Edited version of your written advice

Authorisation Number: 1012864773019

Date of advice: 27 August 2015

Ruling

Subject: PAYG withholding obligations

Question 1

Does Company A have an obligation to deduct and remit PAYG in relation to the Australian portion of a foreign resident's notional Australian wages?

Answer

No.

This ruling applies for the following period:

1 July 2014 to 1 July 2015

Relevant facts and circumstances

Company A is a Foreign entity which has a Permanent Establishment (PE) (according to the definition contained in subsection 6(1) of the ITAA 1936) in Australia.

The PE arose because Company A won a contract (the Project) requiring work to be done in Australia over a period of years. The Project is to upgrade certain vehicles.

The PE commenced with the arrival of a number of foreign employees. Some employees were engaged in the tasks of upgrading and modifying the vehicles and are likely to be in Australia for some years. Some employees were involved in a management or advisory capacity and only in Australia for short periods.

Most of the staff applied for Australian Tax File Numbers (TFNs) and provided TFN declarations to Company A, which sent them to the ATO. Company A has calculated and paid Australian PAYG in respect of these employees.

X - employment

X is a Foreign resident employed by Company A. X travels to various countries where Company A has a presence in order to test vehicles for Company A's clients.

For less than a month, X tested vehicles in Australia. The specific role was to evaluate, test and ensure that the modifications were working correctly; not to modify or upgrade any of the vehicles.

In relation to the Project, there is no specific project milestone for tested vehicles. However, there is a payment milestone for the delivery of a number of particular vehicles; achievement of this milestone requires testing modifications made to those vehicles.

The statement of work for the Project does not specify how it should be resourced by Company A. Therefore Company A was not required to provide a particular person to do the testing, but they choose to use an employee familiar with these particular vehicles. Trials were accordingly undertaken by a Company A appointed tester accompanied by a tester provided by Company A's Australian client.

Company A considered that using a local tester would potentially introduce a level of risk and require conversion training, which in any event would have to be conducted by a Company A tester.

X - entry to Australia

Most staff on the Project entered Australia on 457 visas, which allow multiple entries over a stipulated period. Where the period of the stay is greater than one month, the Company A staff were on Short Term International Assignments.

X entered Australia on a business visitor 400 Visa. He was not covered by the Company A Short Term International Assignment policy.

X - pay

Company A charges their Australian client a fee based on its fully absorbed wage rate for project staff plus expenses plus profit. The fully absorbed wage rate is the wage rate for the individual who will book to the Project plus the burdened Tier 1 and Tier 2 costs for the Project.

Tier 1 costs include the wages related on-costs for employees of the Project, i.e. foreign pension and health care charges etc. (similar to Australian superannuation and workers' compensation).

Tier 2 costs are shared overhead expenses and are dealt with at a business level. They include functions which reach across the whole business, including corporate engineering, facilities, IT, HR, central finance, tax and corporate communications. A percentage of the cost of these shared resources is allocated to each Company A project as an overhead. How much is allocated to each project is calculated by 'projected revenue' and is based on the three factors of 'headcount', 'assets' and 'sales'.

X is a member of XYZ at a Company A work depot in the Foreign country, and the wages are calculated as an overhead for that section. He is considered a shared resource, and as such, the wages were not booked directly to the Project, but were accounted for in its Tier 2 costs.

The wages of other staff who attended Australia as part of the Project were accounted for as a direct expense. When Company A lodged the tender for the Project with their client, X's projected time costs were accordingly not part of the budget.

X was not paid any overseas secondment allowances for the time in Australia, (unlike Project staff).

During the time in Australia X was paid from the Foreign country and did not receive any separate Australian pay.

For the purposes of calculating any super guarantee charge and/or PAYG withholding that may be required for X, Company A determined X's 'notional' Australian pay based on the portion of the wage attributable to the dates he was in Australia.

X is not a tax resident of Australia and did not apply for a TFN.

