Edited version of your written advice

Authorisation Number: 1012993775418

Date of advice: 18 April 2016

Ruling

Subject: Foreign branch income and capital gains

Question 1

Is Company A's share of net rental income derived from the lease of the rental property in Country B, non-assessable, non-exempt income under subsection 23AH(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Company A's share of net rental income derived from the lease of the rental property in the Country B is non-assessable, non-exempt income under subsection 23AH(2) of the ITAA 1936.

Question 2

Is Company A's share of capital gains, to be made from the disposal of the rental property in the Country B, be disregarded under subsection 23AH(3) of the ITAA 1936?

Answer

Company A's share of capital gain, to be made in respect of the disposal of the rental property in the Country B is not disregarded under subsection 23AH(3) of the ITAA 1936, and is instead non-assessable, non-exempt income under subsection 23AH(2) of the ITAA 1936.

This ruling applies for the following periods:

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

Relevant facts and circumstances

Background

Company A is a company incorporated in Australia.

Company A is not a trustee of a trust.

Company A is a resident for Australia tax law purposes and is not a Country B resident for Country B tax law purposes.

Company A is a member of Consolidated Group A. The head company is Company HCo.

Company A subscribed for a limited partnership interest in the Fund upon the terms and conditions set out in the Partnership Agreement of the Fund and the Subscription Agreement.

Pursuant to the Subscription Agreement, Company A invested an amount into the Fund. Company A funded the investment by way of equity and loans from members of Consolidated Group A. Company A did not borrow from sources outside of Consolidated Group A.

The Fund is a limited partnership formed in Country B under the laws of Country B and is a resident for Country B tax law purposes.

The General Partner filed a certificate of formation of the Fund (Certificate of LP) in Country B.

The Fund is not a venture capital limited partnership (VCLP), an early stage venture capital limited partnership (ESVCLP), an Australian venture capital fund of funds (AFOF) or a venture capital management partnership (VCMP) for Australian tax law purposes.

The Fund is treated as a partnership for Country B tax law purposes and lodges a yearly Partnership tax return with Country B revenue authority.

Under Country B tax law, tax is imposed on the partners and not the Fund itself. The Fund remits withholding tax in Country B on non-resident's share of the Fund's net income, whether it is distributed or not.

Structure of Country B operation

The Partnership Agreement provided for one partner to be the General Partner and the other partners to be Limited Partners.

A Limited Partners' liability is limited to their capital contribution.

Company A is the only Australian Limited Partner and has an amount of contributed capital investment and voting rights in the Fund. All other investors are foreign investors. Total Australian investment in the Fund is less than 10%.

The General Partner of the Fund is a Country B limited liability company (Company GP).

The Fund directly holds all the membership interest in Company B1 and indirectly all the membership interest in Company B2.

Company B1 is a Country B limited liability company. It is a special purpose entity required by lenders for legal reasons to be the mezzanine debt borrower. It was formed for the primary purpose of borrowing mezzanine finance and to hold all the membership interest in Company B2.

Company B2 is a Country B limited liability company. Its primary purpose is to invest, hold and lease the rental property, the office building in Country B (Rental Property). Company B2 purchased the Rental Property from Company B3.

Company B1 and Company B2 are treated as a disregarded, see-through entity for Country B tax law purposes.

Operation of the Fund

The Fund's activity is the investment in fiscally transparent entities in Country B, Company B1 and Company B2.

The principal office and place of business of the Fund is located in Country B.

The investment activities of the Fund are not conducted by the Fund itself. At all relevant time, the Company GP conducts the Fund's investment activities at the office in Country B and not in Australia.

The central management and control of the Fund is exercised in Country B by Company GP who has authority to conclude contracts on behalf of the Fund.

All day-to-day management activities of the Fund are conducted by Company GP in return for management fees pursuant to the terms of the Partnership Agreement.

The General Partner is not a director or employee of the Fund.

Income of the Fund

The Fund derives income, principally by way of investment income, in the form of rental income in respect to the leasing of the Rental Property by Company B2, the legal owner of the property.

According to the Fund's Country B Tax Return for x period, the only income derived by the Fund is from the Fund's investment in Company B1 and Company B2 in Country B.

The Country B tax return describes the Funds' activity as investment in fiscally transparent entities in Country B.

According to the Fund's unaudited financial statement for x period, the Fund described its revenue as net rental income.

Partnership Agreement

Relevant sections of the Partnership Agreement include:

• formation of the Fund;

• definition of defined terms;

• purpose and business of the Fund;

• authorized activities of the Fund;

• power and limitation of Company GP;

• power and limitation of Limited Partners;

• distribution of income or loss;

• dissolution of the Fund; and

• accounting and reports.

Assumptions

Company A made an election under paragraph 830-10(2)(b) of the ITAA 1997 to treat its interest in the Fund as an interest in a foreign hybrid for the purpose of Division 830 of the ITAA 1997.

