Edited version of your written advice

Authorisation Number: 1012692866363

Ruling

Subject: Permanent establishment

Question 1

Are the activities undertaken by the entity taxable in Australia as being part of a permanent establishment under Article 5 of the Country X Double Taxation Agreement (Country X Agreement)?

Answer

No.

Question 2

Are the activities associated with the activity (but excluding supervisory activities) which are undertaken by the entity sufficient to give rise to a permanent establishment to the entity in Australia under Article 5 of the Country X Agreement?

Answer

Yes.

Question 3

Do the supervisory activities undertaken by the entity give rise to a permanent establishment for the entity in Australia under Article 5 of the Country X Agreement?

Answer

Yes.

This ruling applies for the following periods:

The relevant income tax year

The scheme commences on:

A relevant time

Relevant facts and circumstances

• The entity is a Country X incorporated company and is registered in Australia for income tax purposes.

• In 20XX, the entity began negotiations with an Australian company for the supply and installation of a product in Australia.

• As part of the initial contract negotiations, the entity and an Australian resident formed a consortium to undertake the supply and installation.

• Negotiation of the various contracts for the supply and installation was almost exclusively undertaken in Country X where the terms and conditions relating to the supply and installation were agreed by the entity, the Australian resident and the Australian company under the contract (the Contract).

• The Contract was approved by the Company President of the entity in Country X followed by a ceremonial signing held in Australia. The Contract was supplied with the private ruling application.

The Contract

• Under the Contract, 'Contractor' means the Australian company and 'subcontractor' means the entity and the Australian resident.

• A subclause of the Contract provides that if the entity and the Australian resident are a joint venture, consortium or other unincorporated grouping of two or more persons, they are deemed to be jointly and severally liable to the Australian company for the performance of the Contract.

• Pursuant a clause of the Contract's Form of Agreement, the entity and the Australian resident agreed to undertake all work required for the provision of the supply and installation Project (the Project).

• A subclause to the Contract defines the 'Contract Price' to mean the aggregate of all sums payable under the Contract calculated in accordance with the Contract.

• The Contract provides a breakdown of the Contract Price for payment allocations. In addition to payment allocations for supply, payment allocations appear for the entity for the following services:

• Drawing and Engineering Work,

• Erection,

• Technical Assistant for erection, civil and commissioning at the construction site,

• Transportation, and

• Others.

• The Contracts also includes payment allocations for the Australian resident for the following services (but none for supply):

• Drawing and Engineering Work

• Civil,

• Technical Assistant for erection, civil and commissioning at the construction site,

• Transportation, and

• Others.

• Pursuant to a subclause of the Contract, without prejudice to the principle of joint and several liability, the entity and the Australian resident irrevocably nominated a representative and sole agent with full power to represent the entity and the Australian resident for all matters and authority to bind the entity and the Australian resident for the duration of the Contract.

• Pursuant to a subclause of the Contract, the entity and the Australian resident must nominate a representative with full knowledge of all aspects of the subcontract, have full charge of all operations relating to the performance of the Contract, and have the authority to agree on behalf of the entity and the Australian resident to any change order.

Consortium Agreement

• The entity and the Australian resident entered into a Consortium Agreement for the purpose of carrying out the supply and installation project. The Consortium Agreement was supplied with the private ruling application.

• Pursuant to a subclause of the Consortium Agreement, the relationship between the entity and the Australian resident is not to be construed as a joint venture, partnership, principal and agent, a trust, fiduciary, any other special relationship or a taxable entity.

• Pursuant to the Consortium Agreement, the entity and the Australian resident agreed to an allocated scope of works described in the Contract.

• Under the Consortium Agreement, the entity and the Australian resident agreed to allocate the responsibility for each part of the scope of work.

• Under the Consortium Agreement, the entity and the Australian resident agreed that while certain works were the risk and responsibility of the entity, they were to be performed by the Australian resident in accordance with the Contract. These works were defined as the Australian Resident Subcontract Works installation activities.

• The Consortium Agreement provides that notwithstanding the joint and several liability of the entity and the Australian resident to the Australian Company, each of them will carry out and be solely responsible for obligations identified in the allocated scope of works set out in the Consortium Agreement.

• Under the Consortium Agreement, the entity and the Australian resident agreed that despite the terms of the Contract, entity would pay the Australian resident for the Australian Resident Subcontract Works

• The Consortium Agreement outlines the payment rights and obligations of the entity and the Australian resident in relation to the Project. The Consortium Agreement provides that the Australian resident will be entitled to payment for the Australian Resident Subcontract Works from the entity after the entity has claimed for payment under the Contract for the Australian Resident Subcontract Works.

