Edited version of your written advice

Authorisation Number: 1051409974099

Date of advice: 3 August 2018

Ruling

Subject: Withholding tax on interest paid to a non-resident

Question

Are you liable to withholding tax on interest paid by you to a non-resident pursuant to sub-paragraph 128B(2)(b)(ii) of the Income Tax Assessment Act 1936?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ending 30 June 2019

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You are incorporated in a country other than Australia.

Your officeholders

You have a director that:

n sets the policy of your operations

n actively oversees and controls the day-to-day operations of your business

n maintains oversight of your affairs

n appoints and revokes company officers or agents, and grants them power to carry on the company’s activities.

This director is not a resident of Australia for tax purposes.

Your governing body meets in a country other than Australia and all shareholder meetings are held in that country.

Your members

All shares on issue are ordinary shares. Each share carries the same rights. The majority of shares are not held by an Australian resident shareholder.

The Property

You own property (‘the Property’).

You acquired the Property for the purposes of receiving rental income and making a capital gain when you dispose of the property.

A non-resident person loaned you money in relation to your acquisition of the Property. Interest is payable on this loan.

The non-resident person that loaned you money is not a resident of Australia for tax purposes.

The property is managed by a third party real estate agent. You offer for the property for rent to tenants.

Relevant legislative provisions

Subsection 6(1) of the Income Tax Assessment Act 1936

Sub-paragraph 128B(2)(b)(ii) of the Income Tax Assessment Act 1936

Reasons for decision

Sub-paragraph 128B(2)(b)(ii) of the Income Tax Assessment Act 1936 (‘ITAA 1936’) imposes withholding tax on interest paid to a non-resident by another non-resident if the interest is an outgoing incurred by the payer in carrying on a business at or through a permanent establishment in Australia.

Sub-paragraph 128B(2)(b)(ii) raises two key considerations in determining whether you will be liable to withholding tax on interest paid to a non-resident:

1. Are you a resident of Australia for tax purposes?

2. Is the interest you pay to the non-resident person an outgoing incurred in carrying on a business in Australia through a permanent establishment in Australia?

Issue 1: Resident of Australia

A company is a resident of Australia if:

● it is incorporated in Australia, or

● although not incorporated in Australia it carries on business in Australia and has either

● its central management and control in Australia

● its voting power controlled by shareholders who are residents of Australia: subsection 6(1) of the ITAA 1936.

Are you a resident of Australia?

In your case, you are incorporated in a country other than Australia. Consequently. whether you are a resident of Australia or not turns to whether you carry on business in Australia, and if so, whether your:

● central management and control is in Australia, or

● your voting power is controlled by Australian resident shareholders.

Carrying on a business

Taxation Ruling TR 97/11 highlights that case law has shown it is not possible to definitively state whether a person is carrying on a business, and whether a company is carrying on a business cannot be determined by one factor alone.

Whether the activities of a company constitute carrying on a business is a question of fact, and must be answered after considering the company’s circumstances and activities, having regard to the indicia of carrying on a business.

There is extensive case law in considering whether a company is carrying on a business. Companies have an underlying commercial nature that indicate the same activities carried on by a company are more likely to amount to the carrying on of a business than if they were carried by out an individual or a trust.¹

The indicia considered by the courts in determining whether activities carried on by a person amount to the carrying of a business are:

● the nature of the activities and whether they have a profit-making purpose;

● whether the person intends to carry on a business;

● whether the activities are:

○ repeated and regular;

○ organised in a business-like manner;

● the amount of capital employed in the activities; and

● whether the activity is better described as a hobby or recreation.

Where the activities of a company have a commercial nature or purpose and are conducted in a commercially viable manner, they are likely to be carrying on a business. Furthermore, as set out in Taxation Ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?, companies are typically formed for the purpose of carrying on a business.

Consequently, the activities of a company may have a fundamentally different character to those of an individual. The courts have observed that activities such as receiving rent from property will not result in the presumption that an individual is carrying on a business, whereas it would for a company, ² and it would be difficult to displace the prima facie inference that the gainful use of a company’s property in letting it out for rent would constitute the carrying on of a business.³

In Lilydale Pastoral Co. Pty. Ltd. v FCT,⁴ Pincus J held that the purchase of property to rent out, and the proprietorship of that property, constitute an undertaking of a business or commercial kind.

Are you carrying on a business?

In your case, you currently own property. You specifically purchased the Property with a view to earning rental income. You have rented this property to tenants and have engaged the services of a property manager to do so.

