Edited version of private advice

Authorisation Number: 1051888955492

Date of advice: 19 August 2021

Ruling

Subject: Section 23AH - non-assessable and non-exempt income

Question

Is the income received by Company X via its subsidiary Company Y in the relevant income year, non-assessable non-exempt income under subsection 23AH(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company Y was incorporated in an unlisted country, it does not maintain a permanent establishment in that country.

Company Y is wholly owned by Company X, an Australian resident company that is the head company of a consolidated group for Australian income tax purposes.

Company Y is an Australian resident for tax purposes, as it is managed and controlled in Australia.

Company Y was incorporated for the specific purpose of acquiring offshore assets.

Company Y currently owns an investment portfolio consisting of financial assets or investments and a residential property in the Country A which is leased via a rental agent based in the Country A.

The rental agent procures tenants, collects rent and actively manages the property on behalf of Company Y.

The Company director signed an agreement with a real estate agency to initially provide a letting and renewal service (letting agreement) and extended this service almost 12 months later to add property management services (management services agreement). The property is let as a long-term, unfurnished rental property.

Letting and renewal service

The services included:

(a)          arranging for prospective tenants to view the property and accompany them on the viewing.

(b)          hold a set of keys to the property until the commencement of the tenancy.

(c)           arrange for an inventory and schedule of condition to be prepared by an inventory firm at the beginning and end of any tenancy.

(d)          arrange for contractors to run gas and electricity tests as required by law.

(e)          conduct visits to the property and provide a written report on the visible condition of the building.

(f)            advise on appropriate rent for the property.

(g)          market the property.

(h)          subject to instruction from the landlord, negotiate and agree on the terms of any tenancy with a suitable prospective tenant.

(i)            prepare the appropriate tenancy agreement based upon information provided by the landlord and prospective tenant and ensure that it is signed by the landlord and tenant.

(j)            obtain references from prospective tenants and provide it to the landlord.

(k)           collect the specified deposit from the tenant to be held in a stakeholder account as security.

(l)            prepare a statement of account and remit the rent paid less fee commission and other appropriate deductions.

The renewal service included:

(a)          contacting the landlord towards the end of the tenancy to ascertain whether the landlord wishes for the tenancy to continue.

(b)          if the landlord elects to renew the tenancy, advise tenants on any increases of rent and negotiate any revised terms of the tenancy agreement.

(c)           once the tenancy agreements are signed by both parties send the documents received to the relevant parties.

Management Services Agreement

The management services included:

(a)          arranging for an inventory to be prepared by an inventory firm and arrange for all necessary gas and electrical appliance repairs, checks, notifications and tests prior to the commencement of the tenancy.

(b)          using appropriate contractors to investigate any defects at the property.

(c)           acting as the landlord's agent, arrange for repairs below the value of a cash float, where the value is above the cash float seek landlord approval on proposed repairs.

(d)          visiting the property not less than twice per year.

(e)          arrange for contractors to attend the property to undertake the repairs on the landlord's behalf.

(f)            the landlord's preferred contractor will be instructed to undertake repairs where the agent can reasonably establish contact with contractor and the contractor can carry out the necessary works within a reasonable time frame.

(g)          act as mediator between landlord and tenant in the event of a dispute relating to damage of property or breach of the tenancy agreement.

(h)          attend court, where required, to give evidence in connection with proceedings or arbitration for a fee for each member, employee or consultant who the landlord requires to attend.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 23AH

Income Tax Assessment Act 1936 subsection 23AH(2)

Income Tax Assessment Act 1936 subsection 23AH(5)

Income Tax Assessment Act 1936 subsection 23AH(15)

Income Tax Assessment Act 1936 Part X of Schedule 10

Income Tax Assessment Act 1936 subsection 320(1)

Income Tax Regulations 1936 subregulation 152C(1)

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

Income Tax Assessment Act 1997 subsection 6-10(4)

Income Tax Assessment Act 1997 subsection 6-15(3)

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

Reasons for decision

Subsections 6-5(2) and 6-10(4) of the Income Tax Assessment Act 1997 (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 income, it is not assessable income.

Subsection 23AH(2) of the ITAA 1936 provides that, subject to this section, foreign income derived by a resident company in carrying on business at or through a permanent establishment (PE) in a listed or unlisted country is non-assessable non-exempt income.

