Edited version of your written advice

Authorisation Number: 1012842597359

Date of advice: 24 July 2015

Ruling

Subject: Foreign branch exemption

Question

Is the income derived by HCo from performing services as required by the terms of the Agreement between JCo and HCo non-assessable non-exempt income of HCo pursuant to subsection 23AH(2) of the Income Tax Assessment Act 1936?

Answer

Yes, except to the extent that the income is derived from performing services in Australia.

This ruling applies for the following periods:

Income year 1 July 2012 - 30 June 2013

Income year 1 July 2013 - 30 June 2014

Income year 1 July 2014 - 30 June 2015

Income year 1 July 2015 - 30 June 2016

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

HCo is a resident company and is the head company of a consolidated group.

1. HCo provides services of a particular nature through a subsidiary member of the group, SCo, to a wide variety of industry sectors.

2. SCo has entered into a contract (the Agreement) with JCo, a resident company, under which it is obliged to perform services of a similar nature for F Branch, a permanent establishment (PE) of JCo in a foreign country that is an unlisted country (as defined in section 320 of the Income Tax Assessment Act 1936).

3. There is no double tax agreement (DTA) between Australia and the foreign country.

4. The terms of the Agreement specify particular services (the Services) that SCo must perform, in return for which it is entitled to remuneration (the Fee).

5. The Fee is paid by JCo on a monthly basis in arrears, subject to SCo submitting a statement before the end of the month showing the part of the Fee claimed for the Services completed for that month and demonstrating to JCo's satisfaction that it has satisfactorily performed the Services to which the claim relates.

6. The terms of the Agreement also provide for the Fee to include remuneration for services (the Associated Services) apart from the Services that are necessary for the satisfactory completion and performance of the Services.

7. The Services are provided at a particular site (the Site) in the foreign country on a daily basis by employees of SCo. Some of the Associated Services are also performed at the Site by employees of SCo, with the remainder being performed by SCo's employees in Australia.

8. The Services and Associated Services commenced immediately following execution of the Agreement.

9. The Agreement was made and executed in Australia.

10. The Fee is paid in Australia and is denominated in Australian dollars.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 23AH

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1936 section 319

Income Tax Assessment Act 1936 section 320

Income Tax Assessment Act 1936 section 326

Income Tax Assessment Act 1936 section 384

Income Tax Assessment Act 1936 section 385

Income Tax Assessment Act 1936 section 386

Income Tax Assessment Act 1936 section 432

Income Tax Assessment Act 1936 section 433

Income Tax Assessment Act 1936 section 434

Income Tax Assessment Act 1936 section 435

Income Tax Assessment Act 1936 section 436

Income Tax Assessment Act 1936 section 437

Income Tax Assessment Act 1936 section 446

Income Tax Assessment Act 1936 section 447

Income Tax Assessment Act 1936 section 448

Income Tax Assessment Act 1936 section 450

Income Tax Assessment Act 1936 section 451

Income Tax Assessment Act 1936 section 453

Income Tax Assessment Act 1936 section 457

Income Tax Assessment Act 1997 section 4-5

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

Income Tax Assessment Act 1997 section 6-23

Income Tax Assessment Act 1997 subsection 6-25(2)

Income Tax Assessment Act 1997 section 701-1

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Regulations 1936 subregulation 152C(1)

Income Tax Regulations 1936 Schedule 10 Part 1

Reasons for decision

In these Reasons:

• references to the ITAA 1936 are references to the Income Tax Assessment Act 1936

• references to the ITAA 1997 are references to the Income Tax Assessment Act 1997; and

• all legislative references are to provisions of the ITAA 1936 unless otherwise specified.

Summary

Under section 23AH, a resident company deriving 'foreign income' from carrying on a business through a permanent establishment (PE) of the company in an unlisted country is (despite subsection 6-5(2) of the ITAA 1997) non-assessable non-exempt (NANE) income, provided that either:

• the PE passes a modified version of the active income test in the CFC provisions; or

• the foreign income is not adjusted tainted income according to a modified definition of that term as used in the CFC provisions.

The term 'foreign income' includes income that would, apart from section 23AH, be assessable other than under the capital gains tax provisions, and is derived from sources in a listed country or unlisted country.

'Source' is not a defined term in the income tax law. The courts have consistently maintained that the source of income or profits is a practical matter of fact to be determined according to the circumstances of each case. Where a source of income is located partly within and partly outside the relevant jurisdiction, the courts have indicated that apportionment of the income may be appropriate.

Where an entity that derives foreign income from carrying on a business through a PE is a subsidiary member of a consolidated group, section 701-1 of the ITAA 1997 (the single entity rule) applies such that the company that is the head company of the group during the relevant income year is taken for income tax purposes (including for the purposes of section 23AH) to derive the foreign income from carrying on the business through the PE. In such a case it is the head company, and not the subsidiary member, to which section 23AH is applicable.

