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Ruling

Subject: Foreign branch profits

Question

Does the income derived by the company through its permanent establishment in Country A qualify as non-assessable non-exempt income in Australia under section 23AH of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The company is an Australian incorporated company.

The business of the company is the provision of services and it has opened a branch office in Country A.

The branch operation is conducted through a permanent establishment in Country A. A fully serviced office has been rented in Country A by the company. The company intends to either acquire or rent an office after the initial twelve month period.

The Country A branch has employed a local employee on a full time basis. The employee is stationed at the office in Country A, and attends to administrative duties.

The company is registered in Country A to have its branch operation as a recognised business.

The company is not engaging an agent or agents, either exclusive or otherwise, to conduct its business undertakings in Country A. The company is conducting all business activities directly itself.

The company will not be conducting its business activities via a subsidiary or any other form of controlled entity incorporated in Country A, other than the branch office in Country A.

The principal activity of the Country A branch is provision of services. The branch is providing services to Australians currently residing and working in Country A, enterprises wishing to establish businesses in Country A and Country A nationals wishing to come to Australia or establish business and investment in Australia.

The Country A branch is not practising Country A law or providing services services in respect of Country A matters but rather will restrict its service to the above-mentioned services only, however such services will be provided in Country A.

The main income and other amounts derived by the Country A branch will be from its ordinary business carried out in Country A.

The Country A branch will not be providing any services to Part X Australian resident or a non-resident, in connection with a business carried on by the non-resident at or through a permanent establishment in Australia.

The Country A branch will not be deriving significant passive income.

It is expected that any interest income and net currency exchange gains/losses derived by the company's branch in Country A that may be regarded as tainted income, will be less than 5% of the gross turnover of the branch in a given financial year.

The Country A branch's statutory accounting period will be the same as its years of income in Australia.

The Country A branch will keep accounts for the accounting period in accordance with accepted accounting principles.

The Country A branch is complying with the substantiation requirements in relation to the accounting period.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-15

Income Tax Assessment Act 1997 Section 11-55

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Section 23AH

Income Tax Assessment Act 1936 Subsection 23AH(2)

Income Tax Assessment Act 1936 Subsection 23AH(7)

Income Tax Assessment Act 1936 Subsection 23AH(12)

Income Tax Assessment Act 1936 Subsection 23AH(13)

Income Tax Assessment Act 1936 Subsection 23AH(14)

Income Tax Assessment Act 1936 Subsection 23AH(15)

Income Tax Assessment Act 1936 Subsection 320(1)

Income Tax Assessment Act 1936 Section 432

Income Tax Assessment Act 1936 Section 446

Income Tax Assessment Act 1936 Section 447

Income Tax Assessment Act 1936 Section 448

Reasons for decision

Summary

The income attributable to the company's permanent establishment in Country A is not assessable income or exempt income under section 23AH of the ITAA 1936.

Detailed reasoning

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived from all sources whether in or out of Australia during the income year. However subsection 6-15(3) of the ITAA 1997 provides that if the income is non-assessable non-exempt income, then it is not assessable income.

Included in the list of non-assessable non-exempt income in section 11-55 of the ITAA 1997 are the branch profits of Australian companies under section 23AH of the ITAA 1936.

Subsection 23AH(2) of the ITAA 1936 provides that subject to the section, foreign income derived by an Australian resident company in carrying on a business at or through a permanent establishment in a listed or unlisted country is not assessable income and not exempt income.

As Country A is an unlisted country (subsection 320(1) of the ITAA 1936), the profits attributable to the permanent establishment of the company in Country A will be non-assessable, non-exempt income under section 23AH of the ITAA 1936 if all the requirements of subsection 23AH(2) are satisfied and are not excluded from the operation of subsection 23AH(2) by subsection 23AH(7) of the ITAA 1936.

Subsection 23AH(7) of the ITAA 1936 provides that where the permanent establishment is in an unlisted country, subsection 23AH(2) of the ITAA 1936 will not apply if the foreign income is adjusted tainted income and the permanent establishment does not pass the active income test.

Therefore in order to be excluded from Australian assessable income pursuant to section 23AH of the ITAA 1936:

· the company must be an Australian resident

· the income must be foreign income

· the income must be derived in carrying on a business conducted at or through an

· overseas permanent establishment

· the permanent establishment must pass the active income test, and

· the income must not be adjusted tainted income.

