with volumes exceeding XXX.

•                     As the main shareholder and owner, you receive monthly reports, which you use to prepare a follow up on the budget and do the calculations of the productivity and employee bonuses.

•                     You are involved with financing and communication with banks as well as the tax advisor.

•                     You prepare the yearly budget and perform a monthly follow-up with the other managers.

•                     You lead all the correspondence with the external accounting firms about the annual accounts, review the financial data monthly and make financial decisions of the business such as granting and taking loans, investments and divestments of over XXX, reviewing rental agreements with total payments of over XXX.

•                     You provided a guarantee/security for financing the business premises and currently are negotiating obtaining further working capital.

•                     You are also responsible for decisions involving liquidation or commencement of new business ventures.

You moved to Australia with your family on XXXX and became a resident of Australia for tax purposes.

You confirmed and provided supporting documents like e-mails and minutes that you have managed the business and made any formal and high-level decisions including shareholders resolutions with regards to any of the four related entities being Entity A, Company A, Company B and Entity B from your home address in Suburb X, Australia. For example, you provided minutes from shareholders meeting held on XXXX at your home in Suburb X Australia. You were the sole representative as the sole shareholder for Entity A.

As such, based on the above circumstances, it can be concluded that the central management and control of Entity A is located in Australia and Entity A is an Australian resident under section 94T of the ITAA 1936.

Therefore, paragraph 830-10(1)(d) of the ITAA 1997 is not satisfied.

Paragraph 830-10(1)(e) of the ITAA 1997

According to this paragraph, the limited partnership must be a CFC (Controlled Foreign Company) with at least one "attributable taxpayer" having an "attribution percentage" greater than nil. This will generally mean that there must be at least one Australian resident taxpayer who has at least a 10% interest (directly or indirectly) in the limited partnership.

•                     "CFC" is defined in section 340 of the ITAA 1936 and is basically a non-resident Company that is either controlled by a small group of 5 or fewer Australian taxpayers or is deemed to be controlled by a small group of Australian taxpayers.

•                     "Attributable taxpayer" is defined in section 361 of the ITAA 1936 and refers to an Australian resident taxpayer with a requisite amount of control of a CFC who has the income of the CFC attributed (taxed) to him or her.

•                     "Attribution percentage" is the percentage of the attributable income of the CFC that is attributed (taxed) to the attributable taxpayer.

Basically, the test in paragraph 830-10(1)(e) of the ITAA 1997 requires that (assuming Entity A was not a foreign hybrid) the limited partnership:

•                     would be a CFC in relation to another taxpayer; and

•                     that taxpayer is an attributable taxpayer in relation to the CFC.

Generally, this means that there must be at least one Australian taxpayer who has a direct or indirect interest of at least 10% in the limited partnership. Whether the limited partnership is a CFC is tested at the end of its statutory accounting period (as defined in the CFC provisions) that ends in the same year of income for the attributable taxpayer. The effect of this provision is that, as a general rule, only those limited partnerships from which income could be attributed currently under the CFC regime will, subject to meeting the other tests, be foreign hybrids. (Schedule 10, item 15, paragraph 830-10(1)(e))

In the current case, paragraph 830-10(1)(e) of the ITAA 1997 is satisfied because at the end of a relevant statutory accounting period you were an attributable taxpayer and an Australian resident for tax purposes and had a direct interest greater than 10% in Entity A limited partnership, being the sole limited partner in Entity A.

Conclusion

Accordingly, as not all the requirements of subsection 830-10(1) of the ITAA 1997 are satisfied, Entity A is not a foreign hybrid limited partnership for the purposes of subsection 830-10(1) of the ITAA 1997.

Question 2

You are a partner in Entity A, which is the sole shareholder of Company B. The limited liability Company Company B is the general partner, and Entity A the sole limited partner of Entity B. Entity B is located in Foreign country in Country X and is involved in manufacturing business.

Limited partnership

Similar to Entity A, Entity B meets the definition of a limited partnership for Australian purposes in subsection 6(1) of the ITAA 1936 for the following reasons:

•                     Entity B exhibits the following features that confirm that it should be regarded as a limited partnership rather than as a Company:

-              The partnership is formed under the laws of Country X governing limited partnerships.

-              The relationship of the partners is formalised through and governed by Articles of Partnership as opposed to a memorandum of association.

-              Entity B does not have its own managing body.

-              According to Article 5 of the Articles of the Partnership, Company B as the general partner is entitled and obliged to manage the business on behalf of the partnership.

-              From Entity B perspective, there is no limitation of liability of the general partner Company B.

-              The limited partner Entity A is formally liable up to the amount of the capital contribution.

-              The Entity B does not have perpetual succession in the same manner as a Company, insofar as the partnership will be dissolved upon withdrawal of the general partner;

A partner with a limited liability requirement

Under the Articles of the Partnership, the liability of the limited partner is limited to the capital they contribute. The sole limited partner Entity A has invested in the partnership EUR100,000 and its liability is limited to the amount of its contribution.

Therefore, Entity B also satisfies paragraph (a) of the definition of 'limited partnership' in subsection 995-1(1) of the ITAA 1997 because the liability of at least one of the partners is limited.