• Pursuant to the Consortium Agreement, the entity and the Australian resident agreed to implement a steering committee for the consortium in which the entity would be the chairperson. This is the most senior person from the entity who attends the meeting.

• The Consortium Agreement provides that the purpose of the steering committee, among other things, is to establish business and operational policies and procedures of the consortium and implement them through the Consortium Manager.

• The Consortium Agreement provides that if the steering committee reaches a deadlock in relation to an issue, the chairperson would have the casting vote.

• The Consortium Manager is also authorised to make day to day operating decisions within the policy guidelines as determined by the steering committee pursuant to the Consortium Agreement.

On the ground works

• Characteristics of the product supplied required parts of the product to be made in Country X before being transported to Australia for assembly and installation at the Project site.

• The installation process undertaken by the Australian resident, as the Australian Resident Subcontract Works defined in the Consortium Agreement, will be subject to supervision by the entity's specialist supervisors.

• The Australian resident has engaged contractors and/or employees to undertake these installation works on the ground in Australia. These works consist of installation activities.

• The entity has developed a comprehensive set of plans and instructions in Country X which allow for installation of the product on the ground which has been tailored to suit the requirements of the Project.

• The installation method for the products which have been developed by the entity in Country X has been provided to the Australian resident on a commercial in-confidence basis to allow the Australian resident to undertake the installation works on site using the instructions which have been developed by the entity.

• The installation plans contain instructions and diagrams for use by the Australian resident in identifying the sequencing and techniques to be used over the installation period.

• The installation period will be in excess of X months.

• Over various points of the installation process, the entity has arranged for a number of supervisors to travel to and stay in Australia to oversee the work undertaken to ensure that it is in accordance with the method and other materials provided to the Australian resident.

• The primary focus of the supervisory activities undertaken is to ensure that the installation activities are undertaken by the Australian resident in accordance with the information provided and that they are in accordance with the contractual requirements which the entity has undertaken to provide in terms of the specifications and performance levels of the products under the Contract.

• The Consortium Manager acts as the project coordinator and has been appointed to attend the Project for the installation of the products by the Australian resident. The coordinator reports to the entity's head office information regarding the timing of the completion of the various phases of the project, attainment of milestones and issues as they arise.

• The project coordinator also plays a liaison role with representatives of the Australian company on similar matters and seeks direction from the entity's head office for delivery to local Australian company and Australian resident representatives.

Relevant legislative provisions

Income Tax Assessment Act 1936

Income Tax Assessment Act 1997

Income Tax Assessment Act 1997 section 6-5

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

International Tax Agreements Act 1953

International Tax Agreements Act 1953 section 4

International Tax Agreements Act 1953 subsection 5(1)

Reasons for decision

Question 1

Are the activities undertaken by the entity taxable in Australia as being part of a permanent establishment under Article 5 of the Country X Double Taxation Agreement (Country X Agreement)?

Summary

The activities associated with the fabrication of the products outside of Australia and their delivery in Australia are not part of a permanent establishment of the entity in Australia under Article 5 of the Country X Agreement. These activities occur prior to the entity commencing to carry on its business through a fixed place of business in Australia and differ substantially from the activity of supplying and installing the products in Australia.

Detailed reasoning

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a non-resident taxpayer includes ordinary income derived directly and indirectly from all Australian sources during the income year.

The International Tax Agreements Act 1953 (Agreements Act) must be considered to determine whether Australia has a taxing right in respect of the income derived in Australia by the foreign resident company.

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except in some limited situations).

The Agreements Act gives the Country X Agreement the force of law in Australia.

Article 7 of the Country X 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 enterprise 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.

Article 5 of the Country X Agreement contains a list of examples that each may be regarded as constituting a permanent establishment.

Article 5 of the Country X Agreement does not specifically refer to whether offshore fabrication and delivery to Australia are activities that form part of a permanent establishment involving the supply and construction of a good in the other country.

In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4714; (1990) 21 ATR 531 (Thiel), the High Court accepted that the OECD Commentaries may be referred to when interpreting tax treaties in accordance with Article 32 of the Vienna Convention (See paragraph 90 of Taxation Ruling TR 2001/13). Taxation Ruling TR 2001/13 at paragraphs 101 to 105 explains the Commissioner's view that the OECD Commentaries are relevant to interpreting Australia's tax treaties.

