Edited version of your private ruling

Authorisation Number: 1012529354125

Ruling

Subject: Australian resident Assessable income

Question 1

Is A Limited an Australian resident in terms of subsection 995-1(1) of the Income Tax Assessment Act 1997? No

Answer

No

Question 2

Is the income derived by A Limited from the sale of company products to Australian customers, assessable under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following period:

15 September 2013 to 30 June 2018

The scheme commences on:

The scheme has not yet commenced.

Relevant facts and circumstances

A Limited is a company incorporated overseas. The registered address and principal place of business of A Limited is overseas. A Limited is owned by A Holdings, a company established and tax resident in Country X.

The directors of A Limited are resident overseas and its management and board meetings are held overseas. No management and board meetings are held in Australia.

The controlling shareholders of A Limited are not residents of Australia; they are residents of Country X.

Manufacturers of goods (Manufacturers) have entered into agreements directly with their Australian customers to supply goods in a certain manner (such as price, lead time, and location of stock).

A Limited is positioned as a middle company between the Manufacturers and the customers in Australia.

A Limited is a distributor of goods to customers of the Manufacturers. The goods are manufactured by the Manufacturers overseas. A Limited has customers in the Asia Pacific region of which some are in Australia.

Currently goods are held by A Limited as stock at warehouse facilities overseas. Customers of A Limited in Australia have requested that some goods be consigned to a bonded warehouse located in Australia (Australian Warehouse), which is owned and operated by a third party. There is no shareholding or directorial relationship between the Australian Warehouse operator and A Limited.

Title to the goods will remain with A Limited whilst held in the Australian Warehouse.

Insurance in respect of goods in transit to the Australian Warehouse and goods stored in the Australian Warehouse is included in the insurance cover with an insurer in Country X.

When an Australian customer purchases goods the procedure will be as follows. The Australian customer will send a purchase order by e-mail or fax to the sales office of A Limited overseas. Only the general manager of A Limited who is overseas can conduct negotiations and enter into agreements with the Australian customers for the supply of goods.

If the goods are available from the goods held at the Australian Warehouse, A Limited will instruct the Australian Warehouse to pack the goods for collection by the customer. Alternatively, if the goods are held overseas, A Limited staff will pack the part, prepare all the documents for shipment, and contact the customer's forwarder to collect the goods from the A Limited warehouse overseas.

A Limited does not:

· add any value to the goods it sells during the period of ownership between acquiring them from the Manufacturers and selling and distributing them to customers in Australia;

· have an agent in Australia acting on its behalf in respect of executing or negotiating sales with Australian customers; or

· have any employees in Australia.

Australian customers will settle the invoice for goods purchased from A Limited by remittance transfer to a bank account of A Limited located in Country Z.

Relevant legislative provisions

Income Tax Assessment Act 1936

Subsection 6(1)

Income Tax Assessment Act 1997

Section 6-5

Subsection 6-5(1)

Subsection 6-5(2)

Subsection 6-5(3)

Subsection 6-5(4)

Subsection 995-1(1)

Reasons for decision

Question 1

Summary

We have considered the definition of Australian resident in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and the definition of resident of Australia in terms of paragraph 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) with respect to a company. We have also determined whether A Limited will be carrying on business in Australia and considered whether either of the criteria will be met regarding central management and control of the company in Australia or whether shareholders with control of the company are residents of Australia.

It is concluded that A Limited is not an Australian resident.

Detailed reasoning

The definition of an Australian resident appears in subsection 995-1(1) of the ITAA 1997 where it is said to mean a person who is a resident of Australia for the purposes of the ITAA 1936.

The definition of resident of Australia in subsection 6(1) of the ITAA 1936 with respect to a company reads as follows:

(b) a company which is incorporated in Australia, or which not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.

Each of the conditions in this definition will be considered with respect to A Limited

First, A Limited was incorporated overseas it was not incorporated in Australia so that condition is not met.

Secondly, and alternatively, is the requirement that A Limited carry on business in Australia. This is a question of fact which is examined below.

The business in which A Limited is engaged is the sale of goods. That sale process involves many activities. It can be described as an integrated chain of activities of which the delivery of the goods into the hands of the customer is one vital link in the chain. In other words each activity amongst the many activities performed by A Limited, or on its behalf, constitutes A Limited carrying on business.

