Edited version of your written advice

Authorisation Number: 1012760853143

Ruling

Subject: Source of income

Question 1

Is the income derived from business activities undertaken by the partnership foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936?

Answer

No.

Question 2

Is the incentive income derived by the partnership foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936?

Answer

Yes.

This ruling applies for the following period

1 July 2011 to 30 June 2014

The scheme commenced on

The scheme has commenced.

Relevant facts and circumstances

Business activities

1. X, Y and others conducted business activities as an Australian resident partnership.

2. Y as a member of the partnership submitted an online application to B.

3. The online application was made by Y in Australia.

4. Y was an Australian resident for tax purposes at the time.

5. B is located in Country A.

6. The risk of capital is analysed by the partnership in Australia before making a decision to invest.

7. All decisions with regard to the deployment of capital are made by the partnership in Australia.

8. The partnership engages D to act on its behalf with B.

9. D is specifically trained to use partnership guidelines to carry out business activities on behalf of the partnership.

10. All decisions and actions are taken in Australia.

11. D does not have authority to act outside of the directions provided by the partnership.

12. The partnership pays D for services.

13. D is an Australian resident for tax purposes.

Incentive agreement

14. X as a partner of the partnership is a party to an incentive agreement with B (the B agreement) which entitles the partnership to incentive payments.

15. The B agreement applies to business activity.

16. The B agreement was negotiated by X, on behalf of the partnership, and C on behalf of B. All negotiations were by email correspondence between X in Country Q and C in Country A.

17. The B agreement was evidenced in an exchange of emails between X and C.

18. X was resident in Country Q for tax purposes at the time of the negotiation and execution of the B agreement.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6AB

Electronic Transactions Act 1999 Section 5

Electronic Transactions Act 1999 Section 14B

Reasons for decision

Question 1

Summary

In determining the source of the income derived by the partnership from business activities, being income derived under a contract, the contractual arrangement as a whole is examined. This is in order to identify relevant factors that affect the income and to allocate a relative weight or relative importance to each of those factors and thus in turn to determine the source of the income. The factors include the place where the contract is made; the nature of the activity that gives rise to the income and where it occurs, as well as where payment under the contract takes place.

In ascertaining the place where the contract is made the postal acceptance rule in Entores Ltd v. Miles Far East Corporation (1955) 2 QB 327; (1955) 2 All ER 493 is examined as well as the application of the Electronic Transactions Act 1999.

A number of cases are considered in a line of authority commencing with Nathan v. FC of T (1918) 25 CLR 183 which established that the determination of source is a 'practical hard matter of fact'.

Those other cases cited with respect to the determination of source have an emphasis upon the need to identify relevant factors and to give a relative weight to each.

The first factor is the place the contract is made. Another key factor is where the 'essence' of the business which gives rise to the income or profits is undertaken. The place of payment under the contract is also a factor to be considered.

Principles of contract law regarding offer and acceptance were applied to the facts of the arrangement.

The comprehensive description of the activities demonstrated that they involve a series of operations.

As it was found that the decision making takes place in Australia it is Australia where the essence of the business is carried on.

The place of payment under the contract is Country A.

With respect to the weight allocated to the various factors the greatest weight was given to where the essence of the business is carried on and that was Australia.

Consequently the source of the income from the activities is Australia.

Therefore the income derived by the partnership from the business activities is not foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936.

Detailed reasoning

The term 'foreign income' in section 6AB of the Income Tax Assessment Act 1936 (ITAA 1936) is defined to mean income derived from sources in a foreign country or foreign countries.

Accordingly, in order to determine the source of income which is derived from a contract it is necessary to identify a number of key factors surrounding the contractual arrangement and to determine the relative weight or relative importance to be allocated to each of those factors.

The factors and the relevant questions in this case are:

(i) Where is the contract made?

(ii) Where is the business being carried on?

(iii) Where are the goods sold or the services rendered?

(iv) Where is the payment for the goods or services made?

(i) Where is the contract made?

In this question we are dealing with the contracts undertaken.

The parties to the contract did not deal with one another face to face; each was in a different country namely Australia and Country A when the contract was made. Accordingly, in terms of the fundamental principles of contract law the way in which the offer and acceptance were communicated must be examined.