During the relevant income years covered by this ruling, Company B2 will sell the Rental Property in Country B and will derive a capital gain from the sale of this property.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Subsection 6-5(2)

Income Tax Assessment Act 1936 Subsection 6-10(4)

Income Tax Assessment Act 1936 Subsection 6-15(3)

Income Tax Assessment Act 1936 Section 11-55

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1936 Section 23AH

Income Tax Assessment Act 1936 Subsection 23AH(1)

Income Tax Assessment Act 1936 Subsection 23AH(2)

Income Tax Assessment Act 1936 Subsection 23AH(3)

Income Tax Assessment Act 1936 Subsection 23AH(5)

Income Tax Assessment Act 1936 Subsection 23AH(6)

Income Tax Assessment Act 1936 Subsection 23AH(10)

Income Tax Assessment Act 1936 Subsection 23AH(11)

Income Tax Assessment Act 1936 Subsection 23AH(12)

Income Tax Assessment Act 1936 Subsection 23AH(13)

Income Tax Assessment Act 1936 Subsection 23AH(14)

Income Tax Assessment Act 1936 Subsection 23AH(15)

Income Tax Assessment Act 1936 Subsection 94D(1)

Income Tax Assessment Act 1936 Subsection 94D(2)

Income Tax Assessment Act 1936 Subsection 94D(5)

Income Tax Assessment Act 1936 Division 5

Income Tax Assessment Act 1936 Division 5A

Income Tax Assessment Act 1936 Section 94J

Income Tax Assessment Act 1936 Section 94T

Income Tax Assessment Act 1936 Subsection 320(1)

Income Tax Assessment Act 1936 Subsection 317(1)

Income Tax Assessment Act 1936 Subsection 319(1)

Income Tax Assessment Act 1936 Section 340

Income Tax Assessment Act 1936 Section 361

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 435

Income Tax Assessment Act 1936 Subsection 446(1)

Income Tax Assessment Act 1936 Former subsection 485AA(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Division 830

Income Tax Assessment Act 1997 Section 830-1

Income Tax Assessment Act 1997 Section 830-5

Income Tax Assessment Act 1997 Section 830-10

Income Tax Assessment Act 1997 Subsection 830-10(1)

Income Tax Assessment Act 1997 Subsection 830-10(2)

Income Tax Assessment Act 1997 Section 830-20

Income Tax Assessment Act 1997 Subsection 830-15(1)

Income Tax Assessment Act 1997 Subsection 830-15(5)

Income Tax Assessment Act 1997 Section 830-75

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

Income Tax Assessment (1936 Act) Regulation 2015 Regulation 17

Income Tax Assessment (1936 Act) Regulation 2015 Regulation 19

Income Tax Regulations 1936 Former Regulation 152C

Income Tax Regulations 1936 Former Schedule 9

Income Tax Regulations 1936 Former Schedule 10

International Tax Agreements Act 1953 Section 3AAA

International Tax Agreements Act 1953 Section 3AAB

Reasons for decision

In these reasons, all legislative references are to provisions of the ITAA 1936 unless otherwise specified.

Question 1

Prior to discussing Company A's entitlement to exemption under subsection 23AH(2) in respect of the income derived from its interest in the Fund, it is necessary to consider the operation of the foreign hybrid provision in Division 830 of the ITAA 1997. This is for the purpose of characterising Company A's interest in the Fund and thus its treatment for Australian tax law purposes.

Division 830 of the ITAA 1997 provides for certain hybrid entities that are treated as partnerships for the purpose of foreign tax, but as companies for Australian tax law purposes, to be treated as partnerships for Australian tax law purposes (section 830-1 of the ITAA 1997).

The expression 'foreign hybrid' means a foreign hybrid limited partnership or a foreign hybrid company (section 830-5 of the ITAA 1997).

Foreign hybrid limited partnership

Subsection 830-10(1) of the ITAA 1997 provides that a limited partnership is a foreign hybrid limited partnership in relation to an income year if:

a) it was formed in a foreign country; and

b) foreign tax is imposed under the law of the foreign country on the partners, not the limited partnership, in respect of the income or profits of the partnership for the income year; and

c) at no time during the income year is the limited partnership, for the purposes of a law of any foreign country that imposes foreign tax on entities because they are residents of the foreign country, a resident of that country; and

d) disregarding subsection 94D(5) of the Income Tax Assessment Act 1936, at no time during the income year is it an Australian resident; and

e) disregarding that subsection, in relation to the same income year of another taxpayer:

(i) the limited partnership is a controlled foreign company (CFC) at the end of a statutory accounting period that ends in the income year; and

(ii) at the end of the statutory accounting period, the taxpayer is an attributable taxpayer in relation to the CFC with an attribution percentage greater than nil.

For a limited partnership to be a foreign hybrid limited partnership, it must satisfy all the conditions in subsection 830-10(1) of the ITAA 1997, including meeting the definition of a 'limited partnership'.

An interest in a foreign hybrid limited partnership also includes an interest in respect of which a taxpayer has made an election under paragraph 830-10(2)(b) of the ITAA 1997 or former subsection 485AA(1).