Entity B is considered a limited partnership for the purposes of applying subsection 830-10(1) of the ITAA 1997.

Foreign Hybrid Limited Partnership (FHLP)

Paragraph 830-10(1)(a) of the ITAA 1997

Paragraph 830-10(1)(a) of the ITAA 1997 is satisfied because Entity B is a limited partnership, which was formed in Country X.

Paragraph 830-10(1)(b) of the ITAA 1997

Paragraph 830-10(1)(b) requires foreign income tax to be imposed at the level of the partners and not the limited partnership in respect of any income or profit derived by the partnership.

Example 3: income tax because of activities

19. KG1 is a limited partnership formed in Country X which performs business activities at its fixed base in Country X, such that it is a 'taxpayer' for Foreign trade tax purposes.

20. Foreign trade tax would be imposed on KG1 in respect of its 'trade profits'.

21. As Foreign trade tax is imposed on KG1, the requirement in paragraph 830- 10(1)(b) that foreign income tax is not imposed on the limited partnership is not satisfied, and as a result KG1 is not a foreign hybrid.

22. It is understood that, as well as trade tax being imposed on KG1, Foreign income tax would be imposed on the partners in respect of the income of KG1. However, this does not result in KG1 satisfying the requirements of paragraph 830-10(1)(b).

The above example from TD 2009/2 demonstrates that where the foreign country imposes trade tax on the partnership even if Foreign income tax is then assessed to the partners, it will still not satisfy the requirement in paragraph 830-10(1)(b) and the entity will not be a foreign hybrid limited partnership.

First requirement - limited partnership must not be subject to income tax

•                     You stated that Entity B is a partnership under the Foreign tax legislation and a flow through vehicle not taxed in its own right.

•                     You stated that Entity B is subject to trade tax. The assessment is raised on the entity but if trade tax is paid it will be allocated to your personal income tax.

•                     In 2XXX, Entity B paid total trade tax of XXX.

Paragraph 3 of TD 2009/2 states that paragraph 830-10(1)(b) does not require the limited partnership or the partners to have earned actual taxable income or profits in the income year, it is only necessary to consider whether the tax would be imposed on the limited partnership or the partners if there were such income or profits.

In your case, the Foreign trade tax was imposed on Entity B on the profit made from trading activities. As such, this requirement is not satisfied.

Second requirement - partners bear the tax on income or profits of the limited partnership

In your case, Entity B operates an active business in Country X being the manufacturing business. You stated that as the ultimate limited partner in Entity B through your partnership interest in Entity A, you are personally liable for the entire Foreign income tax on the profits made by Entity B. As such, this sub-requirement that the partners must be taxed on their share of the income of the partnership is satisfied.

As such, due to the imposition of trade tax on Entity B, notwithstanding that the partners are taxed on the income of the partnership, the relevant requirement in paragraph 830-10(1)(b) of the ITAA 1997 will not be satisfied and Entity B is not a FHLP.

Paragraph 830-10(1)(c) of the ITAA 1997

There is no other foreign country that has taxed Entity B partnership on the basis of it being a resident of that country. Therefore, paragraph 830-10(1)(c) of the ITAA 1997 is satisfied.

Paragraph 830-10(1)(d) of the ITAA 1997

As previously outlined, the question that arises is whether Entity B, being a corporate limited partnership, is a resident of Australia under section 94T of the ITAA 1936.

Relevantly, Entity B will be a resident of Australia under section 94T of the ITAA 1936 if its central management and control is in Australia per paragraph 94T(1)(f) of the ITAA 1936.

The Partnership's central management and control is in Australia

Whether Entity B is an Australian resident or not is a question of fact. The main condition that is relevant in the current case is whether its central management and control is in Australia.

As discussed above, TR 2018/5 provides guidance on central management and control test of residency.

The fact that the factory where Entity B is operating is located in Country X is not decisive. The ruling provides that one of the major factors is where the high-level decisions are made, which determine the Company's general policies and the direction of its operations.

The day-to- day management and operations decision are specifically distinguished from decisions involving the control and direction of a Company.

The central management and control of a Company is generally exercised by the Board of Directors, which in the case of a corporate limited partnership is found in the general partner, who is subject to unlimited liability and has a role similar to that of the Board as it sets the strategy and direction of the business.

The general partner in Entity B is Company B. Company B has full rights to represent and take decisions on behalf of Entity B. Therefore, central management and control will be determined by where Company B's Board of Directors makes decisions in respect of Entity B's activities.

Central management and control analysis

Identifying who exercises central management and control is a question of fact.

Paragraph 22 of TR 2018/5 states that:

When determining who exercises a Company's central management and control, all the relevant facts and circumstances must be considered. Facts and circumstances to be considered in determining who exercises a Company's central management and control include the role of anyone who assumes the role of the directors' role in managing and controlling the Company's affairs or has a role in the decision-making processes or governance of the Company.

According to paragraph 16 TR 2018/5, acts that demonstrate central management and control include:

•                     setting investment and operational policy including:

-              setting the policy on disposal of trading stock, and/or the use and development of capital assets

-              deciding to buy and sell significant assets of the Company

•                     appointing Company officers and agents and granting them power to carry on the Company's business (and the revocation of such appointments and powers)

•                     overseeing and controlling those appointed to carry out the day-to-day business of the Company but do not need to actively intervene, and

•                     matters of finance, including determining how profits are used and the declaration of dividends.