It is appropriate to begin with an examination of the postal acceptance rule. The postal acceptance rule is a long established principle which provides that where an offer has been communicated by post then acceptance of the offer will take effect when a letter accepting the offer is posted, that is, given to the post office. This is because the post office is the implied agent of the party making the offer.

However, in this case the communications are not by post but instead are made electronically.

In Entores Ltd v. Miles Far East Corporation (1955) 2 QB 327; (1955) 2 All ER 493 where communication was by telex, Denning LJ at p 332 said:

'When a contract is made by post it is clear law throughout the common law countries that the acceptance is complete as soon as the letter is put in the post box, and that is the place where the contract is made.'

His Lordship then turned to the case of instantaneous communications and said that the rule for these is different. His Lordship said at p 334:

'The contract is only complete when the acceptance is received by the offeror, and the contract is made at the place where the acceptance is received.'

Electronic Transactions Act 1999

The application of this Australian legislation to the contracts must be considered.

Section 5 of the Electronic Transactions Act 1999 contains definitions of terms.

While section 14B, deals with the place of dispatch and place of receipt.

Having regard to section 14B and the above definitions, the place of contract for online transactions will be the place of business of B.

A contractual offer by the partnership is received and accepted by B in Country A in terms of section 14B of the Electronic Transactions Act 1999.

Acceptance of the offer in Country A means that the contract is made in Country A.

(ii) Where is the business being carried on?

In the analysis of the law provided with the application is a discussion of the concept of the essence of the business in support of the submission that the source of the income derived from the business activities conducted under the arrangement described above is not foreign income for the purposes of section 6AB of the ITAA 1936.

The analysis begins with an examination of a number of cases for the purpose of drawing out a line of authority which supports the proposition that where the essence of a business is a series of operations, the place where one operation is performed cannot be fastened upon as the source of the business income and that one must have regard to all stages in the process.

Case law principles of source

The source of income is a question of fact.

There is a long line of cases in which the question of source has been examined and from those cases some judicial principles or source rules have been established to determine the source of income.

Those principles require that a number of factors be considered and that a relative weight or relative importance be given to such factors in order to arrive at a decision about the source of the income.

In Nathan v FCT (1918) 25 CLR 183 (Nathan), Isaacs J at p 189 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 Nathan the income was income derived from property being dividends whereas in the present case it is business income which is derived by the partnership.

In the application Nathan and a number of other cases are cited which established a judicial line of authority. The further cases cited included Cliffs International Inc. v. Federal Commissioner of Taxation (1985) 80 FLR 12 (Cliffs International); Spotless Services Limited v. Federal Commissioner of Taxation (1993) 25 ATR 344; Federal Commissioner of Taxation v Spotless Services Limited (1995) 32 ATR 309; Federal Commissioner of Taxation v. Efstathakis (1979) FCA 28; and Federal Commissioner of Taxation v Mitchum (1965) 113 CLR 401.

In Cliffs International there was an examination of many other cases in the course of the judgement by Kennedy J. Amongst those cases were C of T (NSW) v. Kirk (1900) AC 588 (Kirk) and C of T (NSW) v. Meeks (1915) 19 CLR 568 (Meeks).

With respect to Kirk it was said by Kennedy J:

The Privy Council was concerned, in C. of T. (N.S.W.) v. Kirk (1900) A.C. 588, with the source of income from sales of ore mined in New South Wales, some of which had been treated in that State and some in South Australia. None of the contracts of sale was made in New South Wales, and none of the purchase money was paid in that State. The Privy Council identified four processes in the earning or production of the income - (i) the extraction of the ore from the soil; (ii) the conversion of the crude ore into a merchantable product; (iii) the sale of the product; and (iv) the receipt of the moneys arising from the sale. All of these processes were regarded as necessary stages which terminated in money. It was considered fallacious to leave out of sight the initial stages and to fasten attention exclusively on the final stage in the production of the income. It was not necessary for their Lordships to apportion the income between the four stages, because the question asked in the special case was, in effect, simply whether the companies earned any part of their profits in New South Wales. It was held that they did.