A company which is incorporated in Australia is an Australian resident (subsection 6(1) of the ITAA 1936). As the company is incorporated in Australia, it is an Australian resident.

Subsection 23AH(15) of the ITAA 1936 defines foreign income, for the purposes of section 23AH of the ITAA 1936, as including an amount that:

· apart from this section, would otherwise be included in assessable income under a provision of this Act (other than capital gains tax), and

· is derived from sources in a listed country or unlisted country.

The company provides services. The profits from its Country A office are ordinary income of the business and are therefore included in its assessable income under subsection 6-5(2) of the ITAA 1997.

The company's Country A office from which the company's business is managed during the period of business is its permanent establishment in Country A (subsection 23AH(15) and section 6(1) of the ITAA 1936).

The income so derived is therefore foreign income as defined in subsection 23AH(15) of the ITAA 1936 and is derived from carrying on the company's business through its permanent establishment in Country A.

The active income test is defined in subsection 23AH(12) of the ITAA 1936. It requires the permanent establishment to pass the active income test in section 432 of the ITAA 1936. Additionally, subsection 23AH(12) requires that certain assumptions in subsection 23AH(14) of the ITAA 1936 are made.

The active income test in section 432 requires, amongst other things, the following conditions be met:

(a) the tainted income ratio test under section 433 of the ITAA 1936;

(b) that accounts are kept for the statutory accounting period in accordance with the accepted accounting principles; and

(c) that the substantiation requirements are complied with in relation to the accounting period under section 451 of the ITAA 1936..

In relation to subsection 23AH(14) of the ITAA 1936 the relevant assumptions in this case are that the only income derived by the company is the income derived in carrying on business at or through the permanent establishment and the company's statutory accounting period is the same as its year of income.

In respect of the tainted income ratio, this ratio is calculated using gross tainted turnover to gross turnover and is required to be less than 0.05 (section 433 of the ITAA 1936).

Section 435 of the ITAA 1936 defines gross tainted turnover to include passive income, tainted sales income and tainted services income.

Passive income includes dividends, tainted interest income, tainted rental income, tainted royalty income, income derived from carrying on a business of trading in tainted assets and net tainted currency exchange gains (section 446 of the ITAA 1936).

Tainted sales income relates to the income from the sale of goods (section 447 of the ITAA 1936).

Tainted services income includes income from the provision of services to an entity which is a Part X Australian resident or if not such a resident, the income is derived in connection with the entity's business in Australia (section 448 of the ITAA 1936).

As the income attributable to the company's Country A branch will be solely from providing services, there will be no passive income, tainted sales income or tainted services income. Therefore, the tainted income ratio is zero and the tainted income ratio test under section 433 of the ITAA 1936 is passed.

In the case of the Country A branch deriving tainted income such as interest income and net currency exchange gains/losses, as long as the tainted income is not exceeding 5%, the active income test is satisfied given other criteria of the same are satisfied.

The company will keep accounts for the statutory accounting period in accordance with accepted principles and will comply with the substantiation requirements under section 451 of the ITAA 1936.

Accordingly, the company's permanent establishment in Country A satisfies the active income test and therefore section 23AH(12) of the ITAA 1936 is satisfied.

In considering adjusted tainted income under subsection 23AH(13) of the ITAA 1936, this is defined in section 317 of the ITAA 1936 as having the meaning given in section 386. The same assumptions for the active income test in subsection 23AH(14) as outlined above also apply.

Section 386 of the ITAA 1936 defines adjusted tainted income as being passive income, tainted sales income and tainted services income with certain modifications. These modifications essentially include gross amounts instead of net gains from the disposal of tainted assets and tainted commodity investments, and from currency exchange fluctuations.

It is concluded that the income of the company's permanent establishment in Country A is not passive income, tainted sales income or tainted services income. As such, the income of the permanent establishment is not adjusted tainted income under subsection 23AH(13) of the ITAA 1936.

Accordingly, the income attributable to the company's permanent establishment in Country A is not assessable income or exempt income under section 23AH of the ITAA 1936 as all the requirements for the application of subsection 23AH(2) are satisfied and subsection 23AH(7) does not apply to exclude such amounts from the operation of subsection 23AH(2). Consequently, the income is not assessable income pursuant to subsection 6-15(3) of the ITAA 1997.