Edited version of private ruling

Authorisation Number: 1011602584700

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Ruling

Subject: Permanent establishment

Question 1

Does the Company have a permanent establishment in Australia in terms of the Permanent Establishment Article of the double tax agreement between Australia and Country X (the Country X DTA)?

Answer

No.

This ruling applies for the following period

1 July 2010 to 30 June 2014

Relevant facts

The Company is a resident of Country X.

Z is a Country X entity; it is not related to the Company.

The Company makes a product, which it sells to Z for use in Z products.

The Company's product is part of a Z product which has the Z brand on it, is marketed by Z as a Z product and can only be purchased from Z.

The Company does not sell directly to customers in Australia.

The Company has a global agreement with Z under which Z has global rights to re-sell the Company product to any entity to which the rights to resell Z products has been given. In this case the reseller is Z Australia and the Z Australia dealers which sell Z products to Australian customers and to customers in a large part of the Asia Pacific region.

Z has asked the Company to provide technical support to Z Australia for the Z products that contain the Company product.

In order to maintain the good relationship with Z the Company has agreed to employ an Australian resident to service the clients of Z Australia. The Australian resident will be paid by the Company.

Z or Z Australia will direct the work to be performed by the employee in servicing clients as required. The employee will not have an office from which to operate but will attend the office of Z Australia in Australia when requested.

The activity carried on by the Company in Australia is not for the purpose of seeking out clients or to make sales. No sales are made and no invoices are issued by the Company for the services provided.

The equipment used by the employee includes a laptop computer and a mobile phone.

Relevant legislative provisions

Article 5 and Article 7 of the Country X DTA

Reasons for decision

Question 1

Summary

The question requires consideration of the application of the Country X DTA in order to determine whether a Country X company is carrying on business in Australia through a permanent establishment. If this is so then that enterprise of the Country X company will be taxable in Australia on the income derived through that permanent establishment.

Detailed reasoning

The activity carried on by the employee of the Company in Australia is the provision of after sales service in respect of the Company product which is a component of Z products sold in Australia and the Asia Pacific region.

The Business Profits Article of the Country X DTA in the International Tax Agreements Act 1953 (Agreements Act) provides that the profits of a Country X enterprise shall be taxable only in Country X unless the enterprise carries on business in Australia through a permanent establishment.

The term 'enterprise' is not defined in the Country X DTA or in the Agreements Act.

By engaging an employee to provide after sales service the Company has an enterprise within the meaning of that word as considered by the High Court in Thiel v. Federal Commissioner of Taxation (1990) 64 ALJR 516;(1990) 171 CLR 338; (1990) 94 ALR 647; (1990) 90 ATC 4717; (1990) 21 ATR 531.

That enterprise is carrying on business in Australia.

It is therefore necessary to determine whether the business is being carried on through a permanent establishment.

The Permanent Establishment Article contains the definition of a permanent establishment for the purposes of the Country X DTA. That article defines a permanent establishment to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Further the term 'permanent establishment' includes an office.

The employee will operate from the offices of Z Australia in Australia.

Having an amount of space, such as an office at the disposal of the employee, which is used for business activities, is sufficient to constitute a place of business even though located in premises owned by another enterprise.

The article requires that the place of business must be 'fixed' which is to say that it must be established at a distinct place with a certain degree of permanence.

Taxation Ruling TR 2002/5 examines the concept of permanence in the context of geographic permanence and temporal permanence. An office is a place which has geographic permanence.

The second criterion to be met in order for a place through which an enterprise carries on business to come within the definition of a permanent establishment is temporal permanence.

In this regard the judgement of Sheppard J in Applegate v. FCT 78 ATC 4054; (1978) 8 ATR 372 is relevant. In that case when discussing the meaning of 'permanent' in the phrase 'permanent place of abode' his honour said at p 4060 and p 378:

… permanent is used in the sense of something which is to be contrasted with that which is temporary or transitory. It does not mean everlasting. The question is thus one of fact and degree.

The commentary on Article 5 in the 2010 OECD Model Tax Convention on Income and on Capital discusses what represents permanence and states:

6.1 … where a particular place of business is used for only very short periods of time but such usage takes place regularly over long periods of time, the place of business should not be considered to be of a purely temporary nature. (emphasis added)

Given the circumstances in which the employee will operate, that is, use the office intermittently on an ongoing basis but for an indefinite period it is concluded that the Company has a fixed place of business in Australia.

However, it is necessary to also examine the exceptions in the Permanent Establishment Article.

An exception provides that an enterprise shall not be deemed to have a permanent establishment merely by reason of the maintenance of a fixed place of business solely for the purpose of activities which have a preparatory or auxiliary character for the enterprise, such as advertising or scientific research.

The activities are not of a preparatory character so that aspect will not be considered further however consideration will be given to the auxiliary character of the activities.

The term 'auxiliary' is not defined in the Country X DTA or in the Agreements Act.

Accordingly it is necessary to look elsewhere for a definition of this term.

The Macquarie Dictionary definition of 'auxiliary' includes:

1. giving support, helping, aiding, assisting.

2. subsidiary, additional …

The commentary on the Permanent Establishment Article in the 2010 OECD Model Tax Convention on Income and on Capital with respect to activities of a preparatory and auxiliary character has been considered.

The commentary in part reads:

23. … a fixed place of business through which the enterprise exercises solely an activity which has for the enterprise a[n] … auxiliary character, is deemed not to be a permanent establishment. … Furthermore, this … exception to the general definition in paragraph 1 … when read with that paragraph, provides a more selective test, by which to determine what constitutes a permanent establishment. … it limits that definition and excludes … a number of forms of business organisations which, although they are carried on through a fixed place of business, should not be treated as permanent establishments. It is recognised that such a place of business may well contribute to the productivity of the enterprise, but the services it performs are so remote from the actual realisation of profits that it is difficult to allocate any profit to the fixed place of business in question. Examples are fixed places of business solely for … the servicing of a patent or a know-how contract, if such activities have a[n] … auxiliary character.

The activities of the Australian enterprise of the Company in providing services to the customers of Z Australia and its dealers in Australia and the Asia Pacific region are considered to be of an auxiliary character. This is where the services provided are in respect of the Z products which contain the Company product. In terms of the above commentary it is considered to be like the servicing of a patent or a know-how contract.

Further the OECD commentary quoted above regarding activities being remote from the realisation of profits is considered relevant given that the Company profits are derived from the sale of its product to Z in Country X. No income is derived by the Company in Australia from providing the services to Z customers in Australia and the Asia Pacific region.

Another provision of the Permanent Establishment Article which requires consideration is that relating to a dependent agent. As the employee's role is only to service Z Australia customers as directed by Z or Z Australia and not to seek sales of the Company product the employee, although a dependent agent, lacks the authority to conclude contracts on behalf of the enterprise and thus there is no permanent establishment in terms of that provision.

Therefore, although the enterprise activities are carried on through a fixed place of business in Australia that fixed place is not a permanent establishment for the purposes of the Country X DTA.

Does Part IVA, or any other anti-avoidance provision, apply to this ruling?

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

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936 please go to our website www.ato.gov.au and enter 'part iva general' in the search box in the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.