A sale to an Australian customer requires that the goods be made available to the customer in Australia and the performance of that activity in Australia will mean that A Limited will be carrying on business in Australia.

Under the proposed arrangement A Limited will have in place the Australian Warehouse where the goods are stored will pack and release the goods to the Australian customer. Although this activity is performed by the Australian Warehouse and not by A Limited itself it is a critical activity in the sale process. Importantly it is the point at which title to the goods will pass from A Limited to the Australian customer. Therefore by virtue of this activity taking place in Australia A Limited will be carrying on business in Australia.

Turning to the two further qualifying conditions necessary to determine whether A Limited is a resident of Australia it is necessary to consider where the central management and control of A Limited takes place, and the location of shareholders who control the voting power in A Limited.

Given the statement that the directors of A Limited are resident overseas; that a location overseas is usually the location for management and board meetings; plus the fact that no management and board meetings are held in Australia, and impliedly none will be held in Australia, it is accepted that the central management and control of A Limited is not in Australia.

Further in respect of shareholders with voting control of A Limited it is stated that they are not residents of Australia, they are residents of Country X.

Accordingly it is concluded that A Limited will not be a resident of Australia in terms of subsection 6(1) of the ITAA 1936 and in turn will not be an Australian resident in terms of subsection 995-1(1) of the ITAA 1997.

Question 2

Summary

We have considered the application of section 6-5 of the ITAA 1997 to the proposed arrangement for the sale of goods by A Limited to customers in Australia where those goods are stored at a warehouse in Australia that is operated by a third party.

We have considered whether the income from such sales has a source in Australia. In doing so we have applied the common law source rules as to where the contract is made; where the contract is performed; and where payment is made under the contract.

Further, we have looked beyond the source rules to examine what gives rise to the profits of A Limited and where those profits are earned.

We have concluded that the profits are earned overseas.

Accordingly, there will be no Australian source income derived from sales to Australian customers under the proposed arrangement utilising the Australian warehouse and thus section 6-5 of the ITAA 1997 will not apply.

Detailed reasoning

Subsection 995-1(1) of the ITAA 1997 states that ordinary income is defined in section 6-5 of the ITAA 1997.

Subsection 6-5(1) of the ITAA 1997 provides that:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

A Limited derives income from the sale of goods to Australian customers. Income from the sale of goods is ordinary income.

Subsection 6-5(2) sets out the treatment of ordinary income that applies to an Australian resident while subsection 6-5(3) sets out the treatment of ordinary income that applies to a foreign resident.

In answer to question 1 above it was found that A Limited will not satisfy the definition of an Australian resident in subsection 995-1(1) of the ITAA 1997. Therefore A Limited will be a foreign resident and thus the application of subsection 6-5(3) must be considered.

Subsection 6-5(3) provides:

If you are a foreign resident, your assessable income includes:

(a) the *ordinary income you *derived directly or indirectly from all *Australian sources during the income year; and

(b) other *ordinary income that provisions include in your assessable income for the income year on some basis other than having an *Australian source.

Note: Asterisked terms are defined in the Dictionary starting at section 995-1 of the ITAA 1997.

The term "Australian source" is defined in subsection 995-1(1) of the ITAA 1997 as follows:

*ordinary income or *statutory income has an Australian source if, and only if, it is *derived from a source in Australia for the purposes of the Income Tax Assessment Act 1936.

In turn the term "derived" has a meaning affected by subsection 6-5(4) of the ITAA 1997 which reads:

In working out whether you have derived an amount of *ordinary income, and (if so) when you derived it, you are taken to have the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

In order for subsection 6-5(3) of the ITAA 1997 to apply, it is necessary to determine whether the income from the sale of the goods is ordinary income from an Australian source. The term "source" is not defined in the ITAA 1997 so it is necessary to look elsewhere for a definition. In this regard the common law rules for determining the source of income will be applied.

Accordingly in this case the question of source is to be answered by considering aspects of the contract that will give rise to the derivation of the income. That is, consideration of the contract with respect to three basic elements being:

· where the contract is made;

· where the contract is performed; and

· where payment under the contract takes place.

