Edited version of private advice

Authorisation Number: 1052241592403

Date of advice: 12 April 2024

Ruling

Subject: Permanent establishment

Question

Is Business A a resident of Australia under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Does Business A have a permanent establishment (PE) in Australia within the meaning of Article 5 of the XYZ Convention (the Convention)?

Answer

No.

Question 3

Will the profits of Business A be excluded from tax in Australia under Article 7 of the Convention?

Answer

Yes.

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

1.     Business A is a company incorporated in Country X.

2.     Business A is a tax resident of Country X.

3.     Business A's sole director (the Director) is based in Country X.

4.     Business A has ordinary shares on issue and all shareholders reside in Country X.

5.     Business A is an internet-based business and promote their products through a mix of their websites in both Country X and Australia.

6.     All contracts entered into by Business A are negotiated and agreed to by the Director in Country X.

7.     Payment from Australian clients are made by way of bank transfer into an Australian bank account.

8.     Business A's websites have been designed, coded and updated in the Country X. Business A does not have any Australian based server(s).

9.     Business A's Australian clients are redirected to Country X through Australian website.

10.     Business A is controlled and managed by the Director in the Country X office. The director also attends to all of the general management duties, order processing, strategy, pricing management, stock control and purchase, product management, invoicing and bookkeeping within the Company X office.

11.     Business A leases storage space in a storage facility in Australia where stock of the product is stored prior to delivery. The storage space is leased from an unrelated party.Business A has 1 employee who only undertakes packing and dispatching activities within the storage yard.

12.     The Director travels to Australia every two to four months. Whilst in Australia, the director's activities are primarily related to the checking of stock to ensure that it matches computer generated reports produced in Country X.

13.     The Australian based activity of Business A holds no intellectual property and all commercial risk(s), including but not limited to stock risk and general commercial risk, is borne by the head office in Country X.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6(1)

Income Tax Assessment Act 1997 subsection 6-5(3)

International Tax Agreements Act 1953 subsection 3AAA (1)

International Tax Agreements Act 1953 subsection 5(1)

Convention between the Australian and Country X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion (the Convention) Article 5

Reasons for decision

Question 1

Is Business A a resident of Australia under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Detailed reasoning

The term 'resident' in relation to a company is defined within subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936). The effect of the definition of 'resident or resident of Australia' in section 6 is that a company will qualify if it's:

•         incorporated in Australia, or

•         not incorporated in Australia, but carries on business in Australia, and has its central management and control in Australia, or

•         not incorporated in Australia, but carries on business in Australia, and has its voting power controlled by shareholders who are residents of Australia.

The definition sets the criteria necessary to establish residency of a company. The first element of the definition states that a company which is incorporated in Australia, is a resident of Australia (the incorporation test). For a company incorporated in Australia, this is where the examination ends to determine if the company is a resident under the definition.

If a company is not incorporated in Australia, a company will be a resident under 'the central management and control (CM&C) test' of company residency in paragraph (b) if it carries on business in Australia and has its CM&C in Australia.

Alternatively, a company which is not incorporated in Australia will be a resident under 'the voting power test' if it carries on business in Australia and has its voting power controlled by shareholders who are residents of Australia.

Incorporation Test

Business A is incorporated in the Country X. Therefore, it is not incorporated in Australia and is not a resident company under the incorporation test within subsection 6(1) of the ITAA 1936.

CM&C Test

There's ATO guidance relevant to the second corporate residency test.

Taxation Ruling TR 2018/5 Income tax: central management and control test of residency (TR 2018/5) sets out the Commissioner's view on how to apply the CM&C test of company residency following Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589 (Bywater).

Summary of some propositions made by this ruling include:

•         If a company carries on business and has its central management and control in Australia, it will carry on business in Australia within the meaning of the central management and control test of residency. It is not necessary for the substantive trading or investment activities of the business that generate its profits to take place in Australia. [Paragraphs 7-8]

•         Central management and control mean the control and direction of a company's operations. This is about making high-level decisions that set the company's general policies and determine the types of transactions it enters. It isn't usually about conducting day-to-day operations. [Paragraphs 10-13]

•         Who exercises central management and control is a question of fact. As a starting point, companies are normally controlled by their directors, who have legal power to control the company. However, legal power isn't decisive; companies may be effectively controlled by other entities. [Paragraphs 19-29]

•         While no single consideration is decisive, the location of central management and control is generally about where the decision makers meet and exercise control from. [Paragraphs 34-38]

Paragraph 11 of TR 2018/5 states:

that the key element in the control and direction of a company's operations is the making of high-level decisions that set the company's general policies and determine the direction of its operations and the type of transactions it will enter.