Limited partnership

A limited partnership is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(a) an association of persons (other than a company) carrying on business as partners or in receipt of *ordinary income or *statutory income jointly, where the liability of at least one of those persons is limited; or

(b) an association of persons (other than one referred to in paragraph (a)) with legal personality separate from those persons that was formed solely for the purpose of becoming a *VCLP, an *ESVCLP, an *AFOF or a *VCMP and to carry on activities that are carried on by a body of that kind.

* denotes a term defined in section 995-1 of the ITAA 1997

In determining whether the liability of at least one of the partners is limited, paragraph 13 of Taxation Determination TD 2008/15 Income tax: Can an unincorporated association of persons acting only in Australia who do not carry on a business in common with a view to profit be a corporate limited partnership within the meaning of section 94D of the Income Tax Assessment Act 1936? states:

The reference to the liability of at least one of the 'partners' being limited is a reference to a limitation (applying under the legal system applicable to the association) of their liability to third parties for, or to contribute to, the debts, obligations or other liabilities of the 'partnership'. Those debts, obligations or other liabilities will be those arising from the partners carrying on business as partners, or from their joint receipt of income, whichever character their association has.

In ATO Interpretative Decision ATO ID 2008/80 Income tax: Foreign hybrid limited partnership: Delaware limited partnership, the ATO stated that a limited partnership formed under the Delaware Revised Uniform Limited Partnership Act has features both commonly associated with a business carried on by partners as partners and with a company.

While the separate legal entity status is more commonly associated with companies (for example see Rose v. FCT (1951) 84 CLR 118; 9 ATD 334; 5 AITR 197), this feature of itself does not necessarily lead to characterisation as a company. Rather, the question remains as to whether the business is being carried on by the relevant persons as partners (as opposed to by the separate legal entity on its own behalf) (see for example Major (Inspector of Taxes) v. Brodie & Another [1998] STC 491, at 498).

In this particular case, the Fund is established as a limited partnership under Country B laws with at least one partner being a Limited Partner. The partners have executed a Partnership Agreement which includes, amongst others, the following terms:

• the Fund does not have a perpetual succession in the same manner as a company. Rather, the Fund shall continue to operate from the date it was formed until the Fund is dissolved in accordance with the Partnership Agreement or an event causing the dissolution of the Fund under the laws of Country B;

• the liability of a Limited Partner is limited to the extent of their capital contribution;

• the Fund's business is operated, managed and controlled by Company GP, who is authorised to make all decisions affecting the business of the Fund, and where appropriate, to bind the Fund;

• Limited Partners shall not take part in the management or control of the business of the Fund, and shall have no power or authority to bind the Fund, other than provided under the laws of Country B or as set forth in the Partnership Agreement;

• Company GP may not transfer its interest as General Partner without the consent of the Limited Partners. Similarly, a Limited Partner may not transfer its interest in the Fund without the consent of the General Partner; and

• net profits and losses of the Fund shall be allocated to each Partner for distribution in accordance with the Partnership Agreement, indicating that the profits and losses belong to the partners as they arise.

Whilst the Fund has a separate legal existence which continues until the Certificate of LP is cancelled, the business of the Fund is conducted more in line with how a partnership operates than a company. As such, the Fund is a limited partnership within the meaning of paragraph 995-1(1)(a) of the ITAA 1997. It is therefore not necessary to consider paragraph 995-1(1)(b) of the ITAA 1997.

Conditions in paragraphs 830-10(1)(a) to (b)

Paragraphs 830-10(1)(a) to (d) of the ITAA 1997 are satisfied for the following reasons:

• the Fund is a limited partnership formed under the laws of Country B;

• the Fund is a fiscally transparent entity. Under Country B tax law, the Fund is not taxed in its own right rather tax is imposed on the Partners in respect of income or profits of the Fund;

• the Fund is formed in the Country B and is not a resident of any other country.

• Under section 94T, a partnership which is not incorporated in Australia can be an Australian resident if:

a) the partnership carries on business in Australia; or

b) the partnership's central management and control is in Australia

It has been stated as a fact that, the Company B conducts the business of the Fund in Country B and the central management and control of the Fund is exercised by the Company GP in Country B. Accordingly, the Fund will not be regarded as an Australian resident during the relevant income years covered by this ruling.

Conditions in paragraph 830-10(1)(e)

Subsection 94D(5) provides that a foreign hybrid limited partnership in relation to a year of income because of subsection 830-10(1) of the ITAA 1997 is not a corporate limited partnership in relation to the year of income.

Paragraph 830-10(1) (e) of the ITAA 1997 provides that disregarding the above provision (subsection 94D (5)), the Fund must be a controlled foreign company (CFC) with at least one attributable taxpayer having an attribution percentage greater than nil.

A CFC must qualify as a 'company' and must be a resident of a listed or unlisted country (section 340).

Subsection 995-1(1) of the ITAA 1997 defines 'company' as a body corporate or any other unincorporated association of body of persons, but does not include a partnership or a non-entity joint venture. Note 2 to the definition states that a reference to a company includes a reference to a corporate limited partnership pursuant to section 94J.

A corporate limited partnership is defined in paragraph 94D(1)(a) to include a limited partnership formed in the 1995-96 year of income or a later year of income. However, a partnership that is a VCLP, an ESVCLP, an AFOF or a VCMP cannot be a corporate limited partnership (subsection 94D (2)).