Business activities

Company B is the general partner of Entity B, a manufacturing business and currently employs XX staff. The factory where the business is being carried on is located in Country X. Paragraph 32 of TR 2018/5 states that central management and control of a Company is not necessarily exercised where the trading or investment activities of the Company are carried on.

Paragraph 34 then confirms that where a Company's central management and control is exercised is not determined by where the directors, or other persons, who control and manage it, are resident or live. What matters is where they actually perform the activities to control and direct the Company.

Paragraphs 36 and 37 provide factors that demonstrate central management and control:

•                     where the governing body meets,

•                     where the Company declares and pays dividends,

•                     minutes recording where high-level decisions are made,

•                     where those who control and direct the Company's operations live,

•                     where the Company's books are kept,

•                     where the shareholder's meetings are held,

•                     where the shareholders reside.

Application to your circumstances with respect to Entity B:

Management and Operations

You resigned from the role of a Managing Director with regards to daily management and business operations and remained a sole shareholder.

The new Managing Director reside and exercise their roles in Country X.

The Managing director is responsible for:

•                     Overseeing and controlling the remaining managers who are appointed to carry out the day-to-day business operations.

•                     Day to day conduct and management of the Company B business and trading activities as described in the Facts of this document such as hiring and terminating staff, procurement of materials and trading stock.

In your role as the Director of Entity A and respectively Entity B:

•                     You are responsible for overseeing and controlling the work of the Managing director. You do this by regular phone calls (every week or two), frequent e-mails and VPN access to the server of Entity B.

•                     You are responsible for approximately 100 requests for approval per year for job quotes with volumes exceeding XXX.

•                     As the main shareholder and owner, you receive monthly reports, which you use to prepare a follow up on the budget and do the calculations of the productivity and employee bonuses.

•                     You are involved with financing and communication with banks as well as the tax advisor.

•                     You prepare the yearly budget and perform a monthly follow-up with the other managers.

•                     You are also responsible for decisions involving liquidation or commencement of new business ventures.

You moved to Australia with your family and became a resident of Australia for tax purposes.

You confirmed that since you moved to Australia on XXXX, you have managed the business and made all formal decisions including shareholder resolutions with regards to any of the four related entities being Entity A, Company A, Company B and Entity B from your home address in Suburb X, Australia.

In conclusion, you in your capacity as the General Manager and representative of the Board of Directors are making the high-level decisions setting up the strategy and determining the direction of the business operations.

From the facts outlined it is clear that there are multiple parties involved in the operation and management of the business. However, the Managing Director's role is more in keeping with the day-to-day management of the business. Notwithstanding his role, the decisions you make from Australia are of a more strategic nature involving larger scale transactions, including the Managing Director's bonus.

Although you are not involved in the day-to-day operations of the business you do participate in those key high-level decisions in respect of Entity B regularly and oversee the conduct and operations of the locally appointed managers. You manage and control the entity's affairs and actively participate in the decision-making processes and governance of the business. Therefore, the central management and control of Entity B lies with you in Australia.

As such, Entity B is a resident of Australia under section 94T of the ITAA 1936 as its central management and control is in Australia.

Therefore, paragraph 830-10(1)(d) of the ITAA 1997 is not satisfied.

Paragraph 830-10(1)(e) of the ITAA 1997

In the current case, paragraph 830-10(1)(e) of the ITAA 1997 is satisfied because at the end of a relevant statutory accounting period Entity A was an attributable taxpayer and as determined above an Australian resident for tax purposes and had a direct interest greater than 10% in Entity B limited partnership.

Conclusion

Accordingly, as not all the requirements of subsection 830-10(1) of the ITAA 1997 are satisfied, Entity B is not a foreign hybrid limited partnership for the purposes of subsection 830-10(1) of the ITAA 1997.

Entity B is a corporate limited partnership for Australian income tax purposes, as it is a limited partnership formed after 19 August 1992 per subsection 94D(1) of the ITAA 1936.

This has the effect of treating Entity B for all purposes of Australian tax as a Company.

Question 3

In Question 1, it was concluded as part of the analysis under paragraph 830-10(1)(d) of the ITAA 1997 that Entity A was a resident of Australia for income tax purposes under section 94T of the ITAA 1936, on the basis that its central management and control was located in Australia if it was treated as a corporate limited partnership.

As part of the analysis above, it was demonstrated that Entity A is a corporate limited partnership.

As such, it is concluded that Entity A, being a corporate limited partnership with its central management and control in Australia, is a resident of Australia for income tax purposes under section 94T of the ITAA 1936, making it a resident within the meaning of subsection 6(1) of the ITAA 1936.

Being a resident of Australia, Entity A will therefore be assessable on its income from all sources, whether in or out of Australia, under subsections 6-5(2) and 6-10(4) of the ITAA 1997. It will be required to prepare and lodge tax returns in Australia as if it is an Australian Company on this basis. This will be from the time in which its central management and control was located in Australia.