Paragraph 19 of TR 2018/5 states that identifying who exercises CM&C is a question of fact. Paragraphs 20-22 of TR 2018/5 provide that:

•         Normally, where a company is run by its directors in accordance with its constitution and the company law rules applicable to that company, which give its directors the power to manage the company, the company's directors will control and direct its operations. It follows that ordinarily it is a company's directors who exercise its central management and control

•         However, the actions of a company's directors, or others with the legal power and authority to control and manage the company, are not the end of the enquiry as to who exercises central management and control. There is no presumption that the directors of a company will always exercise its central management and control.

•         When determining who exercises a company's central management and control, all the relevant facts and circumstances must be considered. Facts and circumstances to be considered in determining who exercises a company's central management and control include the role of anyone who assumes the role of the directors' role in managing and controlling the company's affairs or has a role in the decision-making processes or governance of the company.

TR 2018/5 states at paragraph 34:

Where a company's central management and control is exercised is not determined by where the directors, or other persons, who control and manage it, are resident or live. What matters is where they actually perform the activities to control and direct the company.

The matters that are most likely to determine where those who control and direct the operations of a company do so are listed at paragraph 36 of TR 2018/5:

•         where those who exercise central management and control do so, rather than where they live

•         where the governing body of the company meets

•         where the company declares and pays dividends

•         the nature of the business and whether it dictates where control and management decisions are made in practice, and

•         minutes or other documents recording where high-level decisions are made.

TR 2018/5 provides at paragraph 35 that no single factor alone will necessarily determine where the CM&C of a company is exercised, and that the relevance and weight to be given to each will depend on the facts and circumstances of the case and surrounding circumstances.

In applying the circumstances stated in TR 2018/5 to Business A, the following is relevant.

•         The director attends to all of the general management duties, order processing, strategy, pricing management, stock control and purchase, product management, invoicing and bookkeeping within the Country X office.

•         All contracts entered into by Business A are negotiated and agreed to by the Director in Country X.

•         Business A operates one office located in Country X.

•         The Director resides in Country X and he controls Business A's operations from Country X.

•         The Director only made short visits to Australia. Whilst in Australia, the Director's activities were primarily related to the checking of stock to ensure that it matched computer-generated reports produced in Country X.

•         The Director did not enter significant contracts or make any high-level decisions during those Australian visits.

As noted above, a key element in the control and direction of a company's operations is the making of high-level decisions that set the company's general policies and determine the direction of its operations and the type of transactions it will enter.

In this case, taking into account the facts and circumstances outlined above, the central management and control of Business A is exercised in Country X as the Director (who resides in Country X) is the sole director and controls and directs the company from Country X, all key management, operational and strategic decisions are made in Country X.

Therefore, Business A is not a resident company under the CM&C test within subsection 6(1) of the ITAA 1936.

Voting Power Test

To satisfy the voting power test when a company is not incorporated in Australia, two circumstances both need to be met. These are that the company 'carries on business in Australia' and has its 'voting power controlled by shareholders who are residents of Australia.

As the voting power of Business A is controlled by shareholders who are not residents of Australia the test is not satisfied.

Conclusion

For the reasons outlined above Business A does not satisfy the incorporation, the CM&C or the voting power tests. Therefore, Business A is not a resident of Australia under subsection 6(1) of the ITAA 1936.

Question 2

Does Business A have a permanent establishment (PE) in Australia within the meaning of Article 5 of the XYZ Convention (the Convention)?

Detailed reasoning

Article 5 of the Convention (Article 5) is relevant in relation to determining whether Business A is operating through a PE in Australia. Article 5 relevantly provides the following:

1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of the enterprise is wholly or partly carried on.