Whilst for Meeks it was said by Kennedy J:

A similar conclusion was reached by the High Court in C. of T. (N.S.W.) v. Meeks (1915) 19 C.L.R. 568. In discussing the New South Wales legislation, Griffiths C.J. said, at p. 579:

'The Act uses the word `source' in connection with income to denote a concept to which locality can be attributed. The first question for determination, therefore, is what was the source from which this income was derived. The next question is what is the locality of that source. Without attempting to give an exhaustive definition, I am of opinion that, when a person or company carries on in the State of New South Wales the business of dealing with natural products for the purposes of preparing them for use, or of extracting from them other products, and then disposing of the ultimate product by way of sale, any income arising from contracts entered into in the ordinary course of that business for disposing of those products, wherever the contracts themselves are made, has its source, in part at least, in the business undertaking. In another sense the source may be said to be the capital embarked in the undertaking, which in this case must be very large. In either view there can be no doubt that the locality of the source is the place where the undertaking is carried on, in this case of New South Wales.'

It was not disputed that some of the income might properly be apportioned as deriving from a source outside New South Wales. Indeed, Isaacs J. was of the view that there should be an apportionment. However, no formula for any such apportionment was suggested.

In addition to these cases is added FC of T v. Angliss [1931] HCA 32; (1931) 46 CLR 417 (Angliss) where in the judgement of Starke J at p 422 it was said:

Another rule founded on Commissioners of Taxation v Kirk is that where the business is a whole set of operations, then the place where one operation is performed cannot be fastened on as the locality from which the whole of the profits are derived. As Lord Davey observed in Kirk's case, all these operations 'are necessary stages which terminate in money, and the income is the money resulting less all expenses attendant on all the stages.'

Later at p 423 Starke J said:

Do the profits arise or accrue wholly or in part from business operations carried or in Australia - or in England, &c., as the case may be? Or - to use the phrase of Lord Atkin - where do the operations take place from which the profits in substance arise? The question in last resort is really one of fact.

In Australian Machinery and Investment Co Ltd v. Commissioner of Taxation (1946) 180 CLR 9 (Australian Machinery) Starke J was again concerned with the question of source when he said:

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 p 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'. One rule deducible from the decided cases is that where the essence of the business ordinarily consists in making certain classes of contracts and in carrying those contracts into operation with a view to profit or income then for the purposes of Income Tax Acts, such as here under consideration, the business is carried on within the locality where such contracts are habitually made which is the source of the profit or income (cf Lovell & Christmas Ltd v. Commissioner of Taxes (NZ), [1908] AC 46; Commissioner of Taxes (Vict) v. British Australian Wool Realization Association Ltd, [1931] AC 234 , at pp 254-255; Public Officer of Studebaker Corporation of Australasia Ltd v. Commissioner of Taxation (NSW) (1921), 29 CLR 225 ; Commissioner of Taxation (WA) v. D & W Murray Ltd (1929), 42 CLR 332.)

Another rule is that where the essence of the business is a series of operations with a view to profit or income then the place where one operation is performed cannot be fastened on as the locality from which the whole of the profits or income are derived or as the source thereof. The profit or the income is the money resulting less expenses attendant on all the stages. The source or sources thereof are the places where those operations are conducted (Commissioners of Taxation (NSW) v Kirk, [1900] AC 588; Mount Morgan Gold Mining Co Ltd v. Commissioner of Income Tax (Q) (1923), 33 CLR 76; Commissioner of Taxation (NSW) v. Hillsdon Watt Ltd (1937), 57 CLR 36.)

It is contended in the application that the essence of the business in the arrangement undertaken by the partnership is of the second kind described in Australian Machinery, that is, the series of operations carried on in Australia, and that the execution of contracts, as in Meeks and in Cliffs International, is only the final stage of the business transacted, and a mere formality.

It is understood that the business is essentially the skill of the participants applied in a sophisticate decision-making process using specific information and the analysis of that information in order to choose the particular business activity.

This analysis is performed under strict guidelines provided by the partnership to D.

D has received training in such use. D is located in Australia and utilises the strategy developed by the partnership.

