Edited version of private ruling

Authorisation Number: 1011485588473

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Ruling

Subject: Company residency - permanent establishment - interest income

Question 1

Is the Company an Australian resident company?

Answer

No.

Question 2

Does the Company have a permanent establishment (PE) in Australia?

Answer

Yes.

Question 3

Is the interest income derived by the Company's bank account No 1, subject to tax in Australia as part of the income of the PE?

Answer

Yes.

Question 4

Is the interest income derived by the Company's bank account No 2, 3, 4 and 5 subject to tax in Australia at a rate not exceeding 10% of the gross amount?

Answer

Yes.

This ruling applies for the following period

Income year ended 30 June 2006

Income year ended 30 June 2007

Income year ended 30 June 2008

Income year ended 30 June 2009

Income year ending 30 June 2010

Relevant facts

The Company is incorporated in Country X, registered as a foreign branch in Australia.

All directors and shareholders of the Company are residents of Country X. They do not live in Australia.

All board meetings are held and decisions are made in the Company's head office in Country X.

The Company's head office appoints a General Manager and Financial Controller from its management team in head office and seconds them to Australia where a leased office is maintained.

Both the General Manager and Financial Controller return to Country X to attend management meetings and business conferences a few times a year at the head office.

The General Manager holds a power of attorney under which he possesses the legal right to exercise and make decisions for day to day business operation in Australia.

The General Manager and Financial Controller produce monthly budget and financial reports for the head office in Country X.

The main purpose of the Australian branch office is to provide better customer services to the customers in Australia.

The function of the Australian office is to support the head office in Country X, assist in marketing and promoting the Company and to provide customer services, sales service, as well as assist with other operational matter in Australia.

Sales of the Company are made through a variety of mediums andinclude cash, credit card sales and company cheques.

The counter sales are made through the staff in the Australian branch office.

The Company maintains bank accounts in Australia. The purposes of these bank accounts were provided.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

International Tax Agreement Act, Schedule X

International Tax Agreement Act 1953, Schedule X, Article 5

Income Tax Assessment Act 1936 Subsection 128B(5)

Income Tax Assessment Act 1936 Subparagraph 128B(2)(b)(i)

Income Tax Assessment Act 1936 paragraph 128(3)(h)(ii)

International Tax Agreement Act 1953

Reasons for decision

Question 1

The Company residency

The definition of resident for a company in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that a foreign incorporated company may be treated as an Australian resident if the company is carrying on business in Australia, and either has its central management and control in Australia or its voting power held by Australian resident shareholders.

Taxation Ruling TR 2004/15 provides guidelines for determining whether a company not incorporated in Australia is a resident under this definition of 'resident' in subsection 6(1) in the ITAA 1936.

Based on this definition, for a company that is not incorporated in Australia to be considered a resident, it must be carrying on business in Australia and either have its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia (paragraphs 4 -5 of Taxation Ruling TR 2004/15).

The Company carries on a business in Australia. The Company provides services in Australia, maintains a branch office in Australia where its staff carries out day to day business operational activities.

With respect to 'central management and control' (CM&C) the guidance provided in TR 2004/15 is that, the CM&C test focuses on management and control decisions made at the highest levels in the Company. Paragraphs 48 & 49 of TR 2004/15 provide that usually these high level decisions are made by the Company's board of directors and therefore the place where the board meets is highly relevant in determining where CM&C is located. Although this is not the sole factor for consideration, it provides a prima facie indicator of where the CM&C is located, unless, of course the board is not the high level decision maker.

In this case, although the General Manager has authority to make decisions for the day to day business operation of the Australian branch office, the General Manager produces monthly budgets and financial reports for its head-office and is required to attend board meetings held in the head office outside of Australia. The board oversees the decisions made in the Australian branch office and all the high level strategic management decisions of the Company are exercised by its board that meets in their head office in Country X. This is similar to example 9 of TR 2004/5 where it is considered that the CM&C of the Company is not considered to be in Australia.

It is also states that the voting power of the Company is not controlled by Australian resident shareholders. Therefore, the Company is not considered to satisfy the definition of a 'resident' company under subsection 6(1) of the ITAA 1936.

Although it carries on business in Australia, its CM&C is not in Australia and its voting power is not controlled by shareholders who are residents of Australia. Consequently, the Company is not an Australian resident under subsection 6(1) of the ITAA 1936.