It has been determined that the Fund is a limited partnership (established in a year later than the 1995-96 income year) within the meaning of paragraph 995-1(1) (a) of the ITAA 1997 and is not a VCLP, an ESVCLP, an AFOF or a VCMP. Accordingly, the Fund meets the conditions in paragraph 94D(1)(a) and subsection 94D(2) and is a corporate limited partnership in relation to the income years covered by this ruling. As the definition of 'company' in section 94J includes a corporate limited partnership, the Fund will be a company for the purposes of section 340.

The Fund meets the conditions in paragraph 94D(1)(a) and subsection 94D(2) and is a corporate limited partnership in relation to the income years covered by this ruling. As the definition of 'company' in section 94J includes a corporate limited partnership, the Fund will be a company for the purposes of section 340.

Listed country

The term 'listed country' has the meaning given by subsection 320(1) to mean 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.

Regulation 19 of the Income Tax Assessment (1936 Act) Regulation 2015 (ITR 2015) declares Country B as a listed country (formerly regulation 152C and schedule 10 of the Income Tax Regulations 1936 (ITR 1936) for income years prior to the 2015/16).

As the Fund is formed in Country B and is a resident of Country B, it will be a resident of a listed country.

CFC

A company will be treated as a CFC if it satisfies any one of the control tests in section 340.

An attributable taxpayer in relation to a CFC is an Australian entity whose associate-inclusive control interest in the CFC is at least 10% or the CFC is controlled by a group of 5 or fewer Australian entities (either alone or with an associate), and the entity is an Australian 1% within that group (section 361).

An Australian 1% entity is an entity whose associate-inclusive control interest in the CFC is at least 1% (subsection 317(1)).

The Fund is not a CFC and Company A is not an attributable taxpayer in relation to the Fund.

As not all of the conditions in subsection 830-10(1) of the ITAA 1997 are satisfied, the Fund is not a foreign hybrid limited partnership for the purpose of Division 830 of the ITAA 1997.

Election under subsection 830-10(2) of the ITAA 1997

As stated in the assumption, Company A made an election under paragraph 830-10(2)(b) of the ITAA 1997 to treat its interest in the Fund as an interest in a foreign hybrid for the purpose of Division 830 of the ITAA 1997.

The effect of making the election is that, for the purpose of applying Australian taxation laws to the partner's interest, the limited partnership is treated as a foreign hybrid limited partnership in relation to an income year during which the election is made (subsection 830-10(2)).

Accordingly, the Fund is treated as a partnership and subject to partnership taxation treatment under Division 5. In the absence of this election, the Fund will be treated as a company and subject to company taxation treatment under Division 5A.

Foreign hybrid company

Section 830-20 of the ITAA 1997 provides that a foreign hybrid company is treated as a partnership for Australian tax purposes. Subsection 830-15(1) of the ITAA 1997 sets out the requirements for a foreign hybrid company:

A company is a foreign hybrid company in relation to an income year if:

a) at all times during the income year when the company is in existence, the partnership treatment requirements for the income year in subsection (2) or (3) are satisfied; and

b) at no time during the income year is the company, for the purposes of a law of any foreign country that imposes *foreign tax on entities because they are residents of the foreign country, a resident of that country; and

c) at no time during the income year is the company an Australian resident; and

d) disregarding this Division, in relation to the same income year of another taxpayer:

i. the company is a *CFC at the end of a *statutory accounting period that ends in the income year; and

ii. at the end of the statutory accounting period, the taxpayer is an attributable taxpayer in relation to the CFC with an *attribution percentage greater than nil.

* denotes a term defined in section 995-1 of the ITAA 1997.

An interest in a foreign hybrid company also includes an interest in respect of which a taxpayer has made an election under paragraph subsection 830-15(5) of the ITAA 1997 or former section 485AA.

In this particular case, Company B1 and Company B2 do not meet the requirements of paragraph 830-15(1) (d) as these entities are not CFCs and Company A is not an attributable taxpayer in relation to these companies.

In these instances, Company A may make an election under subsection 830-15(5) of the ITAA 1997 to treat its interest in these entities as foreign hybrid companies, which it has not done. Accordingly, Company B1 and Company B2 are treated as companies for Australian tax law purposes and subject to company taxation treatment under Division 5A.

Foreign branch income

Subsections 6-5(2) and 6-10(4) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary and statutory income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. However, subsection 6-15(3) of the ITAA 1997 provides that if an amount is non-assessable, non-exempt (NANE) income, it is not assessable income.

Section 11-55 of the ITAA 1997 lists those provisions dealing with NANE income. Included in the list are the branch profits of Australian companies under section 23AH.

Subsection 23AH(1) states that the objects of section 23AH are:

(a) to ensure that active foreign branch income derived by a resident company, and capital gains made by a resident company in disposing of non-tainted assets used in deriving foreign branch income ... are not assessable income or exempt income of the company; and

(b) to include in the assessable income of a resident company that part of its income and capital gains derived through a branch in a foreign country that is comparable to the amounts that would be included in an attributable taxpayer's assessable income for income and capital gains derived by a CFC resident in the same foreign country; and

(c) to get the same outcomes where one or more partnerships or trusts are interposed between a resident company and a foreign branch.