The essence of the business is the decision making which takes place in Australia. This is because it is that activity and the processing of information carried on in Australia by D at the direction of the partnership which gives rise to the profit from the business.

(iii) Where are the goods sold or the services rendered?

There are no goods being sold by the partnership in its operations.

Nor is the partnership rendering any services.

It is contended that unlike the situation involving the trading of shares and options there is no trading of the contracts. Instead the execution of the contract is simply the final stage of the business process.

Accordingly, no further consideration of this question is required.

(iv) Where is the payment for the goods or services made?

There are no payments for goods traded or services provided in this case.

However, a successful contract will result in a payment being received by the partnership. In turn, the payment will be recorded in the books of account for the partnership in order to determine whether a profit or loss is realised by the partnership. Therefore it is necessary to examine such payments.

The payments are credited by B to an account.

This record is maintained by B in Country A.

Accordingly payment is considered to take place in Country A.

Conclusion

The four questions posed about the factors which determine the source of income have been answered so it is now necessary to consider the weight to be given to each of those factors in order to determine the source of the income from the partnership business.

Country A is the place where each separate contract is made with B. This is in accordance with the analysis above where it was found that the contract is made in Country A when accepted by B.

Country A is also the place where the payment is made by B.

Yet, the making of the contract in Country A and the payment under the contract in Country A are not sufficiently significant in the context of the arrangement in this ruling to support a finding that Country A is the source of the partnership income.

The extracts from the judgements of Starke J in both Angliss and Australian Machinery, which are cited above, emphasise that it is necessary to consider all the stages in a process that gives rise to the business income and not simply to fasten upon one stage as the determinant of the source of the income.

The description of the business operation of the partnership shows it to go through multiple stages in reaching the position where a decision is made. That process is described above.

The essence of the partnership business is the making of investments.

All these decisions are said to be made by the partnership in Australia.

Accordingly, as this decision making process takes place in Australia, it is Australia which is the source of the income from the partnership business.

Therefore the income derived by the partnership from business activities is not foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936.

Question 2

Summary

In determining the source of the income derived by the partnership from the incentive agreement with B in Country A, being income derived under a contract, the contractual arrangement as a whole is examined. This is in order to identify relevant factors that affect the income and to allocate a relative weight or relative importance to each of those factors and thus in turn to determine the source of the income. The factors include the place where the contract is made; the nature of the activity that gives rise to the income and where it occurs, as well as where payment under the contract takes place.

In ascertaining the place where the contract is made the postal acceptance rule in Entores Ltd v. Miles Far East Corporation (1955) 2 QB 327; (1955) 2 All ER 493 is examined as well as Olivaylle Pty Ltd v. Flottweg GMBH & Co KGAA (No 4) [2009] FCA 522.

A number of cases are considered in a line of authority including Australian Machinery and Investment Co Ltd v. Commissioner of Taxation (1946) 180 CLR 9 (Australian Machinery) , Lovell and Christmas Ltd v. Commissioner of Taxation (NZ) (1908) AC 46 (Lovell) and Commissioners of Inland Revenue v. Hang Seng Bank Ltd (1991) AC 306 (Hang Seng).

The cited cases have an emphasis upon the need to identify relevant factors in the determination of the source of the income and to give a relative weight to each factor.

The first factor is the place the contract is made. Another key factor is where the 'essence' of the business which gives rise to the income or profits is undertaken. The place of payment under the contract is also a factor to be considered.

Principles of contract law regarding offer and acceptance were applied to the facts of the arrangement and it was found that the incentive agreement with B was formed in Country A.

Australian Machinery, Lovell and Hang Seng are all cases in which the place where the contract was made was found to be determinative of the source of the income.

With respect to the partnership the activity that gives rise to the receipt of income from an incentive agreement between the partnership and another entity is the actual making of the incentive agreement itself.

It is noted that the partnership is said to have entered various incentive agreements.

Payment under the incentive agreement is credited to the account maintained by B in Country A and hence the place of payment under the contract is Country A.

With respect to the weight allocated to the various factors the greatest weight was given to where the contract was made and that was Country A.

Consequently the source of the income from the incentive agreement is Country A.