In the present case, SCo derives income from meeting its obligations under the Agreement. As a practical matter of fact, the performance of these services is the source of that income. Evidently, the greater part of the income is derived from services performed in the foreign country, the remainder being derived from services performed in Australia. The part of the income that is derived from services performed in the foreign country is foreign income, whereas the part derived from services performed in Australia is not.

This is a conclusion based entirely on traditional source concepts: this ruling is not required to address, nor does it address, transfer pricing.

SCo carries on business providing services in a number of locations, of which the Site in the foreign country is one. It has a PE there through which that business is carried on.

Applying the single entity rule, HCo would be taken to derive the foreign income from carrying on the business of providing services through a PE of HCo in an unlisted country, for each income year for which it is the head company of the HCo consolidated group.

Finally, HCo has passed the active income test for the income years ending 30 June 2013, 2014, 2015 and 2016. It is therefore not necessary to consider whether the foreign income is adjusted tainted income during any of those income years.

Accordingly, the income taken under the single entity rule to be derived by HCo from the services performed by SCo under the Agreement is non-assessable non-exempt income of HCo to the extent it is not derived from services performed in Australia.

Detailed reasoning

Relevant law

Prevalence of subsection 23AH(2) over general source rule

Subsection 6-5(2) of the ITAA 1997 states that if you are an Australian resident, your assessable income includes the *ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

However, subsection 6-25(2) of the ITAA 1997 states that unless the contrary intention appears, the provisions of 'this Act' outside Part 1-3 of the ITAA 1997 (to which section 6-5 of that Act belongs) prevail over the rules about ordinary income.

The term 'this Act' is defined in subsection 995-1(1) of the ITAA 1997 and includes the ITAA 1936.

Section 6-23 of the ITAA 1997 states that an amount of *ordinary income or *statutory income is non-assessable non-exempt income if a provision of this Act or of another *Commonwealth law states that it is not assessable income and is not *exempt income.

Subsection 23AH(2) states:

Subject to this section, foreign income derived by a company, at a time when the company is a resident in carrying on a business, at or through a PE of the company in a listed country or unlisted country is not assessable income, and is not exempt income, of the company.

Subsection 6-25(2) of the ITAA 1997 has the effect that subsection 23AH(2) prevails over subsection 6-5(2) of the ITAA 1997.

Effect of the single entity rule on the application of subsection 23AH(2)

Subsection 701-1(1) of the ITAA 1997 (the 'single entity rule') treats an entity that is a subsidiary member of a consolidated group for any period and any other subsidiary members of the group as being parts of the head company of the group, rather than separate entities, for that period.

The single entity rule is a deeming provision, and like all such provisions, has effect 'only for the purposes for which they are resorted to': FCT v Comber (1986) 10 FCR 88 at 96; 86 ATC 4171 at 4177; 65 ALR 451 at 458, per Fisher J. Those purposes are the 'head company core purposes' and 'entity core purposes' expressed in subsections 701-1(2) and (3) of the ITAA 1997 respectively, which are:

• working out the amount of the head company's / entity's liability (if any) for income tax calculated by reference to any income year in which any of the period occurs or any later income year; and

• working out the amount of the head company's / entity's loss (if any) of a particular sort for any such income year.

Subsection 701-1(4) of the ITAA 1997 lists all the sorts of loss as follows (all are terms defined in subsection 995-1(1) of the ITAA 1997):

• tax loss

• film loss

• net capital loss.

Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 states the consequences of the single entity rule in the following terms (at paragraph 7):

(a) the actions and transactions of a subsidiary member are treated as having been undertaken by the head company;

…

If subsection 23AH(2) applies to an entity, it will affect how the income tax liability or tax loss or capital loss of the entity is worked out, and so is pertinent to the head company core purposes and entity core purposes. Therefore, if a subsidiary member of a consolidated group derives foreign income in carrying on a business at or through a PE of the subsidiary member in a listed country or unlisted country, the head company of the group will be taken under the single entity rule to derive the income in carrying on the business at or through a PE of the head company in the listed country or unlisted country for the purposes of subsection 23AH(2).

Conditions to be satisfied for subsection 23AH(2) to apply

Subsection 23AH(2) poses five tests for the taxpayer, all of which it must pass in order that the income is treated as NANE income. The taxpayer must:

1. be a company

2. derive 'foreign income'

3. be a resident at the time of derivation

4. derive the income in carrying on a business

5. carry on the business at or through a PE of the company in a listed country or unlisted country.

