Edited version of private advice

Authorisation Number: 1051570683369

Date of advice: 23 August 2019

Ruling

Subject: Permanent establishment

Question

Does the foreign entity have a permanent establishment in Australia in relation to the activities pursuant to Article 5(1) of the Country X Double Taxation Agreement (Country X Agreement)?

Answer

Yes.

This ruling applies for the following periods:

The relevant income tax years

The scheme commences on:

A relevant time

Relevant facts and circumstances

The Foreign Entity is a resident of Country X for income tax purposes.

The Head Contract

An Australian Head Contractor has been engaged by an Australian Customer for the development of a project (the Project).

It was agreed that the Head Contractor could subcontract the whole or any part of the services to subcontractors. The Head Contractor shall be liable for the act, defaults and omissions of the subcontractors and employees and agents of the subcontractors as if they were acts or omission of the Head Contractor.

The Subcontract

The Head Contractor has subcontracted some of the work to the Foreign Entity.

It was agreed that the Foreign Entity shall assume toward the Head Contractor all rights and obligations that the Head Contractor assume toward the Australian Customer under the Head Contract.

The Foreign Entity sent its employee Y to Australia to oversee the implementation of the services under the Head Contract.

Y did not sign or negotiate contracts and did not have the authority to sign or negotiate contracts on behalf of the Foreign Entity. Y's role did not involve the use of substantial equipment.

Y either worked out of the Head Contractor's office, the Project site or Y's home office in Australia.

The Sub-subcontract

After working in Australia for a certain period, Y ceased to be the employee of the Foreign Entity and formed a company in Australia (the Sub-subcontractor). The Foreign Entity contracted the Sub-subcontractor owned by Y to provide the services formerly provided by Y as an employee of the Foreign Entity. These services were then provided by Y.

There was no substantial change to the work performed by the Sub-subcontractor from that which Y performed as an employee. Under the agreement, neither Y nor Sub-subcontractor has the authority to sign or negotiate contracts on behalf of the Foreign Entity.

The Sub-subcontractor has continued to work out of the Australian Head Company's office, the Project site and Y's home office in Australia.

Reasons for decision

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a non-resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year.

When determining whether Australia has a taxing right in respect of income derived in Australia by a foreign resident company, we must also consider the International Tax Agreements Act 1953 (Agreements Act).

Subsection 4(1) of the Agreements Act incorporates the Income Tax Assessment Act 1936 (ITAA 1936) and ITAA 1997 so that those Acts are read as one with the Agreements Act. Subsection 4(2) of the Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited situations).

The Agreements Act gives the Country X Agreement the force of law in Australia.

Article 7 of the Country X Agreement governs the taxation of business profits derived from Australia by a resident of the Country X. Under Article 7 of the Country X Agreement, the business profits of an enterprise of the Country X shall be only taxable in the Country X unless the enterprise carries on business in Australia through a permanent establishment situated in Australia. If so, the profit of the enterprise that is attributable to that permanent establishment in Australia may be taxed in Australia.

The term 'permanent establishment' is defined in Article 5 of the Country X Agreement.

Article 5 of the Country X Agreement contains a list of examples that each may be regarded as constituting a permanent establishment.

In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4714; (1990) 21 ATR 531 (Thiel), the High Court accepted that the OECD Commentaries may be referred to when interpreting tax treaties in accordance with Article 32 of the Vienna Convention (See paragraph 90 of Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements).

The Commissioner has also expressed the view at paragraph 18 of 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? that it is appropriate to take into account the commentary text when interpreting the definition of permanent establishment in subsection 6(1) of the ITAA 1936.

On 21 November 2017, the OECD Council approved the contents of the 2017 Update to the OECD Model Tax Convention (OECD Commentary). Paragraph 44 of the OECD Commentary on Article 5 affirms that:

A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a fixed place of business. This is the case once the enterprise prepares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the enterprise should not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently

On this basis, the definition of a 'permanent establishment' contains three conditions (as outlined in paragraph 6 of the OECD Commentary on Article 5):

·         the existence of a 'place of business',

·         this place of business must be fixed, and

·         the business of the enterprise is, wholly or partly, carried on through this fixed place of business.

Existence of a 'place of business'

The OECD Commentary on Article 5 relevantly states at paragraph 10 that -

The term "place of business" covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose... It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise...