As you are a company with the intention of deriving income, making a gain from your assets, and are currently undertaking the profit-making activity of renting property, in accordance with the principles outlined in TR 2017/D7, we consider that you are carrying on a business in Australia.

Central management and control

Central management and control is the control and direction of a company’s operations. This is different to the day-to-day conduct and management of a company’s activities and operations. The key element is the making of high-level decisions that set the company’s policies and determine the direction of its operations and the type of transactions it will enter.

Normally, a company is run and managed by its directors. In your case, you have four appointed directors. However, a person who has legal power or authority to control and direct a company, but does not use it, does not exercise central management and control.

Your appointed director is the sole person who makes decisions pertaining to your policies and direction of your operations. This director alone determines what transactions you will enter into.

This director does not reside in Australia and is not a resident of Australia for tax purposes. Consequently, your central management and control is not in Australia.

Voting power

As less than 50% of your shares on issue are held by Australian tax resident shareholders, your voting power cannot be considered to be ‘controlled by shareholders who are residents of Australia’ under the definition of ‘resident’ in subsection 6(1) of the ITAA 1936.

Overall

Although you are carrying on a business in Australia, your central management and control is not in Australia, nor is your voting power controlled by Australian tax resident shareholders. Therefore, you are not a resident of Australia for tax purposes.

Issue 2: Outgoing incurred in carrying on a business through a permanent establishment

For the reasons expressed above, it has been established that you are carrying on a business in Australia.

The interest payable to the non-resident person is an outgoing incurred in carrying on that business, as the interest payable arises from a loan ultimately used to finance the acquisition of the Property.

However, subparagraph 128B(2)(b)(ii) also requires that the carrying on of the business in Australia be ‘at or through a permanent establishment of that person or those persons in Australia’.

Subsection 6(1) of the ITAA 1936 defines permanent establishment as follows:

'permanent establishment', in relation to a person (including the Commonwealth, a State or an authority of the Commonwealth or a State), means a place at or through which the person carries on any business and, without limiting the generality of the foregoing, includes:

a) a place where the person is carrying on business through an agent;

b) a place where the person has, is using or is installing substantial equipment or substantial machinery;

c) a place where the person is engaged in a construction project; and

d) where the person is engaged in selling goods manufactured, assembled, processed, packed or distributed by another person for, or at or to the order of, the first-mentioned person and either of those persons participates in the management, control or capital of the other person or another person participates in the management, control or capital of both of those persons - the place where the goods are manufactured, assembled, processed, packed or distributed;

but does not include:

e) a place where the person is engaged in business dealings through a bona fide commission agent or broker who, in relation to those dealings, acts in the ordinary course of his or her business as a commission agent or broker and does not receive remuneration otherwise than at a rate customary in relation to dealings of that kind, not being a place where the person otherwise carries on business;

f) a place where the person is carrying on business through an agent:

(i) who does not have, or does not habitually exercise, a general authority to negotiate and conclude contracts on behalf of the person; or

(ii) whose authority extends to filling orders on behalf of the person from a stock of goods or merchandise situated in the country where the place is located, but who does not regularly exercise that authority, not being a place where the person otherwise carries on business; or

g) a place of business maintained by the person solely for the purpose of purchasing goods or merchandise.

This definition of permanent establishment is based on the concept of permanent establishments used in Australia’s tax treaties. The definition in subsection 6(1) 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, in this context, should not be taken to mean forever. It must be construed in the context of each particular business.⁵

Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest at paragraph 6 states it could not generally be said that a non-resident has a permanent establishment solely because the non-resident’s property is managed by a real estate agent.

Do you have a permanent establishment in Australia?

The day-to-day management of the Property is carried out by a property manager. Pursuant to IT 2423, we do not consider the property management to lend to a conclusion that you have a permanent establishment in Australia.

Therefore, in light of your circumstances, we do not consider that you have a permanent establishment as defined in subsection 6(1) of the ITAA 1936.

Are you carrying on a business at or through a permanent establishment in Australia?

As discussed earlier, you are carrying on a business in Australia. However, as you do not have a permanent establishment in Australia, you cannot be considered to be ‘carrying on that business at or through a permanent establishment…in Australia’ pursuant to the terms of subparagraph 128B(2)(b)(ii) of the ITAA 1936. As such, interest payable to the non-resident person which is incurred in carrying on the business of the property rental does not fall within the scope of that provision.