Definitions of terms used in subsection 23AH(2)

The term 'company' is stated in subsection 23AH(15) to have the same meaning as in subsection 6(1) (which states it has the same meaning as in subsection 995-1(1) of the ITAA 1997, i.e. a body corporate or any other unincorporated association or body of persons, but not a partnership or a 'non-entity joint venture'), but does not include a company in the capacity of a trustee.

A company is a 'resident' under subsection 6(1) if it is incorporated in Australia.

The term 'foreign income' is defined in subsection 23AH(15) and includes an amount that:

(a) apart from section 23AH, would be included in assessable income under a provision of the Act other than Part 3-1 or 3-3 of the ITAA 1997; and

(b) is derived from sources in a listed country or unlisted country.

As noted above, but for section 23AH, subsection 6-5(2) of the ITAA 1997 would apply to include in assessable income ordinary income derived by a resident company in carrying on a business at or through a PE in a listed or unlisted country. Such income would be foreign income as defined above if it is established that it is derived from sources in a listed country or unlisted country. This requires an examination of the common law concept of 'source', a term not defined in either the ITAA 1936 or the ITAA 1997. This matter will be returned to later.

A 'permanent establishment' or 'PE', in relation to a listed country or unlisted country, is stated in subsection 23AH(15) to have the same meaning as in the DTA in relation to that country if there is one, or if not, to have the meaning given by subsection 6(1). In the present case, there is no DTA, so the subsection 6(1) definition applies. This states that:

permanent establishment, in relation to a person …, means a place at or through which the person carries on any business …

The definition also lists specific inclusions and exclusions, none of which apply to the present case. 'Person' is stated in subsection 6(1) to have the same meaning as in the ITAA 1997. Subsection 995-1(1) of the ITAA 1997 states that 'person includes a company'.

In Taxation Ruling TR 2002/5 Income tax: Permanent establishment - What is 'a place at or through which [a] person carries on any business' in the definition of permanent establishment in subsection 6(1) of the Income Tax Assessment Act 1936?, it is stated at paragraph 9:

For the purposes of the definition of PE in subsection 6(1) 'a place at or through which [a] person carries on any business' is a reference to a place used for carrying on that person's business activities. That place must have an element of permanence, both geographic and temporal. Permanence must be construed in the context of each particular business and is a question of fact and degree. Permanent in this context does not mean forever.

The Commissioner explains the concepts of geographical and temporal permanence further at paragraphs 29-30 of TR 2002/5. It is stated there (in part):

A place at or through which a person carries on any business in the context of the definition of PE in subsection 6(1) must be geographically permanent. Any area, viewed commercially and as a whole, may, in relation to the business concerned, be a place.

and:

The second criteria [sic] for a place at or through which a person carries on any business to exist for the purposes of the definition of PE in subsection 6(1) is temporal permanence, ie the business presence must not be of a purely temporary nature. In other words, the business must operate at that place for a period of time.

Further, at paragraph 33 of TR 2002/5, the Commissioner states:

Whether temporal permanence exists is a matter of fact and degree. However, as a guide, if a business operates at or through a place continuously for six months of more that place will be temporally permanent.

The terms 'listed country' and 'unlisted country' are stated in subsection 23AH(15) as having the same meanings as in Part X. In that Part, section 317 states that section 320 contains the meanings of both terms, which are as follows:

listed country has the meaning given by subsection 320(1), being a foreign country, or a part of a foreign country, that is declared by the regulations to be a listed country for the purposes of Part X. Subregulation 152C(1) of the Income Tax Regulations 1936 (the Regulations) states that:

For the definition of listed country in subsection 320(1) of the Act, a foreign country or a part of a foreign country listed in Part 1 of Schedule 10 is declared to be a listed country for the purposes of Part X of the Act.

The countries listed in Part 1 of Schedule 10 of the Regulations are Canada, France, Germany, Japan, New Zealand, the United Kingdom of Great Britain and Northern Ireland and the United States of America.

unlisted country has the meaning given by subsection 320(1), being:

(a) a foreign country that does not (either in whole or in part) consist of a listed country or listed countries; or

(b) if one or more parts of a foreign country are listed countries -- the remainder of that foreign country.

Exceptions to application of subsection 23AH(2)

As the words 'subject to this section' in subsection 23AH(2) imply, section 23AH contains exclusions that, if they apply, prevent subsection 23AH(2) from applying to foreign income derived by the taxpayer notwithstanding that it may have passed the abovementioned five tests. The relevant exclusion in the present case is contained in subsection 23AH(7), which states:

Subsection (2) does not apply to foreign income derived by the company if:

(a) the PE is in an unlisted country; and

(b) the PE does not pass the active income test (see subsection (12)); and

(c) the foreign income is adjusted tainted income (see subsection (13)).