Question 4

In Question 2, it was concluded as part of the analysis under paragraph 830-10(1)(d) of the ITAA 1997 that Entity B was a resident of Australia for income tax purposes under section 94T of the ITAA 1936, on the basis that its central management and control was located in Australia if it was treated as a corporate limited partnership.

As part of the analysis above, it was demonstrated that Entity B is a corporate limited partnership.

As such, it is concluded that Entity B, being a corporate limited partnership with its central management and control in Australia, is a resident of Australia for income tax purposes under section 94T of the ITAA 1936, making it a resident within the meaning of subsection 6(1) of the ITAA 1936.

Being a resident of Australia, Entity B will therefore be assessable on its income from all sources, whether in or out of Australia, under subsections 6-5(2) and 6-10(4) of the ITAA 1997. It will be required to prepare and lodge tax returns in Australia as if it is an Australian Company on this basis. This will be from the time in which its central management and control was located in Australia.

Question 5

Double Tax Agreement (DTA) - dual residents

As Australian resident taxpayers are taxed on their worldwide income, a resident taxpayer in receipt of a foreign sourced income may be subject to tax twice - once in Australia and again in the country of source. To alleviate this, tax treaties between signatory countries allocate taxing rights between the country of residence and the country of source. Per subsection 4(2) of the International Tax Agreements Act 1953 (ITA 1953), a DTA in force takes priority over other tax law (except Part IVA of the ITAA1936).

Entity A is covered under the Foreign DTA since it is a resident of Australia under subsection 6(1) of the ITAA 1936.

The income that you have derived in Country X would be taxed in accordance with the Australia's domestic tax laws taking into account the Foreign DTA to avoid double taxation.

You stated that Entity A is treated as a transparent entity in Country X, being a limited partnership and a flow through vehicle passing the income and expenses to you as the partner liable to any taxation on its profits.

In Australia, however, we have determined that Entity A is a corporate limited partnership and taxed as a Company.

Source of income

Next, we need to consider the type of income earned by Entity A. The only purpose of Entity A is to hold shares in Company B, be the sole limited partner in Entity B, and to own and lease the premises in Country X to Entity B. Therefore, there are two potential sources of income for Entity A:

•                     Rental income for the lease of the factory; and

•                     Share in any income of Entity B.

Rental income - Article 6 of the DTA and income from immovable property

Article 6 of the Foreign DTA provides that income derived by a resident of a Contracting State from immovable property situated in the other Contracting State may be taxed in that other state. Paragraph 2 of Article 6 specifically includes a lease of land or any other interest in or over land as well as property accessory to immovable property. The lease of the factory is not considered carrying on a business and would constitute income from immovable property and taxed in Country X.

Under Foreign tax legislation, all Entity A income and expenses, which are directly linked to Entity B are to be neutralised as part of related party transactions. This includes income and expenses linked to the renting of the premises such as rent, depreciation and loan interest. Only minor administrative expenses of remained on the profit and loss account of Entity A in 20XX. Since, Entity A had negative income it was not required to pay any tax including trade tax.

However, as Entity A is a Company for Australian income tax purposes, and for Australian income tax purposes is treated as an entity separate to Entity B, the effect of the rental agreement is not neutralised, and instead, rental income and expenses relating to deriving that income need to be recognised for Australian income tax purposes.

In accordance with section 6-5 of the ITAA 1997, the income from renting the factory to Entity B will be included in the assessable income of Entity A in Australia, with the amount grossed up for any tax paid in Country X on the net profits with respect to Entity A's rent, and the appropriate tax credit provided.

An argument may be made that the income is non-assessable non-exempt income (NANE) under section 23AH of the ITAA 1936.

Subsection 23AH(2) of the ITAA 1936 provides that, subject to this section, foreign income derived by a resident Company in carrying on a business at or through a permanent establishment in a listed or unlisted country is NANE.

Country X is a listed country. However, the mere renting of a factory to a related party is unlikely to constitute carrying on a business through a permanent establishment and therefore does not satisfy that requirement of subsection 23AH(2) of the ITAA 1936. Consequently, the rental income received by Entity A in the relevant income year is not considered to be NANE under subsection 23AH(2) of the ITAA 1936 and will not be excluded from assessable income under subsection 6-15(3) of the ITAA 1997.

Profit distribution from Entity B credited to Entity A's shareholder's account

Entity A owns 100% of the economic interests in Entity B.

In accordance with Article 9(2) of the Articles of the Partnership, the profit shares are attributed to the loan accounts of the shareholders at the end of each accounting period, unless otherwise resolved by shareholders.

You stated that Entity B has credited Entity A shareholders loan account with the full amount of the profits made in the XXX income year.

As determined in the analysis above Entity A and Entity B are both regarded as corporate limited partnerships and Australian residents. Distributions from one Australian corporation to another is not subject to the treaty requirements in the DTA between the two countries.

Therefore, we need to refer to the Australian tax legislation dealing with corporate limited partnerships as specified in Division 5A of the ITAA 1936. According to section 94L of Division 5A of the ITAA 1936, when Entity B distributes profits or credits Entity A's shareholder's account, the Australian tax law deems the amount a dividend and assessable to Entity A. For more advice on what constitutes a distribution or credit of profits to a partner in a corporate limited partnership that will be deemed a dividend, reference may be had to Draft Taxation RulingTR 2017/D4 when does a corporate limited partnership 'credit' an amount to a partner in a partnership? (TR 2017/D4)

Subsection 6(1) of the ITAA 1936 defines dividend to include:

(a) any distribution made by a Company to any of its shareholders, whether in money or other property; and

(b) any amount credited by a Company to any of its shareholders as shareholders.