Therefore, in order for the income received by Company X to be non-assessable non-exempt income under subsection 23AH(2) of the ITAA 1936 the following conditions must be satisfied:

•         the income must be foreign income, and

•         the foreign income must be derived in carrying on a business at or through a PE.

Carrying on a business

The term 'business' is defined in subsection 995-1(1) of the ITAA 1997 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee. This definition is not exhaustive and therefore the term 'business' includes any activities that would ordinarily be understood to be a business.

Whilst the term 'business' is defined, the concept of carrying on a business is not defined in either the ITAA 1936 or the ITAA 1997.

Whether a company is carrying on a business is a question of fact to be determined in an objective manner on the specific facts of each case. From the many Court and Tribunal decisions concerning whether a taxpayer is carrying on a business, the following key factors as listed at paragraph 13 in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? have been established and require consideration in determining whether the activities carried on by an entity amounts to the carrying on of a business:

•         whether the taxpayer intends to carry on a business

•         the nature of the activities, particularly whether they have a profit-making purpose

•         the size and scale of the activities and the amount of capital employed in those activities

•         repetition and regularity of the activities

•         whether the activities are being carried on in a systematic and businesslike manner usual for that type of business, and

•         the existence of a business plan.

Further, Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business (TR 2019/1) states that where a profit-making purpose is found to exist, it is likely that the other indices of carrying on a business will support a conclusion that a business is being carried on.

In the case of limited, proprietary limited and no liability companies, the Commissioner accepts that these companies would normally be carrying on a business if they are established and maintained to make a profit for their shareholders and they invest their assets in gainful activities that have both a purpose and prospect of profit.

Company X was incorporated for the specific purpose of acquiring offshore assets, including the current rental property as well as other listed investments of significant value. These investments have resulted in Company X earning regular income and deriving regular profits. Further, these activities have been carried out in a systemic and organised way, accounting records have been maintained and tax returns have been submitted, all with an intention for the shareholders to profit.

Based on the information provided and a consideration of the factors listed above it is the Commissioner's view that Company X is carrying on a business.

Income must be foreign income

The definition of 'foreign income' in subsection 23AH(15) of the ITAA 1936 states that 'foreign income' includes an amount that:

•         apart from section 23AH, would be assessable income under a provision of the ITAA 1936 or the ITAA 1997, and

•         is derived from sources in a listed or unlisted country.

It is necessary to identify if the income is derived in a listed or unlisted country.

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

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

The Country A is listed in Part 1 of Schedule 10 of the Regulations.

The rental income derived by Company X via Company Y, satisfies the definition of foreign income. Specifically, Company X:

•         derives rental income that would be assessable income under a provision of the ITAA 1936 or the ITAA 1997, and

•         this income is derived from a source in a listed country, being the Country A.

Foreign income must be derived in carrying on a business at or through a PE

The final condition to determine is whether the foreign income that is from carrying on a business is being derived 'at or through a PE'.

A 'PE' is defined in subsection 23AH(15) of the ITAA 1936 as follows:

Permanent establishment, or PE, in relation to a listed country or unlisted country:

(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 a double tax agreement exists between Australia and the Country A, the meaning of PE will be determined by the double tax agreement.

Specifically, paragraph 1 of Article 5 of the Convention between the Government of Australia and the Government of the Country XXXXXXX for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 (Country A DTA) defines 'PE' to mean:

... a fixed placed of business through which the business of an enterprise is wholly or partly carried on.

Paragraph 2 of Article 5 of the Country A DTA provides the following examples of what is considered a PE:

The term permanent establishment includes especially:

(a)          a place of management;

(b)          a branch;

(c)           an office;

(d)          a factory;

(e)          a workshop;

(f)            a mine, an oil or gas well, a quarry or any other place relating to the exploration for or exploitation of natural resources; and

(g)          an agricultural, pastoral or forestry property.

Whilst not an exhaustive list, based on the information provided, it is the Commissioner's view that Company X does not have any of the above in the Country A. That is, the foreign income that is being derived by Company X from carrying on its business is not being derived at or through a PE.

It is considered Company X's business is that of investing / investment operations that is being managed and controlled from Australia and not specifically a business of letting operations. Therefore, the Country A property is not considered to be a fixed place of business in which Company X conducts its investing / investment operations.