Definition of terms used directly or indirectly in subsection 23AH(7)

The term 'active income test' means the active income test defined in Part X as modified for the purposes of section 23AH by subsection 23AH(12), ie:

A PE of an entity passes the active income test for a year of income if the entity would have passed the active income test in section 432 if:

(a) the assumptions in subsection (14) were made; and

(b) subsection 432(3) and 446(2) and paragraphs 432(1)(b) and (e) and 447(1)(b), (d) and (f) had not been enacted.

The term 'adjusted tainted income' means adjusted tainted income as defined in Part X as modified for the purpose of section 23AH by subsection 23AH(13), ie:

For the purposes of this section, the adjusted tainted income of a PE of an entity is income or other amounts that would be adjusted tainted income of the entity for the purposes of Part X if:

(a) the assumptions in subsection (14) were made; and

(b) subsection 446(2) and paragraphs 447(1)(b), (d) and (f) had not been enacted.

Subsection 23AH(14) states:

The assumptions referred to in paragraphs (12)(a) and (13)(a) are:

(a) except in applying paragraphs 447(1)(a), (c) and (e) and 450(6)(c), (7)(d) and (8)(b), the only income or other amounts derived by the entity were the income derived in carrying on business at or through the PE; and

(b) the entity's statutory accounting periods were the same as the entity's years of income; and

(c) in applying paragraphs 447(1)(a), (c) and (e) and 450(6)(c), (7)(d) and (8)(b):

(i) the part of the entity's operations that consists of the business carried on at or through the PE were a company (the PE company); and

(ii) the remaining part of the entity's operations were a separate company (the HQ company); and

(iii) the PE company and the HQ company had carried out the transactions that they would have carried out if the PE company were engaged in the same or similar activities as the PE under the same or similar conditions as the PE and were dealing wholly independently with the HQ company; and

(iv) any income derived by the HQ company were disregarded; and

(d) if the entity is an AFI entity (within the meaning of subsection 326(2)) - the entity were an AFI subsidiary; and

(e) in applying paragraphs 447(1)(a), (c) and (e), the HQ company were an associate of the PE company.

The term 'statutory accounting period' mentioned in paragraph 23AH(14)(b) is stated in subsection 23AH(15) to have the same meaning as in Part X. Section 317 states the term has the meaning given by section 319.

Subsection 319(1) states that: 'Subject to this section, each period of 12 months finishing at the end of 30 June is a statutory accounting period of a company.'

The conditions for passing the active income test are set out in subsection 432, as follows:

(1) Subject to sections 437 and 453, for the purposes of this Part, a company is taken to pass the active income test in relation to a statutory accounting period if, and only if:

(a) the company was in existence at the end of the statutory accounting period; and

(b) [treated by subsection 23AH(12) as not having been enacted]

(c) the company has kept accounts for the statutory accounting period and:

(i) the accounts are prepared in accordance with commercially accepted accounting principles; and

(ii) the accounts give a true and fair view of the financial position of the company; and

(d) the company has complied with the substantiation requirements set out in section 451 in relation to the statutory accounting period; and

(e) [treated by subsection 23AH(12) as not having been enacted]

(f) the tainted income ratio of the company for the statutory accounting period is less than 0.05.

(2) (repealed)

(3) [treated by subsection 23AH(12) as not having been enacted]

Note: Subsection 23AH(12) may also affect the calculation of the tainted income ratio through its effect on the calculation of its components.

adjusted tainted income has the meaning given by section 386, which makes certain modifications to the meaning of passive income (defined in section 446), tainted sales income (defined in section 447) and tainted services income (defined in section 448) for the purposes of sections 384, 385 and 457.

tainted income ratio is defined in section 433, which states:

(1) For the purposes of this Part, if a company is a resident of a particular listed country or a particular unlisted country at the end of a statutory accounting period, the tainted income ratio of the company for the statutory accounting period is calculated using the formula:

Gross tainted turnover means the gross tainted turnover of the company of the statutory accounting period.

Gross turnover means the gross turnover of the company of the statutory accounting period

(2) (repealed)

(3) For the purposes of this Part the tainted income ratio of a company for a statutory accounting period is taken to be less than 0.05 if both the numerator and the denominator in the applicable fraction are 0.