Any payment or crediting made by Entity B to Entity A (or ultimately you) is treated as dividend being a distribution of profit and thus satisfying the definition of a dividend in subsection 6(1) of the ITAA 1936.

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder in a Company (whether the Company is a resident or a non-resident) includes dividends that are paid to the shareholder by a Company out of profits derived by it from any source and all non-share dividends paid to the shareholder by the Company. The term "paid" in relation to dividends includes credited or distributed.

Therefore, any profit distribution or crediting of the profits of Entity B to Entity A would be assessable to Entity A on receipt as a dividend in accordance with section 44 of the ITAA 1936 and included in its tax return for the relevant period. This may give rise to a tax liability in Australia.

Note: Any dividends received from Entity B would most likely be unfranked considering they are sourced from offshore profits and are amounts on which no Australian tax is paid (see Question 7 below). Franking credits are only generated by companies who have taxable profits in Australia and pay tax in Australia. Since Entity B operates in Country X through a permanent establishment and is not presently taxed in Australia, it is likely it can only distribute unfranked dividends to Entity A.

Question 6

As an Australian resident for tax purposes, in accordance with sections 6-5 and 6-10 of the ITAA 1997, your assessable income includes ordinary and statutory income from all sources, whether in or out of Australia.

For the same reasons outlined above in Question 4, since Entity A is a corporate limited partnership and treated as an Australian resident Company, any distribution or credit you receive in your capacity as the sole shareholder and owner would be treated as dividend in accordance with section 94L of the ITAA 1936 and assessable in the year the distribution or credit was made.

Guidance with respect to Question 6

The above outlines that you would not be taxable on an accruals basis in Australia with respect to the income accruing for the business you operate through your interests as the ultimate limited partner in Entity A and Entity B respectively. The profits in respect of Entity A would be taxable to you on realisation basis on receipt of a dividend or a deemed dividend from Entity A. A dividend will include any amount paid or credited to you as outlined in section 94M of the ITAA 1936.

Guidance on entitlement to franking credits

Only a resident franking entity can frank a distribution. Section 202-15 of ITAA 1997 defines a franking entity to include corporate tax entity such as a Company and corporate limited partnership.

According to section 202-5 of the ITAA 1997 a franking entity that is an Australian resident can frank a distribution to a shareholder by allocating franking credits to the distribution. The mechanism for allocating a franking credit to a distribution is not prescribed by the legislation. Section 202-5 Note 2 makes it clear that the mechanism is determined by the entity making a resolution or some other means. An entity's constituent documents may provide guidance as to the appropriate mechanism for that entity.

Therefore, Entity A would be considered a franking entity and following payment of tax in Australia, it may distribute to you as the sole shareholder franked dividend with attached franking credits in accordance with a resolution as prescribed by section 202-5 of the ITAA 1997. This may arise where Entity A generates franking credits by paying Australian income tax on unfranked dividends received from Entity B or the net rental income it derives from leasing the relevant factory premises to Entity B, or from any other amounts on which it is taxed in Australia.

Where the dividend is fully franked, it means that the Company has paid tax on the entire amount at the corporate tax rate.

You would need to gross up the dividend by the franking amount, with the franking amount subsequently available to use as an imputation credit to offset the tax payable.

Question 7

Article 7 of the DTA - Business Profits

Article 7 of the DTA sets out the terms regarding how Australia and Country X may tax the business profits of an enterprise.

Article 7(1) of the DTA states that business profits are taxable only in the country of residence of the recipient unless the enterprise carries on business in the other contracting state through a permanent establishment located in the other country, in which case the other country may also tax the profits.

Entity B's primary source of income relates to business income derived in Country X through an active manufacturing business in Country X.

The business income in 2XXX year was XXXX.

Therefore, in accordance with Article 7 of the DTA, the business profits of Entity B are taxable in Australia unless the business is carried on through a permanent establishment in Country X.

Article 5 Permanent establishment

Article 5 of the Foreign DTA deals with what may constitute a 'permanent establishment'.

Paragraph 1 states that for the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of the enterprise is wholly or partly carried on.

The three main elements are:

•                     he existence of a place of business

•                     a fixed situs (geographically and temporally), and

•                     the enterprise must carry on its business wholly or partially through this place.

Paragraph 2 provides the following examples of "permanent establishment":

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; and

g)            an agricultural, pastoral or forestry property.

The Explanatory Memorandum to the Bill that gave the force of law to the Foreign agreement (the International Tax Amendment Bill 2016) notes that the examples listed in Article 5(2) are subordinate to the general definition and therefore the general conditions outlined in Article 5(1) must first be satisfied.

Paragraph 6 excludes from the term "permanent establishment":

a)    the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

b)    the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

c)    the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

d)    the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the enterprise;

e)    the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity,

f)     the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e), provided that such activity or, in the case of subparagraph (f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.