Relevantly, 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.

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 a resident company notwithstanding that it may have satisfied all the conditions in subsection 23AH(2).

Further, subsection 23AH(10) states:

This section applies to any indirect interest (through one or more partnerships or trust estates) of a company in foreign income derived by a partnership or trustee through a PE of the partnership or trustee in a listed country or unlisted country as if that indirect interest were foreign income derived by the company through a PE of the company in that country.

In effect, subsection 23AH(10) extends the branch profit exemption provided by subsection 23AH(2) to relevant foreign income derived by resident company through interposed partnerships and trusts. Section 23AH(11) operates in the same way in relation to foreign branch capital gains or capital losses.

Conditions under subsection 23AH(2)

To qualify for the exemption in subsection 23AH(2), the taxpayer must be a resident company and the company must, at a time when it is a resident, derive foreign income in carrying on a business at or through a permanent establishment (PE) of the company, in a listed or unlisted country.

It has been determined that Country B is a listed country. However, Company A does not conduct a business at or through a PE of Company A in Country B. On the facts, Company A has an interest in the Fund which derives investment income from its interest in Company B1 and Company B2 in Country B. Company A has an indirect interest in Company B2 which is the entity that derives net rental income from the lease of the Rental Property in Country B.

Resident company

For the purpose of section 23AH, a company does not include a company in the capacity of a trustee (subsection 23AH(15)). Paragraph (b) of the definition of 'resident' in subsection 6(1) provides three alternative tests for the determination of the residence of a company.

As Company A is incorporated in Australia, and is not a trustee of a trust, it is an Australian resident company for the purpose of section 23AH.

Foreign income

Subsection 23AH(15) defines the term 'foreign income' to include an amount that:

(a) apart from this section, would otherwise be included in assessable income under a provision of this Act other Part 3-1 or 3-3 of the Income Tax Assessment Act 1997 (CGT); and

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

The nature of Company A's interest in the Fund is an interest in a foreign hybrid for the purpose of Division 830 of the ITAA 1997. Therefore, Company A will be deriving foreign income in the form of a partnership distribution from the Fund which is attributed to sources in Country B.

According to the Fund's financial statement, the only income derived by the Fund is described as 'net rental income'. As explained later in this report under the heading 'active income test', for Australian tax law purposes, the income derived by the Fund from its investment in fiscally transparent entities in Country B is in the nature of dividend income.

Company A's share of partnership distribution from the Fund is ordinary income for the purpose of subsection 6-5(2) of the ITAA 1997, and is foreign income as defined in section 23AH(15).

Permanent establishment (PE)

The term PE in relation to a listed country is defined in subsection 23AH(15) which relevantly states:

(a) if there is a double tax agreement in relation to that country - has the same meaning as in the double tax agreement; or

(b) in any other case - has the meaning given by subsection 6(1).

As there is a tax treaty between Australia and Country B, it is necessary to consider the applicable agreement as defined in section 3AAA or section 3AAB of the International Tax Agreements Act 1953 (Agreements Act).

The relevant agreement is the AB Convention.

The Permanent Establishment Article of AB Convention defines the term PE.

The ATO's view in respect to interpreting tax treaties is contained in Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's double tax agreements (TR 2001/13). In Thiel v. FCT (1990) 171 CLR 338; 90 ATC 4717; 21 ATR 531, the High Court accepted that the Model and the Commentaries on the Articles of the OECD Model (the OECD Commentary) may be relevant to the interpretation of tax treaties based on the OECD Model. In that case, the High Court approved recourse to the OECD Model and the Commentaries under Article 32 of the Vienna Convention (see paragraph 102 of TR 2001/13).

Paragraph 2 of the OECD Commentary on Article 5 of the OECD Model Tax Convention (Condensed version 2010) explains that the general definition of a PE contains the following conditions:

• the existence of a 'place of business' (i.e. a facility such as premises or, in certain instances, machinery or equipment);

• this place of business must be 'fixed' (i.e. it must be established at a distinct place with a certain degree of permanence);

• the carrying on of the business of the enterprise through this fixed place of business.

The OECD Commentary on Article 5 of the OECD Model Tax Convention further explains that a 'place of business' covers any premises, facilities or installations used for carrying on the business of an enterprise, whether owned, rented or otherwise at the disposal of the enterprise. A 'place of business' has to be 'fixed' in that there has to be a link between the place of business and a specific geographical point. Additionally, the place of business must have a certain degree of permanency.

Accordingly, where the business activities carried on by an enterprise are often moved between neighbouring locations, it needs to be determined whether the activities constitute a single place of business that satisfies the requirements of being a fixed place of business. Alternatively, it needs to be determined whether each location when considered separately will satisfy the requirements of a fixed place of business.

There is no definite rule as to what constitute a length of time in order satisfy the definition of a PE however according to 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? (TR 2002/5) at paragraph 33:

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 or more that place will be temporally permanent.