Relevant legislative provisions

The relevant provisions dealt with in this Ruling are:

• Subsection 6(1) of the ITAA 1936

• Subsection 6-5(1) of the ITAA 1997

• Subsection 6-5(3) of the ITAA 1997

• Subsection 6-20(1) of the ITAA 1997

• Section 11-5 of the ITAA 1997

• Section 11-15 of the ITAA 1997

• Section 12-1 of Schedule 1 to the TAA 1953

• Subsection 12-1(1A) of Schedule 1 to the TAA 1953

• Section 12-35 of Schedule 1 to the TAA 1953

• Section 5 of the International Tax Agreements Act 1953

• Subsection 4(1) of the International Tax Agreements Act 1953

• Article 14 of the United Kingdom Convention

• Article 17 of the United Kingdom Convention

• Article 18 of the United Kingdom Convention

Reasons for decision

When determining a person's liability to pay tax in Australia, it is necessary to consider the domestic income tax laws and any applicable double tax agreements.

Domestic law

Section 12-35 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) requires an entity to withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee, subject to the general exceptions contained in section 12-1 of Schedule 1 to the TAA 1953. Those exceptions include, amongst other things:

• if, in the hands of the recipient the whole of the payment is not assessable income and is not exempt income (subsection 12-1(1A)).

'Exempt income' has the meaning given by subsection 6-20(1) of the Income Tax Assessment Act 1997 (ITAA 1997). It provides that an amount of ordinary or statutory income is exempt income if it is made exempt from income tax by a provision of this Act or another Commonwealth law. The note to this subsection provides that summary lists of provisions about exempt income are contained in sections 11-5 and 11-15 of the ITAA 1997.

Ordinary income is defined in subsection 6-5(1) of the ITAA 1997 as including income according to ordinary concepts.

Subsection 6-5(3) of the ITAA 1997 provides that a Foreign resident's assessable income includes:

• ordinary income derived directly or indirectly from all Australian sources during the income year; and

• other ordinary income that a provision includes in assessable income for the income year on some basis other than having an Australian source.

Applicable double tax agreements

Subsection 4(1) of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the ITAA 1936 and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Agreements listed within section 5 of the Agreements Act have the force of law according to its tenor. The Foreign Country Convention (Foreign Agreement), which on the facts is the relevant agreement to consider, is listed in section 5 of the Agreements Act. The Foreign Agreement operates to avoid the double taxation of income received by residents of Australia and the Foreign country.

Article 14 of the Foreign Agreement deals with income from employment. Paragraph 1 of Article 14 provides that:

Subject to the provisions of Articles 17 and 18 of this Convention, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived from that exercise may be taxed in that other State.

Paragraph 2 further provides:

Notwithstanding the provisions of paragraph 1 of this Article, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year or year of income of that other State; and

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and

(c) the remuneration is not deductible in determining taxable profits of a permanent establishment which the employer has in the other State.

Article 17 deals with pensions and annuities and Article 18 deals with Government Services, and therefore are not relevant on the facts.

X is a resident of a country, a contracting state to the Foreign Agreement. He has derived wages in respect of the employment with Company A. According to Paragraph 1 of Article 14, he should only be taxable in the Foreign country, unless the employment is exercised in the other Contracting State (Australia), in which case so much of the remuneration as is derived from that exercise may be taxed in Australia.

A portion of X's employment during the fiscal year was exercised in Australia. Prima facie, the remuneration he received which is attributable to that period is therefore taxable in Australia.

However, paragraph 2 of Article 14 provides an exception to this if certain conditions are met. The first is that the relevant recipient is not present in the other Contracting State for more than 183 days in any 12 month period of that State's fiscal year.

As X was not in Australia for a period exceeding 183 days in any 12 month period of Australia's fiscal year, he meets this requirement.

The second is that the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State. While X was in Australia he was paid from the Foreign country Company A, which is not a resident of Australia.

The third is that the remuneration is not deductible in determining taxable profits of a PE which the employer has in the other State.

X's wage while in Australia was considered a Tier 2 expense to Company A. Tier 2 costs are overhead expenses and are dealt with at a business level. They include shared functions which reach across the whole business. A percentage of the cost of these shared resources is allocated to each project. The cost is calculated by 'projected revenue' and is based on the three factors of 'headcount', 'assets' and 'sales'.