The OECD Model Tax Convention elaborates on each of these elements. Australia's double tax agreements are based upon the OECD Convention. The OECD Convention can be considered in interpreting a DTA where the wording is ambiguous or for further clarification of the concepts.

Paragraph 6 of the OECD Commentary explains that the definition of permanent establishment in Article 5 contains the following conditions:

1. the existence of a 'place of business', i.e. a facility such as premises or, in certain instances, machinery or equipment;

2. this place of business must be 'fixed', i.e. it must be established at a distinct place with a certain degree of permanence;

3. 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.

Taxation Ruling TR 2002/5 Income tax: Permanent establishment - What is a place at or through which a person carries on any business' in the definition of permanent establishment in subsection 6(1) of the ITAA 1936? (TR 2002/5) sets out the ATO's interpretation of the term permanent establishment. For example, the meaning of geographical permanence is discussed. It is noted that a "place of business" is defined broadly and includes business premises like "a factory, office, farm, mine or market ". The notion of temporal permanence means that this presence must not be of a "purely temporary nature" but does not mean forever. What is permanent must be determined in the context of the business and is a question of fact and degree. The ruling notes that as a guide where a business operates continuously at or through a place of business for six months, it will have temporal permanence.

In your case, Entity B has been operating the manufacturing business through a factory located in Country X since its establishment in 20XX. The factory has the necessary machinery and equipment required for the manufacturing and there are XX employees who work at the factory and are located in Country X. In addition, the registered office for the business is in Country X.

Therefore, the factory from which the business operations are carried on by Entity B satisfies the three conditions of being a permanent establishment:

•                     there is an existing place of business i.e. factory including machinery and equipment

•                     the place of business is fixed

•                     the business has been carried on through that fixed place for more than 6 months and therefore the place of business is not considered to be purely temporary nature.

Therefore, Entity B has a permanent establishment in Country X as defined in Article 5 of the Foreign DTA from which it carries on its business operations of manufacturing precast concrete elements. As such, under Article 7 of the Foreign DTA Entity B is subject to tax in Country X to the extent the profits of the enterprise can be attributed to that permanent establishment.

NANE income and section 23AH of the ITAA 1936

Section 23AH of the ITAA 1936 treats certain foreign branch income derived directly or indirectly by Australian resident companies as NANE for tax purposes.

Subsection 23AH(2) of the ITAA 1936 requires that the relevant income be derived by an Australian resident Company that is carrying on a business at or through a permanent establishment (PE) of the Company in a foreign country. Subsection 23AH(15) of the ITAA 1936 states that PE has the same meaning as it does in the relevant tax treaty.

Therefore, the business income derived by Entity B through the PE in Country X would be treated as NANE income for Australian income tax purposes in accordance with subsection 23AH(2) of the ITAA 1936.

Guidance - Other income of Entity B

Profits of Entity B not attributable to the Foreign permanent establishment would be taxed in Australia as ordinary or statutory income under section 6-5 and 6-10 of the ITAA 1997.

This may arise if any income is earned from activities conducted or attributable to you as the sole shareholder and controlling mind of the relevant entities.

Question 8

The Foreign DTA operates to avoid double taxation of income received by residents of either Contracting State. Under Article 22(1) of the Foreign DTA, Australia will allow a credit for Foreign tax paid, against Australian tax payable, on income derived by an Australian resident from sources in Country X.

Article 2 of the Foreign DTA explicitly covers certain existing taxes imposed by each country. Relevantly, Australia provides relief in respect of Foreign taxes including Foreign federal taxes and those Foreign taxes imposed on behalf of Country X's States, political subdivisions or local authorities such as income tax, corporate income tax, trade tax and capital tax including the supplements levied thereon.

Division 770 of the ITAA 1997 contains the rules governing FITO. The main purpose is to protect a taxpayer from double taxation that may arise where the taxpayer pays foreign tax on income that is also taxable in Australia.

Subsection 770-10(1) provides that a taxpayer is entitled to a FITO for foreign income tax paid in respect of an amount that is included in their assessable income in a year of income.

Foreign income tax is defined in subsection 770-15(1) of ITAA 1997 as a tax imposed by law other than an Australian law and is:

a)            a tax on income; or

b)            a tax on profits or gains, whether of an income or capital nature; or

c)            any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953

To be entitled to an offset under subsection 770-10(1), a taxpayer must have:

•                     included an amount in their assessable income for that income year; and

•                     paid foreign income tax in respect of that amount.

To count towards a tax offset, the foreign income tax must have actually been paid or be deemed to have been paid. It is not enough that the tax is payable.

It is not necessary for you to have paid the foreign income tax in the same income year in which the income or gain on which the tax has been paid is included in your income for Australian income tax purposes. The tax could be paid before or after the income year in which you derive the income. However, the offset can only arise when the foreign income tax is paid, and it is applied to the income year in which the relevant income or gain is included in your assessable income in Australia.

Where income tax has been paid in Country X then a FITO would be allowable in Australia if the tax return has been lodged in Country X.

The FITO is a non-refundable tax offset. The FITO is applied to the Australian income tax liability including the Medicare levy (and the Medicare levy surcharge where applicable). Any excess is not refundable.