Paragraph 11 of the OECD's Commentaries on Article 5: Concerning the definition of permanent establishment affirms that:

A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a fixed place of business. This is the case once the enterprise prepares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the enterprise should not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently.

Article 6 of the Country X Agreement provides that an enterprise is not deemed to have a permanent establishment merely because of, amongst other things, the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise or for the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.

This is supported by the Explanatory Memorandum to the Bill which implemented the Country X Agreement. Of particular relevance are paragraphs of the Explanatory Memorandum which provide that preparatory and auxiliary activities, such as delivery, do not generally give rise to a permanent establishment as the necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist.

In the present case, due to characteristics of the product supplied and installed, parts are fabricated in Country X before being transported to Australia for assembly at the Project site. The fabrication of the parts of the products in Country X is not an activity that forms part of a permanent establishment of the entity in Australia under Article 5 of the treaty because prior to the assembly and installation commencing at the Project site, the entity does not operate an enterprise in Australia through a fixed place of business through which it has been engaged under the contract to supply the products. This is in contrast with the example in paragraph 20 of the OECD's Commentaries in which fabrication and assembly occur within the same country.

While the delivery of the pre-fabricated parts of the products is necessary for the entity to fulfil the obligations of its enterprise activities in Australia under the contract, the fabrication and delivery of the component parts are in the nature of preparatory or auxiliary activities occurring prior to the entity operating through a fixed place of business in Australia. Accordingly, the activities associated with the fabrication of the products outside of Australia and their delivery to the Project site are not part of a permanent establishment of the entity in Australia under Article 5 of the treaty.

Question 2

Are the activities associated with the activity (but excluding supervisory activities) which are undertaken by the entity sufficient to give rise to a permanent establishment to the entity in Australia under Article 5 of the Country X Agreement?

Summary

The entity will have a permanent establishment in Australia under Article 5 of the Country X Agreement for the activities associated with the installation and supply of the products. This is because the entity has subcontracted part of its contractual obligations to supply and install the products at the Project site. Accordingly, the income from the activities associated with the installation and supply of the products which are undertaken at the Project site are sufficient to give rise to a permanent establishment for the entity in Australia under Article 5 of the Country X Agreement.

Detailed reasoning

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

The International Tax Agreements Act 1953 (Agreements Act) must be considered to determine whether Australia has a taxing right in respect of the income derived in Australia by the foreign resident company.

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except in limited situations).

The Agreements Act gives the Country X Agreement the force of law in Australia.

Article 7 of the Country X 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 attributable to the permanent establishment in Australia may be taxed in Australia.

The term 'permanent establishment' is defined in Article 5 of the Country X Agreement.

Article 5(2) of the Country X Agreement contains a list of examples that each can be regarded as constituting a permanent establishment.

In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4714; (1990) 21 ATR 531 (Thiel), the High Court accepted that the OECD Commentaries may be referred to when interpreting tax treaties in accordance with Article 32 of the Vienna Convention (See paragraph 90 of Taxation Ruling TR 2001/13).

Paragraph 11 of the OECD Commentaries on Article 5: Concerning the definition of permanent establishment affirms that:

A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a fixed place of business. This is the case once the enterprise prepares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the enterprise should not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently.

On this basis, the definition of a 'permanent establishment' contains three conditions (as outlined in paragraph 2 of the OECD Commentaries):

• the existence of a 'place of business',

• the place of business must be fixed, and

• the business of the enterprise is carried on through this fixed place of business.

Existence of a 'place of business'

The OECD Commentary on Article 5 Concerning the definition of permanent establishment in the OECD Commentaries (OECD Model Commentary on Article 5) at paragraph 4 relevantly states that -

The term "place of business" covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose… It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise…

Paragraph 4.6 of the OECD Commentary on Article 5 goes on to state -

The words "through which" must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business "through" the location where this activity takes place.

In this case, the business of the entity's enterprise to supply and install the products for the Project occurs at the Project site.

The place of business must be fixed

Paragraph 5 of the OECD Commentary on Article 5 defines 'fixed' as -

According to the definition, the place of business has to be a "fixed" one. Thus in the normal way there has to be a link between the place of business and a specific geographical point. It is immaterial how long an enterprise of a Contracting State operates in the other Contracting State if it does not do so at a distinct place, but this does not mean that the equipment constituting the place of business has to be actually fixed to the soil on which it stands. It is enough that the equipment remains on a particular site (but see paragraph 20 below).