2. The term " permanent establishment " includes especially:

(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 of extraction of natural resources; and

(g) an agricultural, pastoral or forestry property.

3. A building site, or a construction, installation or assembly project constitutes a permanent establishment if it lasts for more than 6 months.

4. Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a Contracting State:

a) performs services in the other Contracting State

(i) through an individual who is present in that other State for a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or

(ii) for a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other State;

... such activities shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other State, unless the activities are limited to those mentioned in paragraph 7 which, if exercised through a fixed place of business, would not make this place of business a permanent establishment under the provisions of that paragraph.

Taxation Ruling TR 2001/13 - Interpreting Australia's Double Tax Agreements (TR 2001/13) sets out the Commissioner's view on interpreting Australian's double tax agreements and provides at paragraph 104 that commentaries on the interpretation and application of the OECD model convention will often need to be considered as a matter of practice, in interpreting tax treaties, at least where the wording is ambiguous.

Commentaries on the OECD Model Tax Convention on Income and Capital released in 2017 (OECD Commentary) provides guidance on the fixed place of business PE. Relevantly, the OECD Commentary provides at paragraph 6 that the definition of 'permanent establishment' contains the following conditions:

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

      ii.       the place of business must be 'fixed', i.e. it must be established at a distinct place with a certain degree of permanence, and

      iii.       the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.

Existence of a place of business

The OECD Commentaries on the Model Tax Conventions (Commentaries) may be used to interpret the meaning of 'place of business'.

The Commentaries on Article 5 explain that:

10. 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. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot (e.g. for the storage of dutiable goods). Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise.

11. As noted above, the mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required....

12. Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that that location is at the disposal of that enterprise. 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. This is illustrated by the following examples. Where an enterprise has an exclusive legal right to use a particular location which is used only for carrying on that enterprise's own business activities (e.g. where it has legal possession of that location), that location is clearly at the disposal of the enterprise. This will also be the case where an enterprise is allowed to use a specific location that belongs to another enterprise or that is used by a number of enterprises and performs its business activities at that location on a continuous basis during an extended period of time.

Paragraph 20 of the 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.

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?: "The subsection 6(1) definition of PE is based on the concept of PE used in Australia's tax treaties. For the purposes of the definition of PE in subsection 6(1) 'a place at or through which [a] person carries on any business' 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 must be construed in the context of each particular business and is a question of fact and degree. Permanent in this context does not mean forever."

In this regard TR2002/5 goes on to state that although it is a question of fact and degree, as a guide, a business operating at or through a place continuously for six months or more will likely be temporally permanent.

The place of business must be 'fixed'

The place of business must also be a fixed place of business. The Commentaries on Article 5 explain:

28. Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist if only if the place of business has a certain degree of permanency, i.e. if it is not 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. It is sometimes difficult to determine whether this is the case...

35. For a place of business to constitute a permanent establishment the enterprise using it must carry on its business wholly or partly through it. As stated in paragraph 3 above, the activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis..

39. 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). This personnel includes employees and other persons receiving instructions from the enterprise (e.g. dependent agents). The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorised to conclude contracts if he works at the fixed place of business of the enterprise..

Application of Article 5 - Storage Yard:

•         The storage yard is a commercially leased space from where business activities of Business A are conducted.

•         The storage yard is leased from a third party and the space is approximately 1200sqm of the 20,000 sqm that is held by the third party.

•         There is no lease for the use of buildings nor office space.

•         Business As business activities are limited to the yard area leased.

•         The business activities are carried out by a dispatcher who is an employee of Business A. The dispatcher duties only involve receiving a picklist, packing the product and organising for it to be dispatched to the client.

•         Business A has been and intends to continue operating from this location for some period of time (unspecified period of time).,

Based on the facts outlined above, the Commissioner considers the Australian storage yard, which is a commercially leased space where certain business activities of Business A are conducted, to be a permanent establishment in Australia under Article 5(1) of the Convention.

Business A has a legal right (via the lease) to use a storage space to conduct business activities for an unspecified period (therefore having a degree of permanency) and therefore, Business A has a fixed place of business through which business activities are carried on.