Therefore the income derived by the partnership from the incentive agreement is foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936.

Detailed reasoning

In order to determine the source of income which is derived from a contract it is necessary to identify a number of key factors surrounding the contractual arrangement and to determine the relative weight or relative importance to be allocated to each of those factors.

The factors and the relevant questions are:

(i) Where is the contract made?

(ii) Where is the business being carried on?

(iii) Where are the goods sold or the services rendered?

(iv) Where is the payment for the goods or services made?

(i) Where is the contract made?

It is submitted that the formation of the incentive agreement with B should be characterised in contractual terms in the following way. The proposing of incentive terms by B constitutes an 'offer'. In turn, the partnership accepts the offer and upon the receipt of the communication of the acceptance by B the contract is formed. On this view it is submitted in the application that the place of formation of the incentive agreement with B would be Country A.

Note that there is some uncertainty as to whether the 'postal acceptance rule' applies to email communication. If the rule does apply then the contract would be concluded in Country Q, that is, when X acting for the partnership communicates the acceptance of the offer by B.

One view is that the most relevant guidance to be found in Australian case law regarding the use of email to negotiate the terms of a contract and the acceptance of an offer is contained in the comments made in obiter by Logan J in Olivaylle Pty Ltd v. Flottweg GMBH & Co KGAA (No 4) [2009] FCA 522 (Olivaylle):

25. Flottweg's acceptance was communicated by email to Olivaylle at its olive grove in Victoria. Experience suggests that email is often, but not invariably, a form of near instantaneous communication. The parties seemed content to assume that place of contract was either Victoria or New South Wales, content because the common law of Australia was the same in either place and so, too was the only statute law considered material. There was no suggestion in submissions that the place of contract was, for example, Germany. As a result the ramifications of the adoption by the parties of email for their pre-contractual communications, particularly the acceptance, were not explored. … Having regard to the position taken by the parties in this case it is not necessary to give detailed consideration to the point. It is enough to observe that I consider that there are analogies to be drawn with the way the law developed in relation to telex communications in an earlier era where what I have termed 'the instantaneous communication rule' came to be adopted, perhaps at the expense of scientific precision but not so in relation to common commercial understanding. Thus, by analogy with cases concerning the position with what were, or were treated as, other forms of instantaneous communication , I consider that the contract was made where the acceptance was receive, ie in Victoria: Entores Ltd v. Miles Far East Corporation [1955] 2 QB 327; W A Dewhurst & Co Pty Ltd v. Cawrse [1960] VicRp 44; [1960] VR 278; Express Airways v Port Augusta Air Services[1980] Qd R 543; Reese Bros Plastics Ltd v. Hamon-Sobelco Australia Pty Ltd (1988) 5 BPR 11,106.

In the circumstances of this ruling it is considered that the contractual relationship is that B is the offeror. B made an offer to provide incentive payments at specified rates subject to a target or threshold value of business activity.

Based on the contractual relationship between the partnership and B and in view of the above comments by Logan J in Olivaylle it is considered that the contract for the incentive agreement was concluded in Country A when the partnership's email communicating acceptance was received by B.

(ii) Where is the business being carried on?

The business of the partnership which is at issue here is the business of deriving the incentive income. It is stated, using terminology similar to that of the Court (see Australian Machinery below), that this part of the partnership's business ordinarily consists in making certain contracts, being the incentive agreements, and in carrying those contracts into operation with a view to profit or income. Further, it is stated that the partnership entered various incentive agreements. The incentive agreement entered into with B is said to be one such agreement.

It is submitted that there are cases from which can be drawn a line of authority that places importance on the place where the contract is formed in determining the source of income.

The line of authority includes Australian Machinery and Investment Co Ltd v. Commissioner of Taxation (1946) 180 CLR 9 (Australian Machinery) and Lovell and Christmas Ltd v. Commissioner of Taxation (NZ) (1908) AC 46 (Lovell).

In Australian Machinery the issue was the source of income from the sale of shares in England. This was in circumstances where Australian Machinery acquired mining leases in Western Australia. The consideration given for those acquisitions was shares in Western Australian companies. Those shares were subsequently disposed of in England for cash, options and shares in English companies.