Paragraph 20 of the OECD Commentary on Article 5 mentioned above relates to construction sites and states -

The very nature of a construction or installation project may be such that the contractor's activity has to be relocated continuously or at least from time to time, as the project progresses. This would be the case for instance where roads or canals were being constructed, waterways dredged, or pipe-lines laid. Similarly, where parts of a substantial structure such as an offshore platform are assembled at various locations within a country and moved to another location within the country for final assembly, this is part of a single project. In such cases, the fact that the work force is not present for twelve months in one particular location is immaterial. The activities performed at each particular spot are part of a single project, and that project must be regarded as a permanent establishment if, as a whole, it lasts more than twelve months.

In the present instance, the Project site where the entity is contracted to supply and install the products constitutes a 'fixed' place of business for the purposes of the Country X Agreement.

The business of the enterprise is carried on through this fixed place of business

Paragraph 6 of the OECD Commentary on Article 5 relevantly states that -

Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency, i.e. if it is not of a purely temporary nature. A place of business may, however, constitute a permanent establishment even though it exists, in practice, only for a very short period of time because the nature of the business is such that it will only be carried on for that short period of time…

Article 5 of the Country X Agreement provides that a building site or construction or installation project will constitute a permanent establishment if it lasts more than 12 months. Therefore, regardless of whether the other elements of Article 5 are satisfied, a construction site will not constitute a permanent establishment where it does not last for more than 12 months.

In this case the entity, together with an Australian resident, entered into an agreement with an Australian Company, as part of a larger project. The agreement between the entity, the Australian resident and the Australian company forms part of the Subcontract. Under the Contract, the Australian company is the contractor and the entity and the Australian resident are the subcontractor.

Pursuant to the Contract, the entity and the Australian resident agreed to undertake all work required for the supply and installation of the products to be built for the Project.

The contract price for the Contract was the aggregate of all sums payable under the Contract calculated in accordance with the Contract. The Contract provides a breakdown of the contract price for payment allocations. In addition to payment allocations for supply, payment allocations for the entity appear for the following services:

• Drawing and engineering work,

• Erection,

• Technical assistant for erection, civil and commissioning at the construction site,

• Transportation, and

• Others

Payment allocations appear for the Australian resident for the following services:

• Drawing and engineering work,

• Civil,

• Technical assistant for erection, civil and commissioning at the construction site,

• Transportation, and

• Others.

No payment allocations are listed for supply by the Australian resident.

In addition to the Contract, the entity and the Australian resident entered into a Consortium Agreement for the purpose of carrying out the production, supply and installation of the products for the Project.

Pursuant to the Consortium Agreement, the entity and the Australian resident agreed to an allocated scope of works outlined in the Contract. Under the Consortium Agreement, the entity and the Australian resident agreed to allocate the responsibility for each part of the scope of work. Under the Consortium Agreement, the entity and the Australian resident agreed that while certain works were the risk and responsibility of the entity, they were to be performed by the Australian resident in accordance with Contract. The Consortium Agreement defined these works to be the Australian Resident Subcontract Works and included installation activities. The Australian resident has engaged contractors and/or employees to undertake these installation works on the ground in Australia.

The entity has developed a comprehensive set of plans and instructions to allow for the installation of its parts on the ground which has been tailored to suit the requirements of the Project. The installation period will be in excess of 12 months.

Over various points of the installation process, the entity has arranged for a number of supervisors to travel to and stay in Australia to oversee the work undertaken to ensure that it is in accordance with the method and other materials provided to the Australian resident. The latter stages of the installation process undertaken by the Australian resident will be subject to supervision by the entity's specialist supervisors.

The primary focus of the supervisory activities undertaken is to ensure that the installation activities are undertaken by the Australian resident in accordance with the information provided and that it is generally in accordance with the contractual requirements which the entity has undertaken to provide in terms of the specifications of the products under the Contract.

The Consortium Agreement diagrammatically represents the Australian resident to be a subcontractor of the entity for parts of the installation. Under the Consortium Agreement, the entity and the Australian resident agreed that despite the terms of the Contract, the entity would pay the Australian resident for the Australian Resident Subcontract Works. The Consortium Agreement outlines the payment rights and obligations of the entity and the Australian resident in relation to the Project. The Consortium Agreement provides that the Australian resident will be entitled to payment for the Australian Resident Subcontract Works from the entity after the entity has claimed for payment under the Contract for the Australian Resident Subcontract Works.

The Consortium Agreement provides that notwithstanding joint and several liability of the entity and the Australian resident to the Australian company, each of them will carry out and be solely responsible for obligations identified in the allocated scope of works set out in their Consortium Agreement.