Question 2

Permanent Establishment (PE)

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

- a place at or through which the person carries on any business and, without limiting the generality of the foregoing, includes:

- a place where the person is carrying on business through an agent;

- a place where the person has, is using or is installing substantial equipment or substantial machinery;

- a place where the person is engaged in a construction project; and

- where the person is engaged in selling goods manufactured, assembled etc

but does not include:

- a place where the person is engaged in business dealings through a bona fide commission agent or broker etc.

The definition in subsection 6(1) of the ITAA 1936 of a PE refers to a place of business through which the business of the enterprise is wholly or partly carried on. TR 2002/5 at paragraphs 26-28 explained that the word 'place' denotes something that is not transitory or temporary. The phase 'a place at or through which a person carries on a business' should be construed in a way that is broadly consistent with the meaning of PE in our tax treaties.

Australian has an international tax treaty with Country X contained in Schedule X of the International Tax Agreement Act 1953 (the Country X Agreement).

An Article of the Country X Agreement provides that PE in relation to an enterprise means a fixed place of business through which the business of the enterprise is wholly or partly carried on.

An Article provides that PE includes

- a place of management

- a branch

- an office

Based on the facts provided, the Company has a fixed place through which it carries on its business in Australia. The Company maintains an office in Australia, it has employees in Australia who have authority to act and carry out the day to day business operation of the Company by providing service to its customers and conducting some of its sales service through the fixed place in Australia, therefore the Company has a PE in Australia.

Question 3 & 4

Rates of withholding tax on interest income

A foreign resident is liable to pay income tax by way of interest withholding tax under subsection 128B(5) and subparagraph 128B(2)(b)(i) of the ITAA 1936 where interest is paid to it by a resident (paragraph 8 of TR 2006/9).

Paragraph 7(b) of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 provides that this rate is 10%.

However, paragraph 128(3)(h)(ii) of the ITAA 1936 provides that liability for withholding tax under this section does not apply if the interest is derived by a foreign resident in carrying on business in Australia at or through a PE of the foreign resident in Australia.

In determining the Australian tax liability for a foreign resident it is also necessary to consider the International tax treaty with Australia. Article X of the Country X Agreement provides that interest arising in Australia being interest to which a Country X resident is entitled to may be taxed in Australia according to the law of Australia but the tax so charged shall not exceed 10% of the gross amount of the interest.

However, another Article of the Country X Agreement provides that paragraphs 1 & 2 shall not apply if the person beneficially entitled to the interest being a resident of Country X, carries on business in Australia through a PE situated in Australia and the indebtedness in respect of which the interest is paid is effectively connected with the PE or fixed based. If so, the provision of Article Y will apply.

The issue is whether the indebtedness of the bank account, in respect of which the interest is paid, is effectively connected with the branch office. If it is, the relevant Article does not apply to limit the rate of tax to 10% and the provision of another Article shall apply which means that the interest is treated as business profits and taxed accordingly.

The term 'effectively connected' is not defined in the Country X Agreement. The term is also used in other tax treaties in respect of the interest, dividend and royalty articles. The relevant Article of the Country X Agreement provides that, unless the context otherwise requires, any term not defined in the agreement has the meaning it has under the domestic law of the territory concerned. The meaning given under the applicable tax law is to prevail over any other domestic law meaning. The term is not defined under the domestic law.

The OECD Commentary on paragraph 4 of Article 11 states:

…….Paragraph 4 is not based on such a conception which is sometimes referred to as the "force of attraction of the permanent establishment". It does not stipulate that interest arising to a resident of a Contracting State from a source situated in the other State must, by a kind of legal presumption, or fiction even, be related to a permanent establishment which that resident may have in the latter State, so that the said State would not be obliged to limit its taxation in such a case. The paragraph merely provides that in the State of source the interest is taxable as part of the profits of the permanent establishment there owned by the beneficiary which is a resident of the other State, if it is paid in respect of debt-claims forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment. In that case, paragraph 4 relieves the State of source of the interest from any limitation under the Article……. (emphasis added)

To determine whether the indebtedness in respect of which the interest is paid is effectively connected with the branch office it is necessary to consider certain factors. In this case, the indebtedness to which the relevant Article is referring to is the requirement for the bank to repay the amounts deposited in the accounts. If the Australian branch representatives cannot call for the money or use the money for the purposes of the branch business, then the indebtedness is not effectively connected with the branch. Also, the Commentary refers to debt-claims that are "part of the assets of the PE" - if the branch can't access the money in the accounts, then it is not considered an asset of the branch. Therefore, this factor will outweigh other factors such as the purpose of having the money in the accounts.

Based on the facts provided about each of the accounts, the consideration for each of the accounts was provided.