The sale contract begins with an Australian customer making an offer to purchase the goods that are sold by A Limited by means of placing a purchase order that is sent by email or fax to A Limited overseas. It is stated that the offer is negotiated only by the General Manager of A Limited who is located overseas. Therefore negotiations surrounding the offer will originate from overseas and ultimately if such negotiations lead to the purchase offer being acceptable then that acceptance will be communicated from overseas to the customer in Australia electronically via email or fax. In such circumstances the contract will be concluded or made in Australia when the advice of acceptance is received by the Australian customer.

This interpretation follows the decision in Entores Ltd v Miles Far East Corporation [1955] 2 QB 327; [1955] 3 WLR 48; [1955] 2 All ER 493 where the Court of Appeal held in the case of instantaneous communications, such as by telex, the contract is complete when and at the place where the offeror receives acceptance from the offeree - see also WA Dewhurst and Co Pty Ltd v Cawrse [1960] VR 278. This is in contrast to a contract made by post where the contract is made when and at the place that the acceptance of the offeror's offer is placed in the mail box by the offeree.

Turning to the performance of the contract, this requires consideration of what constitutes performance of a contract for the sale of goods. Generally, this is simply the delivery of the goods from the seller to the buyer.

Note that in the course of answering question 1 above as to whether A Limited is an Australian resident it was necessary to consider whether A Limited would be carrying on business in Australia under the proposed arrangement. In reaching the view that A Limited would be carrying on business in Australia weight was given to the fact that in the case of the sale of goods stored at the Australian warehouse the title to the goods will pass from A Limited to the Australian customer when the goods are released from the Australian warehouse. Similarly that event of the passing of the title in the goods is likewise significant in the determination of the place where the contract is performed. The sale by A Limited of goods stored at the Australian warehouse is performed in Australia when the goods are released from the Australian warehouse to the Australian customer.

The third and final element to be considered in determining the source of the income from the contract is to determine where payment takes place. In this regard it is stated that payment will be made to a bank account in Country Z. Given that the payment is to be made in a foreign currency the act of making such a payment requires the Australian customer to arrange with its bank in Australia for the transfer to the seller's bank in Country Z of the relevant funds to satisfy the debt. In this case it is considered that the payment of the debt occurs in Country Z when the payment is received in the seller's bank account in Country Z.

Lastly, it is necessary to consider whether any of the three elements in the above discussion is to be given predominance over or a greater weight than any other element. However, in this case there is nothing to suggest that any one element is more significant than any other.

However, a decision as to source that is based upon this crude arithmetic result where two of the three elements in the source rule indicate Australia to be the source of the income is considered to be an over simplification and not a true reflection of where the income was earned.

Thus, instead of applying that crude measure it is proposed to examine what gives rise to the profits earned by A Limited and where those profits are earned.

In Firestone Tyre and Rubber Co Ltd v Llewellin (Collector of Taxes) [1957] 1 WLR 464; [1957] 1 All ER 561 HL Lord Radcliffe pointed out that 'under the conditions of international business and modern facilities of communications' the place of sales test was 'capable of proving a somewhat ingenuous one'

Lord Radcliffe further said:

'the place of sale will not be the determining factor if there are other circumstances present that outweigh its importance, or unless there are no other circumstances that can.'

In Nathan v FC of T (1918) 25 CLR 183 at 189-190, Isaacs J said:

"The Legislature in using the word 'source' meant, not a legal concept, but something which a practical man would regard as a real source of income. Legal concepts must, of course enter into the question when we have to consider to whom a given source belongs. But the ascertainment of the actual source of a given income is a practical, hard matter of fact."

In Federal Commissioner of Taxation v Efstathakis (1979) 38 FLR 276 at 280; 79 ATC 4256 at 4259; 9 ATR 867 at 870 Bowen CJ stated "the answer is not to be found in the cases, but in the weighting of the relative importance of the various factors which the cases have shown to be relevant."

In Australian Machinery and Investment Company Ltd v Deputy Commissioner of Taxation (WA) Starke J said at (1946) 180 CLR 9 at 27; 3 AITR 359 at 378; (1946) 8 ATD 81 at 95-96:

"The question is from what source or sources these various profits arise or to use Lord Atkin's phrase in Smidth & Co v Greenwood (Surveyor of Taxes) [1921] 3 KB 583 at 593 'where do the operations take place from which the profits (or for the purpose of the Income Tax Act 'the income') in substance arise '."