(4) For the purposes of this Part, the tainted income ratio of a company for a statutory accounting period is to be calculated in the currency in which the profit and loss accounts and the balance-sheet of the company for the statutory accounting period are prepared.

gross turnover of a company for a statutory accounting period is defined in section 434 as being the sum of the following amounts, as shown in the recognised accounts of the company for the statutory accounting period, other than amounts covered by section 436:

• the gross revenue of the company, other than revenue from the disposal of commodity futures contracts, commodity forward contracts or rights and options in respect of such contacts; the disposal of other assets (excluding trading stock); or currency exchange rate fluctuations

• the net gain from the disposal of commodity futures contracts, commodity forward contracts or rights and options in respect of such contacts, or other assets (excluding trading stock); or from currency exchange rate fluctuations

gross tainted turnover is defined in section 435 as follows:

For the purposes of this Part, the gross tainted turnover of a company of a statutory accounting period is so much of the gross turnover of the company of the statutory accounting period as consists of:

(a) passive income of the company of the statutory accounting period; or

(b) tainted sales income of the company of the statutory accounting period; or

(c) tainted services income of the company of the statutory accounting period.

passive income has the meaning given by section 446, as follows:

(1) Subject to this Division, for the purposes of this Part, the following amounts are passive income of a company of a statutory accounting period:

(a) dividends (within the meaning of section 6) paid to the company in the statutory accounting period;

(b) unit trust dividends (within the meaning of Division 6B or 6C of Part III) paid to the company in the statutory accounting period;

(c) a distribution made to the company where the distribution is taken to be a dividend because of section 47;

(d) tainted interest income derived by the company in the statutory accounting period;

(e) annuities derived by the company in the statutory accounting period;

(f) tainted rental income derived by the company in the statutory accounting period;

(g) tainted royalty income derived by the company in the statutory accounting period;

(h) an amount derived by the company in the statutory accounting period as consideration for the assignment, in whole or in part, of any copyright, patent, design, trade mark or other like property or right;

(j) income derived from carrying on a business of trading in tainted assets;

(k) net gains that accrued to the company in the statutory accounting period in respect of the disposal of tainted assets;

(m) net tainted commodity gains that accrued to the company during the statutory accounting period;

(n) net tainted currency exchange gains that accrued to the company during the statutory accounting period.

Note: Subsections (2), (4) and (5) are not relevant to the present case and subsection (3) has been repealed.

tainted sales income has the meaning given by section 447. Under this section, tainted sales income is income from the sale of goods by the company where one of several sets of conditions applies. In the present case, the relevant company does not sell goods, so there is no need to elaborate further.

tainted services income has the meaning given by section 448, and is as follows:

(1) Subject to this Division, for the purposes of this Part, the following amounts are tainted services income of a company of a statutory accounting period:

(a) income (other than premium income) from the provision of services by the company to an entity, if:

(i). the entity was a Part X Australian resident at the time the income was derived; and

(ii). the services were not provided in connection with a business carried on by the entity at that time at or through a permanent establishment of the entity in a listed or unlisted country;

(b) income (other than premium income) from the provision of services by the company to an entity who was not a Part X Australian resident at the time the income was derived, in connection with a business carried on by the entity at that time at or through a permanent establishment of the entity in Australia.

[Paragraphs (c)-(g) are not applicable]

[Subsections (1A)-(7) are not applicable]

The term 'Part X Australian resident' referred to in section 448 is defined in section 317, and means a resident within the meaning of section 6, but does not include an entity where there is a DTA in force in respect of a foreign country, and the DTA contains a tie-breaker provision whose effect, for the purposes of the DTA, is that the entity is a resident solely of the foreign country.

Source in the context of the definition of 'foreign income'

As noted above, in the context of paragraph (b) of the definition of 'foreign income' in subsection 23AH(15), the concept of 'source' requires further examination. 'Source' is not a term defined in either the ITAA 1936 or ITAA 1997, but rather is a concept that has been elucidated by the courts over a long period of time.

The courts have repeatedly confirmed that the source of income or profits is a practical matter to be decided according to the facts and circumstances of each case - 'as a businessman would perceive it' - and have specifically declined to lay down rules of law, as is evidenced by the following sample of judicial opinion:

In Nathan v. Federal Commissioner of Taxation (1918) 25 CLR 183; [1918] HCA 45, Isaacs J said (at CLR 189-190):

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 Re Thorpe Nominees Pty Limited v. The Commissioner of Taxation of the Commonwealth of Australia [1988] FCA 387; 88 ATC 4886; (1988) 19 ATR 1834, Burchett J remarked (ATC at 4897; ATR at 1846):

What the cases require is that the truth of the matter be sought with an eye focused on practical business affairs, rather than on nice distinctions of the law. For the word ``source'', in this context, has no precise or technical reference. It expresses only a general conception of origin, leading the mind broadly, by analogy. The true meaning of the word evokes springs in grottos at Delphi, sooner than the incidence of taxes. So the exactness which the lawyer is prone to seek must be consciously set aside; indeed, with respect to a choice between various contributing factors, it cannot be attained. The substance of the matter, metaphorically conveyed when we speak of the source of income, is a large view of the origin of the income - where it came from - as a businessman would perceive it.'