Application to your circumstances

•                     You stated that Entity A and Entity B are partnerships under the Foreign tax legislation and "flow through" vehicles passing the income and expenses to you as the partner liable to any taxation.

•                     All income of both entities is subject to income tax at the level of the sole shareholder, which is you. For XXX total profit of both companies was XXX. This amount was displayed as the relevant amount in your personal income tax assessment for the application of income tax rate.

•                     The income tax and additional tax in XXX year was XXX including trade tax paid at the entity level with respect to Entity B's business profits. The final tax was assessed and paid by you being the sole shareholder through the assessment of Entity A in 20XX.

Taxation RulingTR 2009/6 Income tax: entitlement to foreign income tax offsets under section 770-10 of the ITAA 1997 where income is derived from investing in fiscally transparent foreign entities (TR 2009/6) deals with income tax and the entitlement to FITO under section 770-10 of the ITAA 1997 where income is derived from investing in fiscally transparent foreign entities.

Paragraph 5 of TR 2009/6 states that a foreign entity is fiscally transparent if no foreign income tax is imposed on its income, either by effect of application of the laws of a foreign country or because of an election, but rather tax is imposed on such income at the level of the partner or member.

Paragraph 13 of TR 2009/6 outlines that a resident taxpayer that has an interest in a fiscally transparent entity that is not a foreign hybrid is entitled to a foreign income tax offset under subsection 770-10(1) or 770-10(2) of the ITAA 1997 for foreign income tax imposed on a dividend or distribution from the foreign entity. The entitlement is only to the extent that the foreign income tax is paid in respect of so much of that dividend or distribution that is included in the taxpayer's assessable income.

This is further explained in paragraph 36 of TR 2009/6 at Example 3, which discusses an Australian resident holding an interest in a fiscally transparent entity that is not a foreign hybrid. The partner is taxed in the foreign jurisdiction in which the fiscally transparent entity is domiciled on an accruals basis in respect of its share of the income of the fiscally transparent entity. If no amount is distributed, no amount is included in the partner's Australian tax return, and no FITO is available. However, if a distribution is made and the partner includes an amount (such as a dividend) attributable to its share of the profits of a fiscally transparent entity, then it will be able to claim a FITO to the extent that the dividend amount corresponds to an amount of income that was taxed in the foreign jurisdiction in the hands of the partner.

Paragraphs 80 and 81 explains the situations where the taxpayer's assessable income includes dividend or deemed dividend payment, including Example 3, in greater detail:

80. Where the taxpayer receives a distribution from the fiscally transparent foreign entity and foreign income tax has been imposed on the taxpayer's share of the profits, there will be a relevant connection between the foreign income tax paid and the distributed amount (characterised as a dividend and included in the taxpayer's assessable income under Australian tax law).

81. That connection exists because the foreign income tax is levied at the level of the partner or member on their share of the entity's net income, rather than on the profits of the fiscally transparent foreign entity. Accordingly, to the extent that a distribution made to the resident taxpayer is included in their assessable income as a dividend, it is considered that the relevant portion of foreign income tax is paid (or taken to have been paid) by the taxpayer in respect of the distributed amount: see discussion at paragraphs 70 and 71 of this Ruling.

Entity A and Entity B are treated as fiscally transparent or "flow through" entities in Country X and the foreign income tax including corporate income tax and additional tax has been assessed at the level of the partner being you as the sole shareholder.

The corporations tax and additional tax are Foreign taxes imposed under Foreign tax law on the income and profits of Entity B and Entity A and are explicitly covered by the DTA (Article 2).

Even though Entity A and Entity B are treated as fiscally transparent partnerships under the Foreign tax law, they are treated as corporate limited partnerships taxed in their own right under Australian tax law. Australia, as your country of residence for tax purposes, treats the relevant rental and business income taxed in Country X under the DTA as amounts derived by Entity A and Entity B respectively rather than amounts ultimately allocated and assessed in your hands. This difference in treatment of income between the State of source (Country X) and the State of residence (Australia) is commonly referred to as a Conflict of Qualification according to paragraph 124 of TR 2009/6.

Paragraph 125 of TR 2009/6 explains that where the difference in treatment is solely referable to differences in the respective domestic laws of the State of source and the State of residence of the taxpayer, it is considered where the State of source has taxed in accordance with the Convention that the State of residence of the taxpayer is obliged to provide relief in accordance with the relevant article of the Model Convention.

Therefore, to the extent that Country X has taxed the income in accordance with the DTA, as interpreted by it as the State of source, Australia is obliged to provide relief in respect of such tax in accordance with Article 22 and apply the provisions for granting a FITO under section 770-10 of the ITAA 1997.

You provided tax returns for the 20XX calendar year, which demonstrated that the tax of XXX (including corporations tax and additional tax) net of trade tax has been assessed to you through the assessment of Entity A and paid by you in Country X. As such, Country X as the State of source has taxed the income in accordance with the tax treaty. The trade tax, being an amount that was not paid by you, is considered in Question 9 below.