Notwithstanding the above conclusion, the OECD Model Tax Convention and Commentary 2017 at paragraph 36 provides that an entity will not be considered to carry on a business through a PE where they are merely renting / leasing out property:

Where tangible property such as facilities, industrial, commercial or scientific (ICS) equipment, buildings, or intangible property such as patents, procedures and similar property, are let or leased to third parties through a fixed place of business maintained by an enterprise of a Contracting State in the other State, this activity will, in general, render the place of business a permanent establishment. The same applies if capital is made available through a fixed place of business. If an enterprise of a State lets or leases facilities, ICS equipment, buildings or intangible property to an enterprise of the other State without maintaining for such letting or leasing activity a fixed place of business in the other State, the leased facility, ICS equipment, building or intangible property, as such, will not constitute a permanent establishment of the lessor provided the contract is limited to the mere leasing of the ICS equipment, etc. This remains the case even when, for example, the lessor supplies personnel after installation to operate the equipment provided that their responsibility is limited solely to the operation or maintenance of the ICS equipment under the direction, responsibility and control of the lessee. If the personnel have wider responsibilities, for example, participation in the decisions regarding the work for which the equipment is used, or if they operate, service, inspect and maintain the equipment under the responsibility and control of the lessor, the activity of the lessor may go beyond the mere leasing of ICS equipment and may constitute an entrepreneurial activity. In such a case a permanent establishment could be deemed to exist if the criterion of permanency is met. [Emphasis added]

In determining whether Company X is merely leasing out the Country A property, it is necessary to determine whether paragraph 6 or 7 of Article 5 of the Country A DTA applies. That is, whether Company X is considered to have a PE in the Country A on the basis that its Agent can be said to be a 'dependent agent'.

Paragraph 6 and 7 of Article 5 of the Country A DTA states:

6. Notwithstanding the provisions of paragraphs 1 and 2 of this Article, where a person - other than an agent of an independent status to whom paragraph 7 of this Article applies - is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts on behalf of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for that enterprise unless the activities of such person are limited to those mentioned in paragraph 5 of this Article which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

7. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such brokers or agents are acting in the ordinary course of their business as such.

It is generally an accepted principle that an enterprise should be treated as having a PE in a State if there is under certain conditions a person acting for it, even though the enterprise may not have a fixed place of business in that State within the meaning of paragraphs 1 and 2 of the PE Article of the relevant DTA.

Paragraph 6 of Article 5 of the Country A DTA stipulates the conditions under which Company X is deemed to have a PE in respect of any activity of a person acting for it, otherwise referred to as a dependent agent. The treatment of a PE is limited to persons who in view of the scope of their authority or the nature of their activity involve the enterprise to a particular extent in business activities in the relevant state.

Paragraph 6 of Article 5 proceeds on the basis that only persons essentially having the authority to conclude contracts can lead to a PE for the enterprise. Such authority needs to be sufficient as to bind the enterprise's participation in the business activity in the relevant state and such authority needs to be exercised regularly, repeatedly and not merely in isolated cases.

Lack of active involvement by an entity in transactions may be indicative of a grant of authority to an agent.

A person who is authorised to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise the required authority, even if the contract is signed by another person in the State in which the enterprise is situated or if the first person has not formally been given a power of representation.

The mere fact, however, that a person has attended or even participated in negotiations in a State between an enterprise and a client will not be sufficient, by itself, to conclude that the person has exercised in that State an authority to conclude contracts in the name of the enterprise.

Company X engaged a real estate agent to manage the Country A property.

The authority afforded to that real estate agent by Company X does not provide the real estate agent with the required authority to make them a dependent agent. The authority afforded to the real estate agent is tightly guided by numerous permissions required of Company X.

Further, whilst the real estate agents are authorised to arrange for contractors to attend the property to undertake repairs on behalf of Company X that authority is limited.

Based on the information provided, it is the Commissioner's view that the real estate agent is considered to be an independent agent conducting their own property agency business, which services they also provide to many other clients. They have a general authority to make some decisions and conclude contracts, but only after the landlord has agreed to do so. That is, the real estate agent does not have the requisite authority to bind Company X's participation in the business activity in the Country A.

Conclusion

On the basis that the requirements of subsection 23AH(2) of the ITAA 1936 cannot be satisfied it is not necessary to consider the exceptions in subsection 23AH(5) of the ITAA 1936. Consequently, the income received by Company X via Company Y in the relevant income year is not considered to be non-assessable non-exempt income under subsection 23AH(2) of the ITAA 1936.