ATO Interpretative Decision

ATO ID 2014/20

Income Tax

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Issue

For the purpose of determining under Article 15 of the Convention between Australia and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income [1981] ATS 14 (the Canadian Convention) Australia's right to tax the remuneration of a Canadian resident employee working in Australia, is the remuneration deductible in determining the taxable profits of the deemed permanent establishment (PE) of the employee's Canadian resident employer?

Decision

Yes. For the purpose of determining Australia's taxing rights under Article 15 of the Canadian Convention, the remuneration is deductible in determining the taxable profits of the deemed PE of the Canadian employer because the payment of the remuneration is attributable to the deemed PE under Article 7 of the Canadian Convention.

Facts

A Canadian resident employer (CanCo) employed a Canadian resident employee under terms requiring the employee to exercise his employment in Australia, working for CanCo's Australian subsidiary (AusCo) for approximately four months (the agreed period) in the income year.

AusCo has a contract with an Australian entity to provide essential services in the agreed period using substantial equipment (Essential Services Agreement).

AusCo did not have the substantial equipment and its own employees to carry out the contract.

AusCo entered into an agreement with CanCo to lease from CanCo its substantial equipment during the agreed period (Equipment Lease Agreement).

AusCo also entered into a separate service agreement with CanCo for the secondment of CanCo's employees, including the Canadian resident employee, to operate and maintain the equipment during the agreed period (Service Agreement).

AusCo pays CanCo a service fee under the Service Agreement and lease fees under the Equipment Lease Agreement.

The Canadian resident employee follows instructions given by CanCo and reports daily to CanCo during his secondment to AusCo.

CanCo continues to pay the remuneration of the employee, including the cost of workers' compensation, benefits, and entitlements, and deducts income tax and remits the amounts to the Canada Revenue Agency.

Reasons for Decision

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

The ultimate issue is whether Australia has a taxing right over the remuneration the Canadian employer paid to the non-resident Canadian employee. This involves considering not only the domestic income tax laws but also any applicable tax treaty as defined in section 3AAA or section 3AAB of the International Tax Agreements Act 1953 (Agreements Act).

Subsection 4(1) of the Agreements Act incorporates the Income Tax Assessment Act 1936 and the ITAA 1997 so that those Acts are read as one with the Agreements Act.

Subsection 4(2) of the Agreements Act provides that the Agreements Act will prevail (except for some limited provisions) where there are inconsistent provisions between the relevant Acts.

Section 6A of the Agreements Act gives effect to the Canadian Convention and must be used in determining the source of income derived by the Canadian resident employer and the Canadian employee.

Under Article 15(1) of the Canadian Convention, Australia has the right to tax the remuneration of the Canadian resident employee as their employment is exercised in Australia subject to Article 15(2).

Article 15(2) of the Canadian Convention provides that the remuneration derived by an individual who is a resident of Canada in respect of employment exercised in Australia shall be taxable only in Canada if all of the following requirements have been met:

(a)

the individual is present in Australia for a period of not more than 183 days in any twelve month period commencing or ending in the Australian year of income; and

(b)

the remuneration is paid by, or on behalf of, an employer who is a resident of Canada; and

(c)

the remuneration is not deductible in determining taxable profits of a PE or a fixed base which the employer has in Australia.

In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4717; (1990) 21 ATR 531 (Thiel), the High Court accepted that the OECD Model Taxation Convention's official Commentaries (the OECD Commentary) may be relevant to the interpretation of Double Tax Agreements based on the OECD Model Tax Convention on Income and on Capital. In Thiel, the High Court approved recourse to the OECD Model Tax Convention and Commentaries under Article 32 of the Vienna Convention on the Law of Treaties (see paragraph 90 of the Taxation Ruling TR 2001/13).

Paragraph 6.2 of the OECD Commentary on Article 15 (the relevant terms of which are substantially identical to those of Article 15 of the Canadian Convention) states that:

the object and purpose of subparagraphs b) and c) of paragraph 2 are to avoid the source taxation of short-term employments to the extent that the employment income is not allowed as a deductible expense in the State of source because the employer is not taxable in that State as he neither is a resident nor has a permanent establishment therein.