In Cliffs International Inc v Federal Commissioner of Taxation 85 ATC 4374; (1985) 80 FLR 12 Kennedy J of the Supreme Court of Western Australia cited the joint judgement of the High Court in C of T (WA) v D & W Murray Ltd 42 CLR 332. There a company incorporated in England carried on the business of wholesale softgoods warehousemen in Western Australia and other States. The London head office bought and exported the goods required by its Australian branches. The relevant legislation imposed a duty on profits made in Western Australia by companies carrying on business within Western Australia. The High Court, in a joint judgement, said at pp 345-346:

"The business of wholesale softgoods warehousemen which the respondent carries on, depends for its profits or gains upon the sale of softgoods bought or acquired for that purpose. Profits are ascertained by comparing on the one side the amount representing the total of (1) the value of stock on hand at the beginning of an accounting period, (2) the cost of purchase and (3) the expenses of conducting the undertaking in the meantime, with the amount representing (a) the value of stock on hand at the end of the period, and (b) the amount recovered by the sale of the commodities on the other side. This means that the profits are obtained and recovered by selling the goods. In our opinion the place where the whole profit of such a business is made is that where the goods are sold. It is, of course, true that buying the goods is a necessary part of a business of this kind, which derives its profits from selling them. It is also true that skill and judgment in buying are or may be essential to the successful or profitable conduct of the business. But it does not follow that in order to determine where the profits were made it is proper to inquire into all the causes which, in combination or in succession, operated to produce them. If it were possible to discover and discriminate among the innumerable factors which contribute to the profitable exercise of a trade and to assign locality to each of them, still no light would be thrown upon the place where profits were made. To attempt to appraise the relative efficacy or potency of these contributory factors, when and if ascertained, and to distribute the profit accordingly among the localities to which the factors have been assigned, is to lose sight of the true nature of the question, which is not why, but where, the profits were earned.

In Commissioner of Inland Revenue v Hang Seng Bank Ltd [1990] 3 WLR 1120; (1990) 3 HKTC 351, [1991] 1 AC 306 the Privy Council considered the source of profits from the acquisition and disposal of foreign currency certificates of deposits and bonds.

In the course of their judgment the Privy Council, (through Lord Bridge of Harwich) alluded to the source rules, which would apply to a number of different transactions. At WLR 1129; HKTC 360, the Privy Councillors stated:

If he has rendered a service or engaged in … the manufacture of goods, the profits will have arisen or derived from the place where the service was rendered or the profit making activity carried on. But if the profit was earned by the exploitation of property assets as by letting property, lending money or dealing in commodities or securities by buying and reselling at a profit, the profit will have arisen or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected.

In this present case, the nature of the business which A Limited carries on is the sale of goods, which it purchases overseas and resells to Australian customers, amongst others. It is the source of the profit from the sale of goods that will be supplied to the Australian customers from the proposed Australian warehouse which is at issue here.

When the business activity of A Limited is looked at in its entirety the supply of goods from the Australian warehouse is just one part of a complex enterprise. That enterprise is carried on predominantly overseas where all the decisions which guide the business and determine its success or failure are made. Decisions such as those relating to which particular goods to acquire from the Manufacturers overseas to be held in stock as well as decisions as to the number of those goods to carry as stock are all made overseas. It is those decisions which determine the capacity of A Limited to satisfy the needs of its customers and hence its ability to make sales whether they are made to customers in Australia or elsewhere. It is overseas that the General Manager of A Limited is located and from where the General Manager negotiates with Australian customers seeking to purchase goods. Ultimately it is overseas that the decision is taken by A Limited as to whether or not a sale will be made to the Australian customer.

Therefore it is concluded that as a hard practical matter of fact it is overseas that the profits will be earned by A Limited from the sales to Australian customers who will be supplied with goods from the Australian warehouse.

Further, as this means that the ordinary income from such sales does not have an Australian source, subsection 6-5(3) of the ITAA 1997 does not apply. That is to say that the income from the sale of goods to Australian customers from the Australian warehouse will not be assessable income of A Limited in Australia.