Application of Paragraph 7 of Article 5

Paragraph 7 of Article 5 lists a number of business activities which are treated as exceptions to the general definition laid down in paragraph 1 and which when carried on through fixed places of business, are not sufficient for these places to constitute permanent establishments. As long as that activity has a preparatory or auxiliary character.

7. Notwithstanding the preceding provisions of this Article, the term 'permanent establishment' shall be deemed not to include:

a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise..

provided that such activities are, in relation to the enterprise, of a preparatory or auxiliary character

In practice, it is often difficult to distinguish between activities that are preparatory or auxiliary character and those activities that are not preparatory or auxiliary in character. The OECD Commentary provides guidance at paragraph 59 to Article 5 in relation to the distinction:

59. It is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which have not. The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole...

60. As a general rule, an activity that has a preparatory character is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole.

An activity that has an auxiliary character, on the other hand, generally corresponds to an activity that is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole. It is unlikely that an activity that requires a significant proportion of the assets or employees of the enterprise could be considered as having an auxiliary character

The use of the Australian storage yard is limited to the storage of the products. The Australian based employee's duties only include packing the products and dispatching it to the client from the storage yard.

The core business activity of Business A is carried out in Country X including general management duties, order processing, strategy, pricing management, stock control, product management, invoicing and bookkeeping.

The activities at the storage yard (leased storage space) do not involve significant assets or resources. The yard is used solely for the purpose of storage and functions to support the core business activities in Country X. The storage space is considered to be auxiliary in nature.

Conclusion:

As a result, Business A does not have a PE in Australia by virtue of the application of paragraph 7 of Article 5 of the Convention.

Application of Article 5 - Business A Website

In addition to the Australian storage yard, it is necessary to consider the application of Article 5 to Business A's website and online presence and whether it constitutes a fixed place of business under the Article.

In considering whether the website will be a 'place of business', paragraphs 123 - 124 of the OECD commentary on Article 5 provides the following guidance:

123. Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a "place of business" as there is no "facility such as premises or, in certain instances, machinery or equipment" (see paragraph 6 above) as far as the software and data constituting that web site is concerned. On the other hand, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a "fixed place of business" of the enterprise that operates that server.

124. The distinction between a web site and the server on which the web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. For example, it is common for the web site through which an enterprise carries on its business to be hosted on the server of an Internet Service Provider (ISP). Although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts typically do not result in the server and its location being at the disposal of the enterprise..., even if the enterprise has been able to determine that its web site should be hosted on a particular server at a particular location. In such a case, the enterprise does not even have a physical presence at that location since the web site is not tangible. In these cases, the enterprise cannot be considered to have acquired a place of business by virtue of that hosting arrangement. However, if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met.

As noted above, Business A holds various domain names, Australian queries are directed to the ".com.au" website. However, the websites have all been designed, coded and updated in the Country X office. Business A does not have any Australian based server(s).

The OECD commentary at paragraphs 123 -124 indicates that if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment.

Business A carries on its business via the website however, Business A does not have a computer server situated in Australia and therefore, Business A does not have a physical presence in Australia, the web site is not tangible property and does not constitute a "place of business'.

Conclusion

The Business A website does not constitute a permanent establishment for the purposes of Article 5 of the Convention.

Question 3

Will the profits of Business A be excluded from tax in Australia under Article 7 of the Convention?

Detailed reasoning

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 and indirectly from all Australian sources during the income year.

In determining liability to Australian tax on Australian sourced income received by a non-resident, it is necessary to consider not only the income tax laws but also any applicable tax treaties contained in the International Tax Agreements Act 1953 (the Agreements Act).

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

Section 5 of the Agreements Act provides that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 of the Agreements Act has the force of law. The Convention is listed in section 5 of the Agreements Act and operates to avoid the double taxation of income received by residents of Australia and Country X.

Article 7 of the Convention governs the taxation of business profits derived from Australia by a resident of Country X.

Article 7(1) of the Convention states

(1)           The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.

Therefore, 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 PE situated in Australia.

Business A is a Country X resident for the purposes of the Convention. It does not have a PE in Australia. Therefore, Article 7(1) of the Convention will apply to Business A and allocate sole taxing rights to Country X.