The Consortium Agreement provides that the entity is the leader of the Consortium (Consortium Manager) and its steering committee. The Consortium Manager was appointed to attend the Project.

The Consortium Agreement sets out the responsibilities of the Consortium Manager. The Consortium Manager is responsible for the management and supervision of the entity's allocated scope of work, including pursuing the entity's rights and entitlements under the Contract with respect to the entity's allocated scope of work. The Consortium Manager is also authorised to make day to day operating decisions as determined by the steering committee pursuant to the Consortium Agreement.

A representative is appointed as the Deputy Consortium Manager pursuant to the Consortium Agreement. The responsibilities of the Deputy Consortium Manager include the management and supervision of the Australian resident's allocated scope of work, including the Australian resident's rights and entitlements under the Contract with respect to the Australian resident's allocated scope of work.

The Contract and Consortium Agreement demonstrate that the entity has subcontracted the activities associated with the installation of the products, but excluding supervisory activities, to the Australian resident. Article 5 of the Country X Agreement does not specifically refer to how or when a Country X enterprise will have a permanent establishment if it subcontracts all or part of its activities in Australia to an Australian enterprise.

Paragraph 19 of the OECD Commentaries on Article 5 states that:

19. … If an enterprise (general contractor) which has undertaken the performance of a comprehensive project subcontracts parts of such a project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as being time spent by the general contractor on the building project. …

Paragraph 19 of the OECD Model Commentaries on Article 5 recognises that an enterprise may carry on its business through subcontractors, either acting alone or together with employees of the enterprise. It is irrelevant whether or not the enterprise itself performs activities in Australia in connection with the construction or installation project - or subcontracts the work to others - either wholly or in part. Hence, the time a subcontractor spends on a building site or construction or installation project is considered to be the time the general contractor spends on the building site or project. In the case of a non-resident enterprise undertaking a construction or installation project in Australia, it means that the enterprise cannot subcontract its way out of having a permanent establishment in Australia.

Consistent with the Article 5(3) of the 2010 OECD Model Convention, there is no requirement in Article 5 of the Country X Agreement that the construction or installation project be directly carried out by the Country X entity for it to have a permanent establishment in Australia - only that it should last more than 12 months.

This position is supported by the Explanatory Memorandum to the Bill which implemented the Country X Agreement.

Although presented in the context of manufacturing or processing on behalf of others, further support for the position that a person acting on behalf of another giving rise to a deemed permanent establishment can be found in the Explanatory Memorandum.

In this case, pursuant to the Contract, the entity and the Australian resident have agreed to undertake all work required for the provision of project management, engineering, procurement, construction, commissioning, assistance to start-up and confirmation of performance tests for parts to be built for the Project. The Contract provides that the entity will receive consideration for the installation activities. The entity has subcontracted the installation activities to the Australian resident and will pay the Australian resident for these activities pursuant to the Consortium Agreement. As part of the subcontracting arrangement between the entity and the Australian resident, the day-to-day operating decisions related to the installation project will be undertaken by the Consortium Manager, a representative of the entity. In addition, the entity will also have specialist supervisors on the ground supervising the installation of the products.

Accordingly, the entity is considered to have carried on the installation activities contracted to it under the contract. This is because the entity, as contractor, is considered to have carried on the activities through the Australian resident as subcontractor.

Conclusion

As such, the entity will have a PE in Australia under Article 5 of the Country X Agreement for the construction or installation project. This is because the entity, through a subcontract arrangement with the Australian resident, will carry on the business of constructing the products at the Project site in Australia for a period of more than 12 months. The entity is considered to have carried on the activities of the Australian resident during this period.

Question 3

Summary

Do the supervisory activities undertaken by the entity give rise to a permanent establishment for the entity in Australia under Article 5 of the Country X Agreement?

Detailed reasoning

As outlined in question 2 above, the entity has contracted to construct and install the products at the Project site and has a permanent establishment in relation to the construction and installation activity under Article 5 of the Country X Agreement. The entity will also have a Permanent Establishment under Article 5 of the Country X Agreement for the supervisory activities occurring at the Project site of the installation project.

In this case, the entity (the construction contractor) has established that it is undertaking supervisory activities in relation to the Project site.

On this basis, as the supervisory activities last more than 12 months, those activities shall be deemed to be performed through a permanent establishment of the entity in Australia. Therefore, the entity will have a permanent establishment in Australia under Article 5 of the Country X Agreement for the supervisory activities occurring at the Project site of the installation project.