Edited version of private ruling

Authorisation Number: 1011628811524

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Ruling

Subject: Permanent establishment

Issue

Permanent establishment

Question

Is the income derived by the Company, a Country X resident company, from the sale of company products in Australia, assessable under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA1997)?

Advice/Answers

No.

This ruling applies for the following period

Income year ended 30 June 2011

The scheme commenced on

The scheme has commenced.

Relevant facts

The Company is a resident of Country X and a non-resident of Australia for Australian income tax and tax treaty purposes.

The Company is in a business of supplying products throughout the world. It has no manufacturing and/or production or storage facilities in Australia. All products are shipped to Australia on a per order basis.

The Company does not currently have an office in Australia or any employees working in Australia.

The Company however states it will lease a serviced office in Australia and will employ two employees ('the Employees') to be based at the leased office for the purpose of performing administrative functions required by the head office. The maintenance of a serviced office in Australia is for the ease of managing time zone issue.

The Employees will have no authority in respect of any business decision or operations of the Company. The scope of their authority or responsibility will extend to performing the following functions:

Acting as a contact point for customers in respect of supply of sample products, lodgement of complaints/issues or to make general queries regarding products; and:

Provide administrative support (such as follow ups regarding outstanding invoices etc) to the Company.

The Employees will not be responsible for the negotiation of supply contract terms and conditions or the supply of products to customers.

The Company operates throughout the world through a mixture of local agents, local consultants and branch offices located in various countries.

The Company's activities in Australia are conducted through the Consultant in Australia who locates and refers on Australian customers to the Company for a commission. The Consultant however has no authority to negotiate or bind the Company to any supply contracts or to collect funds on its behalf in Australia.

The Australian customers negotiate the terms of the agreement with the Company and the terms of the agreement are approved at the Company's head office. Payment of invoices is done directly into the Company's Country X bank account.

Any consultant engaged by the Company is able to consult or deliver services to other businesses which do not compete with the Company's primary business.

The Company currently engages an Australian resident entity as its Australian consultant.

The Consultant is an independent contractor of the Company in accordance with the Consultancy Agreement.

The Consultant provides the following services to the Company:

The primary role is to achieve profitable growth in respect of the Company.

Introduce the Company to customers so as to enable the Company to negotiate and enter into a contract with the customer in respect of the supply of products.

Assist the Company with ordering and supply of products.

All such other duties as the Company shall from time to time reasonably require the consultant to perform in order to further the commercial or social activities of the Company.

The Consultant provides consulting services not just to the Company, but to a number of other clients on a similar basis in both fixed and commission based fees.

The Consultant has at least one other overseas based client that they act for in an agency arrangement.

The Consultant is experienced in sales of products. The Consultant also has experience in acting in agency type arrangements with foreign companies with respect to importation and supply of products.

The Company provides IT support to the Consultant which enables the Consultant to, for example, secure sales by enabling the customer to contract with the Company using specific software.

The computer that the Consultant uses is owned by it not the Company.

No premises or tools are required to be provided by the Company.

The Consultant will not operate out of the proposed Company's office in Australia.

The Consultant is reimbursed for the cost of travel incurred outside and within Australia in addition to the service fee which it receives under the Agreement.

The Company has no legal interest in the Consultant.

The Company does not have a factory or a workshop for storage or manufacturing or production of products in Australia.

Relevant legislative provisions

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

International Tax Agreements Act 1953 Sch27-Art5

International Tax Agreements Act 1953 Sch27-Art7

International Tax Agreements Act 1953 Section 4

Subsection 6-5(3) of the ITAA 1997 provides that the assessable income of a non-resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources.

The income derived by the taxpayer from the sale of their company's products to Australian consumers is ordinary income under subsection 6-5(3) of the ITAA 1997.

In determining liability to Australian tax on Australian sourced income received by a non-resident, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1997 so that both Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Taxation Ruling TR 2001/13 at paragraphs 101 to 105 explains the Commissioner's view that the Commentaries on the Organisation for Economic Co-operation and Development ('OECD') Model Tax Convention on Income and on Capital are relevant to interpreting Australia's tax treaties.

Schedule X to the Agreements Act contains the tax treaty between Australia and Country X ('the Country X Agreement'). The Country X Agreement operates to avoid the double taxation of income received by Australian and Country X residents.

Article 7 of the Agreement governs the taxation of business profits derived from Australia by a resident of Country X. Under Article 7 of the Country X Agreement, the business profits of an enterprise of Country X shall be only taxable in Country X unless the enterprise carries on business in Australia through a permanent establishment situated in Australia. If so, so much of the profit of the enterprises profit attributable to the permanent establishment in Australia may be taxed in Australia.

The term 'permanent establishment' is defined in Article 5(1) of the Country X Agreement as a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Paragraph 2 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that the definition of permanent establishment contains the following requirements:

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

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

· 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.