Australian Machinery is a decision of the Full High Court in which Starke J delivered the following judgement:

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 p 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'. One rule deducible from the decided cases is that where the essence of the business ordinarily consists in making certain classes of contracts and in carrying those contracts into operation with a view to profit or income then for the purposes of Income Tax Acts, such as here under consideration, the business is carried on within the locality where such contracts are habitually made which is the source of the profit or income (cf Commissioner of Taxes (NZ ) v. Lovell & Christmas Ltd, [1908] AC 46 ; Commissioner of Taxes (Vic) v. British Australian Wool Realization Association Ltd, [1931] AC 234 , at pp 254-255; Public Officer of Studebaker Corporation of Australasia Ltd v. Commissioner of Taxation (NSW) (1921), 29 CLR 225 ; Commissioner of Taxation (WA) v. D & W Murray Ltd (1929), 42 CLR 332.)

Another rule is that where the essence of the business is a series of operations with a view to profit or income then the place where one operation is performed cannot be fastened on as the locality from which the whole of the profits or income are derived or as the source thereof. The profit or the income is the money resulting less expenses attendant on all the stages. The source or sources thereof are the places where those operations are conducted (Commissioners of Taxation (NSW) v. Kirk, [1900] AC 588; Mount Morgan Gold Mining Co Ltd v. Commissioner of Income Tax (Q) (1923), 33 CLR 76; Commissioner of Taxation (NSW) v. Hillsdon Watt Ltd (1937), 57 CLR 36.)

Starke J analysed the amounts that arose from sales of shares which appeared in the accounts of the company. In doing so Starke J applied the rule in Lovell and found that the source of the income was England.

That is to say Starke J treated the nature of the business of Australian Machinery as coming within the first description in the above extract from his judgement. In brief that can be restated as:

' … where the essence of the business ordinarily consists in making certain classes of contracts and in carrying those contracts into operation with a view to profit or income then … the business is carried on within the locality where such contracts are habitually made which is the source of the profit or income.'

In order to fully understand this reasoning it is useful to examine the decision in Lovell which was a case heard by the Privy Council.

In that case the income in question was commission deducted by Lovell & Christmas Ltd from moneys it received in London under agency contracts of sales effected in London of New Zealand dairy produce consigned to the company in London by New Zealand dairy companies. Representatives of the company had previously visited New Zealand and negotiated with the New Zealand dairy companies to secure produce to be sold on commission in London and had provided advances against the produce supplied.

It was argued for the company that no profits or income was received by the company in New Zealand or derived by it (that is, arises or accrues to it) in New Zealand. The only profits made by it are received in London, and accrue and arise from the business carried on and transacted in London, and not in New Zealand. The profits consisted of commission received in London on sales effected there, and no profits of any kind are produced in New Zealand by transactions in that locality.

The court agreed with this argument when Sir Arthur Wilson, who delivered the judgment of their Lordships, said:

In the present case their Lordships are of opinion that the business which yields the profit is the business of selling goods on commission in London. The commission is the consideration for effecting such sales. The moneys received by the appellants, out of which they deduct their commission, and from which, therefore, their profits come, are paid to them under the contract of sale effected in London. The earlier arrangements entered into in New Zealand appear to their Lordships to be transactions the object and effect of which is to bring goods from New Zealand within the net of the business which is to yield a profit. To make those transactions a ground for taxing, in New Zealand, the profits actually realized in London would, in their Lordships' opinion, be to extend the area of taxation further than the authorities warrant.

A more recent case which emphasises the importance of the place of contract was cited. That case is a decision of the Privy Council regarding the application of Hong Kong law in Commissioners of Inland Revenue v. Hang Seng Bank Ltd (1991) AC 306 where Lord Bridge said:

The broad guiding principle, attested by many authorities, is that one looks to see what the taxpayer has done to earn the profit in question. If he has rendered a service or engaged in an activity such as the manufacture of goods, the profit 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 in or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected.

Applying the decision in Australian Machinery which found that the business is carried on in the locality where the contracts are made it is that locality which is the source of the profits or gains. In this case the profits or gains are the incentive payments under the incentive agreement and accordingly in the application it is considered that they should have a source in Country A.