In Federal Commissioner of Taxation v. Efstathakis [1979] FCA 28; 79 ATC 4256 at 4259; (1979) 9 ATR 867 at 870, Bowen CJ observed (at ATC 4259; ATR 870) that:

The answer is not to be found in the cases, but in the weighing of the relative importance of the various factors which the cases have shown to be relevant.

In Federal Commissioner of Taxation v. Mitchum [1965] HCA 23 at paragraph 18; (1965) 113 CLR 401 at 407, Barwick CJ (with whose judgment Menzies and Owen JJ agreed), having earlier quoted Nathan approvingly, rejected an attempt by the Commissioner to argue from the decision of the High Court in Federal Commissioner of Taxation v. French (1957) 98 CLR 398 that there was a rule of law that, in the absence of special circumstances, the source of the consideration for the performance of work, or the rendering of services, was the place at which the work was done, or the services performed. He said:

In my opinion, the submission of the Commissioner is unacceptable. The conclusion as to the source of income for the purposes of the Act is a conclusion of fact. There is no statutory definition of 'source' to be applied, the matter being judged as one of practical reality. In each case, the relative weight to be given to the various factors which can be taken into consideration is to be determined by the tribunal entitled to draw the ultimate conclusion as to source. In my opinion, there are no presumptions and no rules of law which require that that question be resolved in any particular sense.

It was not the province of the High Court in that case actually to determine the source of the income.

With reference to the above quote from Efstathakis, the courts have identified various relevant factors whose relative importance has been weighed in deciding what the source is in a given case. These are:

• where the central management and control is located

• where the contract is negotiated and made

• where the payment flowing from the contract is made

• the residence of the taxpayers

• the place where the activity takes place; and

• the place where the services are performed.

In the end, it is the 'practical, hard matter of fact' test that determines which factor or factors are important in any given case. An examination of the case law shows that in applying this test the courts will look to the process by which the income in question arises and focus on what is productive of the income in a practical business sense. Geographical source is then determined by looking to where that activity occurs (e.g. see Commissioner of Taxation (NSW) v. Meeks (1915) 19 CLR 568).

Thus, in Esquire Nominees Ltd. v. Federal Commissioner of Taxation (1972) 129 CLR 208; 73 ATC 4114; (1973) 4 ATR 75 the dividend was paid from a company which did not engage in trade but held investments in other companies. The 'source' of this investment income was the central management and control of the company and hence 'located' in the place where that central management and control was.

By contrast, in Nathan, where the question was also the source of dividend income, the court, through a process of statutory interpretation, determined that the source of dividend income was not the holding of the share itself but the profits out of which the dividend was paid arose. This in turn was not governed by the central, management and control of the company paying the dividend but the business operations and their location.

In Tariff Reinsurances Ltd v. Commissioner of Taxes (Vic) (1938) 59 CLR 194 the appellant was a reinsurer incorporated in London that reinsured two-thirds of the risk of a company incorporated in Victoria that carried on a business of car insurance in return for two-thirds of the premium received by the Victorian company. It was held that the source of income of the reinsurer was a contract constituting a reinsurance treaty made in London in the ordinary course of a business carried on in London. Accordingly, the payments made by the Victorian company to the reinsurer were not taxable in Victoria. The fact that the payments were made in Melbourne was also held not to be a significant factor, whereas in Efstathakis, the place where the payment flowing from the contract is made was considered an important factor by Bowen CJ (along with the place where the services of the taxpayer were performed).

Similarly, in Premier Automatic Ticket Issuers Ltd. v. Federal Commissioner of Taxation (1933) 50 CLR 268, an agreement entered into by the taxpayer, a company incorporated in NSW, with an inventor and another NSW company concerning patent rights in relation to ticket-issuing machines, was found to be the source of the ten per cent of the proceeds the taxpayer was entitled to under the agreement from the subsequent sale and assignment of British letters patents for the inventions to an English company.

On the other hand, in Commissioner of Taxation v Cam & Sons Ltd (1936) 36 SR (NSW) 544 at 548-549, Jordan CJ stated:

In the ordinary course of the employment of a seaman, such as is now under consideration, where there is nothing special, either in the circumstances of the contract of employment or in the payment, and where the work is both done and paid for in the ordinary course, the all-important factor is the doing of the work; and the contract of employment and the payment are relatively insignificant and formal elements. But this is not necessarily so with respect to all wages or salary. In the case of an appointment to a sinecure, the engagement and the payment may be the only significant factors. In the case now before us, the engagement and the payment took place, and part of the work was done, in New South Wales, but the bulk of it was done outside New South Wales. The source of the wages was thus partly within and partly without the State.