Both geographical and temporal permanence are considered in TR 2002/5. Geographical permanence implies a commercial place of business (such as an office or a factory), and temporal permanence implies the operation of the business for a period of time (a guide of six months is given, subject to fact and degree).

On the facts as provided, the business of the Fund is the investment in fiscally transparent entities in Country B. The Fund's principal office and place of business is located in an office in Country B, and the business of the Fund is conducted by the Company GP at this office. Whilst Company GP may change the location of this office and establish additional offices pursuant to the Partnership Agreement, Company A advised that Company GP:

• has conducted the business of the Fund at the office in Country B continuously since the business commenced; and

• will continue to operate the business at this fixed location during the relevant income years subject to this ruling.

In these circumstances, it is considered that the Fund has a PE in Country B for the purpose of the Permanent Establishment Article of AB Convention.

Carrying on a business at or through a PE in a listed country

Subsection 23AH(2) expressly requires that the relevant income be derived by a company that is 'carrying on a business' at or through the PE of the company.

Whilst subsection 23AH(10) deems a taxpayer to derive foreign income at or through a PE of the company in a listed or unlisted country, it does not explicitly deem the taxpayer to 'carry on business' at or through that PE. In this context, paragraph 12 of Taxation Ruling TR 2014/3 Income tax: Satisfying the 'carrying on a business at or through a permanent establishment' requirement in section 23AH of the Income tax Assessment Act 1936 where a company is taken to have a permanent establishment (PE) in relation to substantial equipment state that the principles set out in paragraphs 5 to 11 of that ruling are to be applied when considering whether the foreign income derived by the trustee or partnership, was derived in carrying on a business at or through a PE of the trustee or partnership.

Whether a company derives foreign income in carrying on a business at or through a PE is a question of fact and degree, and is determined having regards to the circumstances of each particular case (paragraph 9 of TR 2014/3).

The definition of 'business' for income tax purposes is wide and includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee (subsection 995-1(1) of the ITAA 1997).

The principles in Taxation Ruling TR 97/11 Income tax: Am I carrying on a business of primary production (TR 97/11) provide guidance on whether a taxpayer is carrying on a business and can be applied in various contexts. Specifically, paragraph 18 of TR 97/11 provides a list of indicators that are relevant in determining whether a taxpayer is carrying on a business. In general, the indicators are:

• significant commercial purpose or character;

• purpose and intention to engage in business;

• intention of profit, as well as a prospect of profit from the activity;

• repetition and regularity of the activity;

• activity is carried on in a similar manner to that of the ordinary trade

• activity organised and carried on in a businesslike manner;

• size and scale of the activity; and

• not a hobby, recreation or sporting activity.

No one indicator is decisive but rather different indicators must be considered in combination and as a whole. The question of whether a business is being carried on is determined in an objective manner based on the weighing up of all the relevant facts and circumstances of each case.

The Partnership Agreement describes the purpose or business of the Fund.

Company B2 is the legal owner of the Rental Property and its primary purpose is to invest, hold and lease this property. Further, the Fund's Country B Tax Return describes the activities of the Fund as investing in fiscally transparent entities, Company B1 and Company B2 in Country B. In these circumstances, it is concluded that the business of holding and leasing the Rental Property is conducted by Company B2, the legal owner of the property.

Based on the facts of this case as assessed against the indicators of carrying on of a business outlined in TR 97/11, the primary business of the Fund is the investment in fiscally transparent entities, Company B1 and Company B2 in Country B. The business of the Fund is conducted by Company GP at the fixed office in Country B. The day-to-day management of the business is conducted by Company GP in Country B and not in Australia. The activities undertaken by Company GP pursuant to the Partnership Agreement are considered to be systemic, commercial and businesslike.

Having considered the Partnership Agreement and the Fund's Country B Tax Return, there is a clear commercial purpose of the Fund to invest in fiscally transparent entities in Country B to derive investment income, principally in the form of rental real estate income, for distribution to the partners. Other types of investment income that will be derived by the Fund from its investment activities in Country B are described in the Partnership Agreement. Further, pursuant to the Partnership Agreement, the Fund also maintains relevant records and financial statements to record the business and affairs of the Fund.

There is a clear intention to derive income from the Fund's investment activities, indicating that the activity is organised and carried out in a businesslike manner with the intention or prospect of deriving profit or gain for the Partners. In these circumstances, the Fund's investment in fiscally transparent entities in Country B is not considered to be a hobby, recreation or sporting activity.

Application of subsection 23AH(10)

In ATO Interpretative Decision ATO ID 2011/35 Income tax: Permanent establishment of a US limited liability company (ATO ID 2011/35), a taxpayer's share of business income derived through a PE of a US LLC that was treated as a foreign hybrid for Australian income tax purposes, was considered to be NANE income under section 23AH. In reaching this conclusion, the ATO stated that subsection 23AH(10) will apply where:

• the taxpayer has an indirect interest (through the US LLC as a partnership) in foreign income; and

• the foreign income is derived by the US LLC at or through a PE of the US LLC in a listed or unlisted country.