Paragraph 20 of the OECD Commentary on Article 5 goes on to state -

The words "through which" must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business "through" the location where this activity takes place

The services required to be performed by the Foreign Entity under the contract with the Australian Head Contractor were performed at the Head Contractor's offices, the Project site or Y's home office in Australia. It is necessary to consider whether each of these locations constitute a fixed place of business of the Foreign Entity.

It is considered that Australian Head Contractor's offices will be a 'place of business' for the Foreign Entity as the offices are at the disposal of the Foreign Entity as the offices are used by Y both as an employee, and as a subcontractor, of the Foreign Entity in performing the services required under the contract between the Foreign Entity and the Australian Head Contractor. The Foreign Entity remains responsible for the performance of all services under the contract with the Head Contractor and in determining whether a place of business exists it does not matter whether those services are performed through the use of the Foreign Entity's own employees or through a subcontracting arrangement.

In considering whether the construction site will be a 'place of business' in circumstances where subcontracting arrangements are used, paragraph 54 of the OECD commentary on Article 5 provides the following guidance:

54. A site exists from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established, e.g. if he installs a planning office for the construction. If an enterprise (general contractor) which has undertaken the performance of a comprehensive project subcontracts all or parts of such a project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as being time spent by the general contractor on the building project for purposes of determining whether a permanent establishment exists for the general contractor. In that case, the site should be considered to be at the disposal of the general contractor during the time spent on that site by any subcontractor where circumstances indicate that, during that time, the general contractor clearly has the construction site at its disposal by reason of factors such as the fact that he has legal possession of the site, controls access to and use of the site and has overall responsibility for what happens at that location during that period. The subcontractor himself has a permanent establishment at the site if his activities there last more than twelve months.

Therefore, the Project site will be a place of business for the Foreign Entity, as the business of the Foreign Entity is (at least partly) being undertaken at the site, either by use of the Foreign Entity's employees or through the subcontracting arrangement.

When considering whether an employee's home office will be the employer's 'place of business' and therefore constitute a permanent establishment of the employer, the OECD commentary on Article 5 provides the following guidance:

11. ... Whether a location may be considered to be at the disposal of an enterprise in such a way that it may constitute a "place of business through which the business of [that] enterprise is wholly or partly carried on" will depend on that enterprise having the effective power to use that location as well as the extent of the presence of the enterprise at that location and the activities that it performs there....

18. Even though part of the business of an enterprise may be carried on at a location such as an individual's home office, that should not lead to the automatic conclusion that that location is at the disposal of that enterprise simply because that location is used by an individual (e.g. an employee) who works for the enterprise. Whether or not a home office constitutes a location at the disposal of the enterprise will depend on the facts and circumstances of each case. In many cases, the carrying on of business activities at the home of an individual (e.g. an employee) will be so intermittent or incidental that the home will not be considered to be a location at the disposal of the enterprise (see paragraph 12 above). Where, however, a home office is used on a continuous basis for carrying on business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to use that location to carry on the enterprise's business (e.g. by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office), the home office may be considered to be at the disposal of the enterprise.

19. A clear example is that of a non-resident consultant who is present for an extended period in a given State where she carries on most of the business activities of her own consulting enterprise from an office set up in her home in that State; in that case, that home office constitutes a location at the disposal of the enterprise. Where, however, a cross-frontier worker performs most of his work from his home situated in one State rather than from the office made available to him in the other State, one should not consider that the home is at the disposal of the enterprise because the enterprise did not require that the home be used for its business activities. It should be noted, however, that since the vast majority of employees reside in a State where their employer has at its disposal one or more places of business to which these employees report, the question of whether or not a home office constitutes a location at the disposal of an enterprise will rarely be a practical issue. Also, the activities carried on at a home office will often be merely auxiliary and will therefore fall within the exception of paragraph 4.

In this case, when Y was an employee, the home office was used on a continuous basis for carrying on business activities for the Foreign Entity. It was clear from the facts and circumstances that the Foreign Entity was expecting that work to be performed at the home office of Y in Australia. This expectation did not change upon commencement of the subcontracting arrangement with the Sub-subcontractor, it was understood that the home office of Y would continue to be used to perform services for which the Foreign Entity remained responsible under the contract between the Foreign Entity and the Head Contractor. The home office of Y thus constitutes a place of business for the Foreign Entity while being used by the Foreign Entity employees and while used under the subcontracting arrangements.