In French, Taylor J quoted both the above paragraphs from Cam & Sons approvingly, stating:

I agree with his Honour's observations and if, as the statute requires, I am compelled to select as the source of an employee's remuneration either the locus of the contract of service, or, the place where remuneration is payable thereunder, or, the place where the services are performed which give rise to the right to remuneration I am content to conclude that, in the absence of special circumstances, this third element should be chosen.

Also, in Federal Commissioner of Taxation v. United Aircraft Corporation (1943) 68 CLR 525; [1943] HCA 50; (1943) 7 ATD 318, the court found that the source of the payment was not 'from pieces of paper' but the supply of information as it was for the supply of that information that payment was made. Rich J commented in that case:

As the question to be determined in this case is a question of fact a decision on one set of facts is not binding and is often of little help on another set of facts. In Premier Automatic Ticket Issuers Ltd. v Federal Commissioner of Taxation ... and Tariff Reinsurances Ltd. v Commissioner of Taxes (Vict.)... - cases which may, perhaps, be regarded as borderline cases - the Court considered that, on the facts in each case, the contract should be regarded as the sole source of income and that therefore the locus of the contract was the locus of the source. But it does not follow that, in every case where a contract is one of the sources, the contract should be regarded as the sole source.

Note that the last sentence hints strongly at the possibility that in some cases, there may be more than one source.

Apportionment between sources

The last sentence of the quote from Cam & Sons above clearly envisages apportionment of a source of income between jurisdictions, a position that was also arrived at in French. In Commissioners of Taxation v. Kirk [1900] AC 588, the Privy Council clearly considered that apportionment of income between jurisdictions was appropriate in that case (though it was not a question they were ultimately asked to address). In that case, in which the taxpayer companies extracted ore from sites in the then colony of NSW, converted the ore into a merchantable product there, sold the finished products exclusively outside the Colony and received payment for the sale outside the Colony, their Lordships remarked:

The fallacy of the judgment of the Supreme Court in this and in Tindal's Case is in leaving out of sight the initial stages, and fastening their attention exclusively on the final stage in the production of the income.

Many other cases could be cited, but an examination of them only serves to further reinforce the impression that the courts will focus, in any given case, on what is productive of the income, in a practical business sense.

Application to the facts

Head company the relevant company to which section 23AH applies

SCo, a subsidiary member of the HCo consolidated group, carries out the services under the Agreement and is remunerated for those services by JCo in accordance with the Agreement. The single entity rule applies such that HCo, as the head company of the group for each relevant income year, is treated for the head company core purposes and entity core purposes as carrying out those services and as deriving the income SCo is entitled to receive under the Agreement for that income year. Accordingly, HCo is the relevant company to which section 23AH is to be applied for each income year covered by this ruling.

Residency, carrying on business through PE in unlisted country

HCo was a resident company at all relevant times. The services performed by employees of SCo in the foreign country under the Agreement have been carried out at the Site over a period of several years as part of SCo's business of providing services of that nature. Accordingly, the required geographical and temporal permanence requirements are met for SCo, and via the single entity rule, HCo, to have a PE in the foreign country, an unlisted country, at or through which it carries on a business.

Whether foreign income derived

In order to satisfy the requirements of subsection 23AH(2), it remains to determine if HCo derives foreign income from carrying on the business at or through its PE in the foreign country, and if so whether or not all of the income derived by it from the provision of services as required under the Agreement constitutes foreign income.

The process by which the Fee from the Agreement was derived may be represented by the following steps:

• Negotiating the contract terms

• Executing (forming) the contract

• Performing the obligations under the contract

• Receiving the payment.

Of these, the activity which answers the description of being a source of income as a practical business person would perceive it is the performance of the obligations. This is evident from the contract terms themselves which require that the 'Services' be performed before an obligation to make a payment arises (see fact 5). Further, the payment for the services is in arrears upon HCo submitting a statement showing the services performed and payment is subject to the approval of JCo (see fact 6). There is no sum payable unless and until the agreed upon services are provided.

In these circumstances, in a practical business sense, it is apparent that the source of the income is the performance of the obligations as required by the Agreement. The execution of the Agreement, whilst a necessary prerequisite, is not a source of income in a practical business sense. This is in contrast to cases such as Tariff Reinsurances and Premier Automatic Ticket Issuers where the execution of the contracts themselves gave rise to the right to receive the income with no performance required. Similarly, the place of central management and control and the place where payments under the contract are made are not considered to a source of the Fee derived by SCo in this case.

The locality of the source then depends on where SCo does the things it has agreed to do in order to receive payment. Whilst the Services are all performed in the foreign country, SCo is also remunerated for the Associated Services. The Services as defined in the Agreement are therefore a very important part of what SCo has agreed to do but they have contracted not just for the performance of the Services in the foreign country by their employees but for everything that needs to occur for the Services to be provided to JCo, ie the Associated Services.