It is further stated in ATO ID 2011/35 that:

… Although subsection 23AH(10) of the ITAA 1936 deems the taxpayer to derive income at or through a PE of the US LLC, it does not explicitly deem the taxpayer to carry on business through that PE.

However, paragraph 23AH(1)(c) of the ITAA 1936 provides that the interposition of a partnership or trust between a resident company and a PE should not prevent the exemption from applying in circumstances where it would apply if the PE was held directly by the resident company. Accordingly, where the partnership has derived foreign income in carrying on a business at or through a PE, subsection 23AH(10) of the ITAA 1936 has the effect that section 23AH applies as though the resident company was placed in the shoes of the partnership.

The ATO's interpretation in ATO ID 2011/35 accords with the intention as expressed in paragraph 2.39 of the Explanatory Memorandum to the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004, which introduced the current version of section 23AH:

The general principle is that the amounts that are included in assessable income of a resident company are the amounts that would have been included had the business of the permanent establishment been carried on directly by the resident company taking into account the company's actual portion of the income. Further, the net income of a trust or partnership in relation to a resident company will not include the permanent establishment income that would not have been assessable nor exempt income if the company had derived that permanent establishment income directly.

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 7) 2003 (EM to the amending Bill) also suggests that this treatment was intended to apply where companies derive income indirectly from a PE via an interposed foreign hybrid entity. In discussing the operation of section 830-75 of the ITAA 1997, paragraphs 9.49 and 9.50 of that EM to the amending Bill indicate that section 23AH is intended to apply to taxpayers making a capital gain or loss indirectly via an interest in a foreign hybrid:

9.49 ... In this case, the capital gain will be treated for the purposes of section 23AH and Part X of the ITAA 1936 as having been subject to tax in a listed country when the deemed disposal took place. Subject to the other conditions in section 23AH being met, any capital gain made by an Australian company member of the foreign hybrid will be exempt from Australian tax at that time. Any capital loss will be ignored in the same circumstances. ...

9.50 Where there is an actual disposal of some or all of an existing partner's/member's interest in the foreign hybrid resulting in a capital gain, and the gain is subject to tax in a listed country, the capital gain under Australian law will be treated as being subject to tax in the listed country at that time. This again may result in the gain being exempt, or a loss ignored, under section 23AH ...

It is concluded in ATO ID 2011/35 that the effect of subsection 23AH(10) is to deem the taxpayer to have derived foreign income in carrying on business at or through a PE for the purpose of subsection 23AH(2).

As stated previously, the Fund's business is investing in fiscally transparent entities in Country B. This business is conducted by Company GP at or through a fixed place of business, the office in Country B. As the dual conditions of 'carrying on a business' and 'through a fixed place' are present, the definition of PE as contained in the Permanent Establishment Article of AB Convention are satisfied.

Applying the principles in ATO ID 2011/35 and subsection 23AH(10), the Fund's business of investing in fiscally transparent entities in Country B, conducted by Company GP at the fixed office in Country B, is treated as if Company A is carrying on that business at that PE for the purpose of subsection 23AH(2).

It is concluded that Company B has a PE in the Country B for the purpose of the Permanent Establishment Article of AB Convention, and the company derives foreign income in carrying on an investment business at the PE of the company in Country B for the purpose of subsection 23AH(2).

Exception: Listed country PE

Subsection 23AH(5) provides that subsection 23AH(2) will not apply to foreign income derived by the company where:

• the PE is in a listed country;

• the PE does not pass the active income test; and

• the foreign income is both adjusted tainted income and eligible designated concession income (EDCI) in relation to a listed country.

All three conditions must apply before subsection 23AH(5) operates to exclude the application of subsection 23AH(2).

Active income test

The active income test is defined in subsection 23AH(12). The test adopts the active income test in section 432 and requires certain assumptions in subsection 23AH(14) to be made. The relevant assumptions in this case are that the only income derived by the Fund are the income derived in carrying on business at or through the PE of the partnership and the entity's statutory accounting period is the same as its year of income.

Generally, each period of 12 months finishing at the end of 30 June is the statutory period of a company (subsection 319(1)).

The active income test in section 432 requires, amongst other things, that the tainted income ratio of the company for the statutory accounting period is less than 0.05.

The tainted income ratio is defined in section 433 to mean the company's 'gross tainted turnover' divided by the company's 'gross turnover' of the statutory accounting period and is required to be less than 0.05.

Goss tainted turnover includes passive income, tainted sales income and tainted services income (section 435).

Passive income include amongst others, dividends (within the meaning of section 6), tainted interest income, tainted rental income, tainted royalty income, income derived from carrying on a business of trading in tainted assets and net gains in respect of the disposal of tainted assets (subsection 446(1)).

Dividends include any distribution made by a company to any of its shareholders, whether in money or other property, and any amount credited to any of its shareholders as shareholders (subsections 6(1) and 44(1)).

The nature of the Fund's sole income is a distribution of net rental income derived by way of investment in fiscally transparent entities in Country B. Whilst Company B applies a look-through approach to treat the net rental income derived by Company B2 as that of the Fund, this treatment does not apply under Australian tax law.