Paragraph 7 of the OECD Commentary on Article 15 provides that the exemption in Article 15(2):

... is given on condition that the remuneration is not borne by that permanent establishment. The phrase "borne by" must be interpreted in the light of the underlying purpose of subparagraph c) of the Article, which is to ensure that the exception provided for in paragraph 2 does not apply to remuneration that could give rise to a deduction, having regard to the principles of Article 7 and the nature of the remuneration, in computing the profits of a permanent establishment situated in the State in which the employment is exercised.

Paragraph 7.1 of the OECD Commentary on Article 15 further elaborates that:

the fact that the employer has, or has not, actually claimed a deduction for the remuneration in computing the profits attributable to the permanent establishment is not necessarily conclusive since the proper test is whether any deduction otherwise available with respect to that remuneration should be taken into account in determining the profits attributable to the permanent establishment.

In this case, it is considered that although the Equipment Lease Agreement and the Service Agreement are separate legal agreements they are interdependent in their operation.

Article 7(1) of the Canadian Convention provides that the profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. If the enterprise carries on or has carried 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 PE.

Article 7(3) of the Canadian Convention provides that:

in the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses of the enterprise, being expenses which are incurred for the purposes of the permanent establishment ...

Article 5(4)(b) of the Canadian Convention deems an enterprise to have a PE in one of the Contracting States and to carry on business through that PE if substantial equipment is being used in that State by, for or under contract with the enterprise other than in connection with a building site or construction, installation or assembly project of the enterprise.

Within the meaning of Articles 5 and 7 of the Canadian Convention, the fact that CanCo leases and operates substantial equipment in Australia, means that CanCo has a deemed PE in Australia through which it carries on business in Australia.

The profits of CanCo from the Equipment Lease Agreement and the Service Agreement are profits attributable to the business that CanCo is deemed to carry on in Australia through its deemed PE in Australia, and are profits that are therefore taxable in Australia.

The business profits of CanCo from the provision of employees under the Service Agreement are also considered attributable under Article 7 of the Canadian Convention to the deemed PE.

The remuneration of the Canadian resident employee in the agreed period is income derived in respect of the employee's employment exercised in Australia. It is also an expense CanCo incurred in fulfilling its obligations under the Service Agreement to supply personnel to operate and maintain the substantial equipment.

Under Article 7(3) of the Canadian Convention that expense is an allowable deduction in determining the profits of CanCo's deemed PE in Australia.

By reason of Article 22(1) of the Canadian Convention the business profits of CanCo which under Article 7 are taxable by Australia are deemed to have an Australian source. Accordingly, CanCo is assessable on those profits, as having an Australian source, under subsection 6-5(3) of the ITAA 1997.

Paragraph 8-1(1)(a) of the ITAA 1997 allows a deduction from assessable income for any loss or outgoing that is incurred in gaining or producing assessable income. The remuneration CanCo paid the Canadian resident employee in respect of his employment exercised in Australia is thus deductible under section 8-1.

Since the remuneration of the Canadian employee is deductible under section 8-1 of the ITAA 1997 in determining the taxable profits of the deemed PE of CanCo, the requirement in Article 15(2)(c) of the Canadian Convention that the remuneration is not deductible has not been met.

Accordingly, Australia has the right to tax the remuneration of the Canadian resident employee working in Australia.

Amendment History

Year of income:  Year ended 30 June 2013

Legislative References:
Income Tax Assessment Act 1997
   subsection 6-5(3)
   section 8-1
   paragraph 8-1(1)(a)

Case References:
Thiel v. Federal Commissioner of Taxation
   (1990) 171 CLR 338
   90 ATC 4717
   (1990) 21 ATR 531

Related Public Rulings (including Determinations)
TR 2001/13

Other References:
Canadian Convention [1981] ATS 14
Article 5
Article 5(4)(b)
Article 7
Article 7(1)
Article 7(3)
Article 15(1)
Article 15(2)
Article 15(2)(c)
Article 22(1)
OECD Model Tax Convention on Income and on Capital
OECD Commentaries on the Articles of the Model Tax Convention
Vienna Convention on the Law of Treaties
Article 32

Keywords
double tax agreements
international law
international tax
permanent establishment
substantial equipment
treaties

Siebel/TDMS Reference Number:  1-5AMCVLG

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  30 May 2014
Date reviewed:  30 June 2017

ISSN: 1445-2782