Although a percentage of Company A's Tier 2 costs would have been allocated to the Project, X's 'notional Australian wages' would not have factored in the calculation. In fact, a portion of the wage would also have been allocated to Tier 2 costs of other Company A projects around the world. Therefore while the Tier 2 costs allocated to the Project would be deductible to the PE generally, X's 'notional Australian wages' were not specifically so. X therefore also meets the third requirement.

X meets all the requirements of paragraph 2 of Article 14. Therefore, notwithstanding paragraph 1 of the same Article, the remuneration in respect of the employment exercised in Australia is taxable in the Foreign country and is not taxable in Australia.

Should PAYG be remitted for X?

Section 12-35 of Schedule 1 of the TAA 1953 requires an entity to withhold an amount from wages paid to an employee, subject to the general exceptions in section 12-1 of Schedule 1 to the TAA 1953. One of those exceptions is subsection 12-1(1A) which includes circumstances where, in the hands of the recipient, the whole of the payment is not assessable income and is not exempt income.

Subsection 6-5(3) of the ITAA 1997 provides that a foreign resident's assessable income includes:

• ordinary income derived directly or indirectly from all Australian sources during the income year; and

• other ordinary income that a provision includes in assessable income for the income year on some basis other than having an Australian source

It has been established that X did not derive ordinary income directly or indirectly from an Australian source in the 2015 financial year. Therefore X did not receive assessable income in 2015.

'Exempt income' has the meaning given by subsection 6-20(1) of the ITAA 1997. It provides that an amount of ordinary or statutory income is exempt income if it is made exempt from income tax by a provision of this Act or another Commonwealth law. Provisions detailing what is exempt income are contained in sections 11-5 and 11-15 of the ITAA 1997. None of them are relevant to X. Accordingly X did not have exempt income in the 2015 financial year.

As X did not have assessable or exempt income in the 2015 financial year, there is no requirement for Company A to withhold an amount from the wages according to section 12-35 of Schedule 1 of the TAA 1953.

Other matters

Rate of withholding

For the purposes of collecting income tax and the other liabilities, the Commissioner may make one or more withholding schedules specifying the amount required to be withheld by an entity from, amongst other things, a withholding payment covered by Subdivision 12-B (which includes section 12-35 of Schedule 1 to the TAA). The relevant withholding schedule for the 2015 financial year provides that the amount the entity should withhold from an amount paid to a foreign resident employee who has not provided a tax file number (TFN), is 47%.

It should be noted that "Schedule 1 - Statement of formulas for calculating amounts to be withheld" on the ato.gov.au website provides further information in respect of amounts required to be withheld from payments made to a foreign resident employee (for example, scale 3 of the schedule).

Is there a need to lodge a tax return?

Subsection 161(1) of the ITAA 1936 provides that every person must lodge a tax return if required by the Commissioner by notice published in the Gazette. The relevant legislative instrument regarding lodgement of returns for the year ended 30 June 2015 is TPAL 2015/2. Relevantly, Table A provides, among other things, that any person who has had an amount withheld from payments or an amount paid to the Commissioner of Taxation (the Commissioner) under the PAYG withholding system is required to lodge a tax return, other than where the withholding payments are covered by:

• Subdivision 12-F of Schedule 1 to the TAA 1953 (relating to certain dividend, interest and royalty payments); or

• Subdivision 12-FA of Schedule 1 to the TAA 1953 (relating to departing Australia superannuation payments); or

• Subdivision 12-H of Schedule 1 to the TAA 1953 (relating to fund payments from managed investment trusts); or

• section 12-319A of Schedule 1 to the TAA 1953 that relate to payments to persons participating in the Seasonal Labour Mobility Program; or

• section 12-320 of Schedule 1 to the TAA 1953 (relating to mining payments); or

• are payments withheld from a superannuation lump sum to which section 303-10 of the ITAA 1997 (concerning certain superannuation lump sum payments received by a person with a terminal medical condition) applies

If all other facts remained the same, however Company A had been required to withhold and remit PAYG on X's behalf, then X would accordingly be required to lodge a tax return for the year ending 30 June 2015.

Did X work in the PE?

For completeness, the Commissioner notes and accepts that while X worked in Australia on the Project, he worked in the PE.