All the income derived from the Agreement would appear from the facts to be ordinary income that would be assessable income (other than under the capital gains provisions) were it not for section 23AH. To the extent that the income was derived under the Agreement from the Services and from that part of the Associated Services performed in the foreign country, it is foreign income as defined in subsection 23AH(15). To the extent that the income was derived under the Agreement from that part of the Associated Services performed in Australia, it is not foreign income and is assessable income.

Whether exception in subsection 23AH(7) applies

As the foreign country is an unlisted country, the condition in paragraph 23AH(7)(a) is satisfied. Since the conditions in all three of paragraphs 23AH(7)(a), (b) and (c) must be satisfied for the exception to apply, it is sufficient to show that HCo passes the active income test (such that the condition in paragraph 23AH(7)(b) is not satisfied) in all the relevant income years in order to demonstrate that the exception does not apply for those income years.

'The entity' referred to in subsection 23AH(12) is HCo, as it is the entity that, under the single entity rule, has the PE in the foreign country. Therefore HCo is the entity that is subject to the active income test in section 432, as modified by the assumptions required in paragraphs 23AH(12)(a) and (b). In particular, the active income test applies to HCo on the assumption that the only income it derived was the income from its PE in the foreign country.

As HCo is in existence as the head company of the HCo consolidated group at the end of each of the income years covered in this ruling, the condition in paragraph 432(1)(a) is satisfied for each of those income years. There is nothing in the assumptions in paragraphs 23AH(12)(a) and (b) that requires that the PE remains in existence at the end of the income year, although those assumptions are relevant for the purposes of applying paragraphs 432(1)(c), (d) and (f).

The condition in paragraph 432(1)(b) is not required to be tested as the assumption under paragraph 23AH(12)(b) is that paragraph 432(1)(b) had not been enacted.

The condition in paragraph 432(1)(c) is satisfied, as SCo has kept the accounts for each income year covered by this ruling that it is required to keep under that paragraph for the PE.

The condition in paragraph 432(1)(d) is satisfied, as SCo has complied with the substantiation requirements in relation to its PE set out in section 451 in relation to each of the income years ending 30 June 2013, 2014, 2015 and 2016.

The condition in paragraph 432(1)(e) is not required to be tested as the assumption under paragraph 23AH(12)(b) is that paragraph 432(1)(e) had not been enacted.

Whether the condition in paragraph 432(1)(f) that the tainted income ratio is less than 0.05 is satisfied is examined below.

Considering the three components of the gross tainted turnover (the numerator of the tainted income ratio):

• none of the income derived by the PE meets the description of passive income

• likewise for tainted sales income, as the PE does not sell goods.

It remains to consider whether the PE has any tainted services income.

The PE has derived income (other than premium income) during each income year covered by this ruling from the provision of services to JCo, which is a Part X Australian resident at the time the income is derived. (Note, that as there is no DTA with the foreign country, JCo satisfies the definition of Part X Australian resident merely by being a resident as defined under subsection 6(1).) However, the services are provided in connection with a business carried on by JCo through a PE of JCo in the foreign country (an unlisted country), being F Branch. Therefore, the condition in paragraph 448(1)(a) is not satisfied.

There is nothing in the facts to suggest that the PE derives income during an income year covered by this ruling from providing services to an entity that is not a Part X Australian resident in connection with a business carried on by the entity at or through a PE in Australia. Therefore, the condition in paragraph 448(1)(b) is not satisfied.

It is not required to consider paragraphs (1)(c)-(g) or subsections (1A)-(7) of section 448 in the circumstances of the case.

Therefore the PE of HCo in the foreign country has no tainted services income in any income year covered by this ruling, and so the gross tainted turnover for each of those income years is nil.

Therefore, if the gross turnover of the PE is greater than nil for any income year covered by this ruling, the tainted income ratio of the PE will be nil. If the gross turnover of the PE is nil for any income year covered by this ruling, then the condition in subsection 433(3) is satisfied and the tainted income ratio is taken to be less than 0.05. In either event, the condition in paragraph 432(1)(f) is satisfied.

Therefore, the PE passes the active income test for each income year covered by this ruling.

Therefore, subsection 23AH(7) does not apply to HCo for any such income year, and consequently does not prevent subsection 23AH(2) from applying in any such income year.

Conclusion

Consequently, the foreign income that HCo derives from providing services as required by the Agreements between JCo and HCo is non-assessable non-exempt income for the income years covered by this ruling. As previously mentioned, however, not all the income that HCo derives from providing services as required by the Agreements is foreign income, and to the extent that it is not, it will be assessable income in the relevant income year.