The place of business must be fixed

The second requirement in the treaty definition, which also features in the administration of subsection 6(1), is that the place of business be "fixed". The Commissioner has ruled that where the phrase appears in the subsection 6(1) definition of permanent establishment, 'a place at or through which [a] person carries on any business' must be a place that has an element of permanence, both geographic and temporal: paragraph 9 of Taxation Ruling TR 2002/5. It is explained further in that ruling that for geographic permanence an area, viewed commercially and as a whole may, in relation to a business concerned, be a place.

Paragraph 21 of the OECD Commentary on Article 5 defines 'fixed' as -

According to the definition, the place of business has to be a "fixed" one. Thus in the normal way there has to be a link between the place of business and a specific geographical point...

Paragraph 28 of the OECD Commentary on Article 5 relevantly states that -

Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency, i.e. if it is not of a purely temporary nature. A place of business may, however, constitute a permanent establishment even though it exists, in practice, only for a very short period of time because the nature of the business is such that it will only be carried on for that short period of time...

In this case, the fact that the services being performed under the contract are being undertaken at different fixed places in Australia does not affect the requirement for each place of business to be fixed.

The Commissioner is satisfied that the Project site, the Head Contractor's office and Y's home office are fixed places of business for the Foreign Entity.

The business of the enterprise is carried on through this fixed place of business

In this case, Y was an employee of the Foreign Entity in Australia for a period of time.

Paragraph 39 of the OECD Commentary on Article 5 states:

There are different ways in which an enterprise may carry on its business. In most cases, the business of an enterprise is carried on by the entrepreneur or persons who are in a paid-employment relationship with the enterprise (personnel).

During this period Y was in Australia to perform business activities that clearly belong to the business of the Foreign Entity.

After that, the Foreign Entity entered into the Sub-subcontract with the Sub-subcontractor to fulfil the Foreign Entity's Subcontract with the Head Contractor.

Paragraph 40 of the OECD Commentary on Article 5 relevantly states -

An enterprise may also carry on its business through subcontractors, acting alone or together with employees of the enterprise. In that case, a permanent establishment will only exist for the enterprise if the other conditions of Article 5 are met (this, however, does not address the separate question of how much profit is attributable to such a permanent establishment). In the context of paragraph 1, the existence of a permanent establishment in these circumstances will require that these subcontractors perform the work of the enterprise at a fixed place of business that is at the disposal of the enterprise. Whether a fixed place of business where subcontractors perform work of an enterprise is at the disposal of that enterprise will be determined on the basis of the guidance in paragraph 12; in the absence of employees of the enterprise, however, it will be necessary to show that such a place is at the disposal of the enterprise on the basis of other factors showing that the enterprise clearly has the effective power to use that site, e.g. because the enterprise owns or has legal possession of that site and controls access to and use of the site. Paragraph 54 illustrates such a situation in the case of a construction site; this could also happen in other situations. An example would be where the enterprise that owns a small hotel and rents out the hotel's rooms through the Internet has subcontracted the on-site operation of the hotel to a company that is remunerated on a cost-plus basis.

Paragraph 40 of the OECD Commentary on Article 5 recognises that an enterprise may carry on its business through subcontractors, either acting alone or together with employees of the enterprise. It is irrelevant whether the enterprise uses employees to undertake work in Australia or subcontracts the work to others, either wholly or in part. That is, an enterprise cannot subcontract out of a permanent establishment in Australia where the other conditions of Article 5 are met.

In this case, pursuant to the Subcontract, the Foreign Entity continues to be liable for its obligations under the Subcontract as well as being liable for the acts and omissions of the Sub-Subcontractor and any of its personnel as if those acts or omissions were the Foreign Entity. That is, the work of the Sub-subcontractor is the work of the Foreign Entity under the Subcontract.

The Foreign Entity, as a Subcontractor, is considered to have carried on the activities through the Sub-subcontractor. Accordingly, the Foreign Entity is considered to have carried on the delivery of services as required by the Subcontract, under Article 5(1) of the Country X Agreement.

Conclusion

The Foreign Entity has a Permanent Establishment in Australia under Article 5(1) of the Country X Agreement for the obligations contained in the Subcontract. This is because the Foreign Entity, through sending its employee to work in Australia or a sub-subcontract arrangement with the Sub-subcontractor, is carrying on its business through the fixed places of business made available in Australia.