It is also a view that, in the circumstances of the partnership, the incentive income is specifically referable to the negotiating skills of the partnership in securing those agreements. This argument is extended to include the view that the essence of the business which yields the profits is the business of entering incentive agreements and particularly that incentive agreement with B. Further the payments received are said to be akin to the commissions in Lovell because they are the outcome of effecting the incentive agreement.

In the application it is conclude that as in Australian Machinery, Lovell and Hang Seng, where the profit is derived from the dealings founded in the exchange of contract, the source of the realised profits will be where the contract is entered into.

The Commissioner's view about the significance of the place of contract as a determinant of the source of income is contained in a number of documents. Those documents include ATO Interpretive Decision ATO ID 2004/904 Income tax Assessability of profits from carrying on a business as a share trader by a non-resident (ATO ID 2004/904) and Draft Taxation Ruling TR 2004/D2 Income tax: the application of the foreign tax offset limit under section 770-75 of the Income Tax Assessment Act 1997 to foreign currency hedging transactions (TR 2004/D2).

In ATO ID 2004/904 the Commissioner cites the judgement of Starke J in Australian Machinery regarding the rule deducible from the decided cases regarding the essence of a business being the making of certain classes of contracts.

More recently the Commissioner's view about the place of contract and the source of income appears in TR 2014/D2.

The conclusion drawn from the above examination of the relevant case law and the Commissioner's view, as expressed in the documents identified above, is that the business of making the contract for the incentive agreement with the B takes place in Country A.

Another interpretation of the arrangement which focuses upon relevant factors and their importance in order to ascertain where the business that gives rise to the incentive payment is being carried on is set out below.

The analysis of the source of income as stated earlier is a 'practical hard matter of fact' in which it is first necessary to determine all the processes which contribute to the earning of income and to determine the relative importance of each factor in earning the income.

In this case there were a number of steps taken by the partnership in order to arrive at the point where it was in a position to derive income from the incentive agreement.

It was the partnership's ability to negotiate the incentive agreement with B, including the specific terms thereof that was the most important factor in the receipt of an incentive payment.

(iii) Where are the goods sold or the services rendered?

The answer given here is essentially the same as the answer given in Question 1 above regarding the business conducted with B.

That answer is as follows:

There are no goods being sold by the partnership in its operations.

Nor is the partnership rendering any services.

Accordingly, no further consideration of this question is required.

(iv) Where is the payment for the goods or services made?

Although there are no goods or services being traded the turnover, being the business activity with B generated an incentive payment. It is thus necessary to examine this payment.

Payment under the incentive agreement is considered to take place in Country A.

Conclusion

The four questions posed about the factors which determine the source of income have been answered so it is now necessary to consider the weight to be given to each of those factors in order to determine the source of the income from the incentive agreement with B.

The nature of the incentive agreement is different from other contracts because the income received by the partnership is not the product of either a sale or the provision of a service by the partnership. Therefore, the question posed about these transactions is not relevant in ascertaining the source of the incentive income in this arrangement.

However, it can be said that Country A is the place where the incentive agreement was made with B. This is in accordance with the analysis above where it was found that the contract was made in Country A when the email communicating the partnership's acceptance of the offer made by B was received by B.

Country A is also the place where the incentive payments were made by B.

The extracts from the judgements in Australian Machinery and Lovell, which are cited above, demonstrate that it is necessary to identify precisely what gives rise to the income in question.

Although the quantum received under the incentive agreement is a result of the total value of business activity that activity is not the reason an incentive payment is received. The reason for the incentive payment lies in the terms of the incentive agreement which the partnership negotiated with B.

In these circumstances the greatest weight is to be given to the place where the incentive agreement was made as a determinant of the source of the incentive income.

Accordingly, as the incentive agreement was made in Country A when the partnership's email acceptance of the B offer was received in Country A, it is Country A which is the source of the partnership income from the incentive agreement with B.

Therefore the income derived by the partnership from the incentive agreement with B is foreign income for the purposes of section 6AB of the Income Tax Assessment Act 1936.