Article 5(2) of the Country X Agreement contains a list of examples each of which can be regarded as constituting a permanent establishment such as an office, a place of management, a branch, a factory or a workshop.

In the present case, the proposed office of the Company in Australia is considered to be a fixed place of business in Australia through which its business is carried on under the terms laid down in Articles 5(1) and 5(2).

Article 5(3) of the Country X Agreement lists a number of business activities which are treated as exceptions to the general definition in Article 5(1) and which are not permanent establishments, even if the activity is carried on through a fixed place of business. The common feature of these activities is that they are, in general, preparatory or auxiliary activities.

The term 'preparatory or auxiliary' is not defined. Paragraph 4 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that the decisive criterion as to whether an activity has a preparatory or auxiliary character is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole. Furthermore, it explains that a fixed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise does not exercise a preparatory or auxiliary activity.

In the present case, it is considered that the administrative support of the Employees to the Company in respect of its Australian operations does not form an 'essential and significant part of the activity' of the Company as a supplier of materials. The activities of supplying sample products, lodgement of complaints/issues or making general queries regarding products and following up outstanding invoices are not 'identical to the general purpose of the whole enterprise' and are therefore auxiliary in nature.

Accordingly, Article 5(3)(e) of the Country X Agreement will apply so that the Company shall not be deemed to have a permanent establishment by reason of the maintenance of a fixed place of business solely for the purpose of activities which have an auxiliary character.

Article 5(4)(a) of the Country X Agreement provides that a permanent establishment will be deemed to exist if a Country X enterprise carries on business in Australia through a person (other than an independent agent) who has authority to conclude contracts on behalf of the enterprise and habitually exercises that authority in Australia.

The Employees do not have the authority to conclude any contracts on behalf of the Company, therefore they will not be deemed to be a permanent establishment of the Company as dependent agents under Article 5(4)(a) of the Country X Agreement.

Under Article 5(5) of the Country X Agreement, where an enterprise of Country X carries on business in Australia through a broker, general commission agent or any agent of an independent status, it shall not be deemed to have a permanent establishment in Australia if the agent is acting in the ordinary course of his business.

Paragraph 37 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that a person will come within the scope of Article 5(5), i.e. he will not constitute a permanent establishment of the enterprise on whose behalf he acts, only if:

· he is independent of the enterprise both legally and economically, and

· he acts in the ordinary course of his business when acting on behalf of the enterprise

Furthermore, paragraph 38.3 of the OECD Commentary on Article 5 of the OECD Model Tax Convention provides that an independent agent will typically be responsible to his principal for the results of his work but not subject to significant control with respect to the manner in which that work is carried out. He will not be subject to detailed instructions from the principal as to the conduct of the work. The fact that the principal is relying on the special skill and knowledge of the Consultant is an indication of independency.

Paragraphs 38.6 of the OECD Commentary on Article 5 of the OECD Model Tax Convention provides that independent agent status is less likely if the activities of the Consultant are performed wholly or almost wholly on behalf of only one enterprise.

Paragraph 38.7 of the OECD Commentary on Article 5 of the OECD Model Tax Convention provides that where the commission agent not only sells the goods or merchandise of the enterprise, but as a permanent agent having authority to conclude contracts, he would be deemed in respect of this activity to be a permanent establishment.

In the present case, the Company's activities in Australia are conducted through the Consultant in Australia who locates and refers on Australian customers to the Company for a commission. The Consultant however has no authority to negotiate or bind the Company to any supply contracts or to collect funds on its behalf in Australia.

The Consultant is in the business of consultancy. The Consultant's experience in sales and in acting in agency type arrangements with foreign companies indicate it possesses special skills and knowledge which the Company can rely upon.

There is no special relationship between the Company and the Consultant. In accordance with the Clause of the Consultancy Agreement the Consultant is an independent contractor and retains the ultimate responsibility for the management and direction in relation to the provision and performance of the services to the Company. In addition, the Consultant does not operate wholly or exclusively for the Company. Accordingly, it does not appear that the Consultant is subject to significant control by the Company nor to detailed instructions from the Company as to the conduct of the consultancy services.

Having regard to the circumstances, it is considered that the Consultant is an agent of an independent status and the business which the Consultant undertakes for the Company is within the ordinary activity of their businesses.

Consequently, the Company shall not be deemed to have a permanent establishment in Australia for the purpose of Article 5(5) of the Country X Agreement.

In conclusion, Article 7 of the Country X Agreement does not apply as the Company is not carrying on a business through a permanent establishment in Australia and therefore the profits cannot be taxed in Australia for the purposes of the Country X Agreement. Consequently, the income received by the Company from the sale of company products in Australia is not assessable under subsection 6-5(3) of the ITAA 1997.