The only income derived by the Fund is from the investment in fiscally transparent entities in Country B. Company B1 and Company B2 are both treated as companies for Australian tax law purposes. Therefore, any distribution of income described by the Fund as net rental income derived from the leasing of the Real Property by Company B2 (or any other income derived by Company B2) is treated as a distribution of a dividend (see subsections 6(1) and 44(1)) to the Fund under Australian taxation laws.

In these circumstances, the income derived by the Fund by way of investment in fiscally transparent entities in Country B, is considered to be income in the nature of a distribution of dividends from fiscally transparent entities in Country B, and is passive income for the purpose of the active income test. Additionally, other investment income described in the Partnership Agreement is also passive income as defined in subsection 446(1).

On this basis, it is considered that the Fund fails the active income test as the tainted income ratio of the Fund would exceed 0.05 for all relevant income years covered by this ruling.

Adjusted tainted income

For a PE in a listed country, where the active income test is not passed, the exemption provided in section 23AH(2) can still apply providing that the foreign income of the PE is not both adjusted tainted income and EDCI.

The term 'adjusted tainted income' under subsection 23AH(13) is defined in subsection 317(1) as having the meaning given in section 386. The same assumptions for the active income test in subsection 23AH(14) as outlined above also apply.

Section 386 defines adjusted tainted income as being passive income, tainted sales income and tainted services income with certain modifications. These modifications essentially include gross amounts instead of net gains from the disposal of tainted assets and tainted commodity investments, and from currency exchange fluctuations.

It is concluded that the foreign income of the Fund comprise of passive income. Accordingly, the income is also considered to be adjusted tainted income under subsection 23AH(13).

Eligible designated concession income (EDCI)

The term EDCI is defined in subsection 23AH(15) to have the same meaning as in Part X. EDCI in relation to a listed country is 'designated concession income' of the particular listed country.

Broadly, subsection 317(1) defines 'designated concession income' in relation to a listed country as income or profits of a kind specified in the regulations, where no foreign tax is payable or reduced tax is payable because of a feature of the tax law of the foreign country specified in the regulations.

The specific types of DCI in relation to Country B are set out in the table in regulation 17 of the ITR 2015 (formerly the table in schedule 9 to the ITR 1936 for income years prior to 2015/16).

The Fund does not derive any designated concession income.

In these circumstances, subsection 23AH(5) does not operate to exclude the application of subsection 23AH(2) in respect of Company A's share of net rental income.

Accordingly, as all of the condition in subsection 23AH(2) are satisfied, Company A's share of the net rental income is non-assessable and non-exempt income.

Question 2

For the purpose of ruling question 2, Company A asked for a ruling to be based on the assumption that during the relevant income years covered by this ruling, Company B2 will sell the Rental Property in Country B and will derive a capital gain from the sale of this property.

Subsections 23AH(3) apply to capital gains from CGT events occurring in income years starting on or after 1 July 2004. Relevantly, subsection 23AH(3) states:

Subject to this section, a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 if:

(a) the gain is made by a company that is a resident; and

(b) the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country; and

(c) the asset is not taxable Australian property.

For a PE in a listed country, subsection 23AH(6) provides that the exemption in subsection 23AH(3) will not apply to a capital gain where the gain is both from a tainted asset and is EDCI in relation to the listed country.

For Australian tax law purposes, section 104-10 of the ITAA 1997 states that CGT event A1 happens when a taxpayer disposes of a CGT asset. A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property. The note to subsection 108-5(2) of the ITAA 1997 specifically refers to land and buildings as an example of a CGT asset.

The CGT asset which is the object of this ruling is the Rental Property located in Country B. However, as stated as a fact, the Rental Property is owned by Company B2. Therefore, a gain made from the disposal of this property is derived by Company B2, and not the Fund itself.

As such, the relevant exemption that applies in respect of Company A's share of capital gains, to be made from the disposal of the Rental Property in Country B is subsection 23AH(2) rather than subsection 23AH(3).

For the same reasons as outlined in question 1 of this ruling, the Fund's business is the investment in fiscally transparent entities in Country B, Company B1 and Company B2. As Company B1 and Company B2 are both treated as companies for Australian tax law purposes, any distribution of capital gain from the sale of the Rental Property by Company B2, that flows -through to the Fun, is treated as a distribution of dividend income (see subsections 6(1) and 44(1)) for the purpose of Australian taxation laws.

As determined in question 1 of this ruling, subsection 23AH(10) applies such that, Company A has a PE in Country B for the purpose of the Permanent Establishment Article of AB Convention, and the company derives foreign income in carrying on an investment business at the PE of the company in Country B for the purpose of subsection 23AH(2). On the facts, as the income of the Fund is not both adjusted tainted and EDCI, subsection 23AH(5) does not operate to exclude the application of subsection 23AH(2).

On this basis, Company A's share of capital gains, to be made in respect of the disposal of the Rental Property in Country B by Company B2, is in the nature of a partnership distribution of investment income derived by the Fund, and is non-assessable, non-exempt income under subsection 23AH(2).