As such, subsection 770-10(1) of the ITAA 1997 will operate such that where you include distribution amounts that you receive from Entity A as a dividend that are attributable to amounts that you have already been assessed in Country X as a partner, you will be entitled to a FITO. The FITO will be to the extent that foreign income tax is paid in respect of so much of that distribution or dividend that is included in assessable income. This may occur in the same year as those profits have accrued if amounts treated as dividends are paid to you by Entity A concurrently, or alternatively, may be in different years to the year you paid tax on those amounts in Country X if the amounts deemed as dividends paid in respect of the business profits are paid in a later year.

It is important to note that the FITO to which you are entitled is restricted to the amount of foreign tax you have actually paid. For the purposes of Question 8, you are treated as having only paid the corporate tax and additional tax with respect to your interest in Entity A net of any trade tax. This means that assuming all profits of Entity A are distributed as dividends in the 2XXX year, your FITO in respect of the corporate tax and additional tax specifically is limited to XXX.

The amount of the FITO will be the amount of foreign income tax paid relative to the amount of income included, subject to any foreign income tax offset limit worked out under section 770-75 of the ITAA 1997.

Guidance

A credit to a partner in a corporate limited partnership may be deemed to be an assessable dividend in certain circumstances. See TR 2017/D4, as well as sections 94L and 94M of the ITAA 1936 for more information.

Question 9

In addition to the corporation's tax and additional tax, there is also trade tax of approximately X% payable to the municipality where the business operates in. Trade tax is a tax on the profits not on revenue.

In 2XXX, neither Company A nor Company B had to pay trade tax since they had no profits. Entity A had a negative taxable income and therefore also did not pay any trade tax.

Only Entity B had to pay trade tax and was issued with a tax assessment of XXX in 2XXX financial year by the Foreign tax authorities.

The trade tax of XXX for the 2XXX income year was then credited to you on your personal income tax.

Trade tax is explicitly covered by Article 2 of the Foreign DTA (Article 2) and therefore constitutes a foreign tax to which FITO under Division 770 of the ITAA 1997 may be available.

As outlined, subsection 770-10(1) of the ITAA 1997 provides that a FITO is available if foreign tax is paid in respect of an amount of income which is all or in part included in your assessable income for the year.

Prima facie, an assessment is raised for trade tax in respect of Entity B who subsequently pays the trade tax. As such, foreign income tax has been paid by Entity B. However, the amounts on which it pays trade tax are treated as NANE income in the hands of Entity B under Australian tax law. Thus, a FITO is not available to Entity B in respect of trade tax.

You have submitted that the trade tax assessed to and paid by Entity B is credited against and subsequently reduces the personal income tax you pay in Country X. It reduces the amount that you pay with respect to your share of the partnership profits of Entity A.

Section 770-130 of the ITAA 1997 allows you a FITO even if the foreign income tax is paid by someone else. Subsection 770-130(1) and (2) of the ITAA 1997 state that you are treated as having paid tax for the purposes of the FITO provisions in respect of an amount included in your assessable income if the foreign tax paid in respect of that amount was paid by someone else. The example provided in subsection 770-130(2) of the ITAA 1997 states that where a partnership pays foreign income tax on the partnership income, if you are a partner in that partnership, you are treated as having paid foreign tax on your share of the income of the partnership, notwithstanding it is the partnership itself that has paid the tax.

You have provided us with information as to how the trade tax is used to calculate your final tax liability in Country X. The trade tax is used to reduce the amount of corporate income tax and the additional tax which you ultimately pay as the ultimate partner in Entity A. Given that Question 8 restricts your FITO entitlement to your corporate income tax and additional tax liability net of the trade tax credit, the trade tax has not previously been considered in your circumstances.

Based on the manner in which it is used to calculate your assessable income in Country X, and your status as the ultimate partner in Entity B through your interest in Entity A, the Commissioner accepts that the trade tax has been paid on your behalf, and therefore you should be treated as having paid foreign tax for the purposes of Division 770 of the ITAA 1997.

Your entitlement to the FITO will be determined when you include in your assessable income amounts in respect of that foreign tax paid. As explained in Question 8, and following the same principles outlined in TR 2009/6 at the relevant paragraphs, when amounts from Entity B's business income are ultimately included as dividends in your assessable income, you will be entitled to the FITO to the extent that foreign tax was paid in respect of the amount of income to which that dividend or distribution was attributable. This may occur in the same year as those profits have accrued if amounts treated as dividends are paid by Entity B to Entity A then to you concurrently, or alternatively, may be in different years to the year you paid tax on those amounts in Country X if the amounts deemed as dividends paid in respect of the business profits are paid in a later year.

The amount of the FITO will be the amount of foreign income tax paid relative to the amount of income included, subject to any foreign income tax offset limit worked out under section 770-75 of the ITAA 1997.

[1] Foreign income tax is defined in section 770-15 of the ITAA 1997 to include tax on income imposed by a law other than Australian law. The words 'foreign income tax' in subsection 830-10(1) of the ITAA 1997 are followed by the bracketed phrase (except credit absorption tax or unitary tax). These terms are also defined in section 770-15 of the ITAA 1997. Very broadly, a 'credit absorption tax' is a tax imposed by a foreign country which seeks to recoup a foreign income tax offset, and a 'unitary tax' is a tax imposed by a foreign country, which takes income, profits or gains derived outside the taxing country, into account in determining its liability for income, profits or gains derived within that taxing country.

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