Australia’s tax law exempts from tax foreign income derived by a company “in carrying on a business, at or through a permanent establishment (“PE”)”. Capital gains are also exempt from tax where “the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE”. These provisions are contained in section 23AH of the Income Tax Assessment Act, 1936.
A recent draft ruling from the Australian Taxation Office provides that this tax exemption would not be available where a PE is deemed to exist and the activities of the enterprise do not amount to it carrying on a business (TR 2013/ D8). TR 2013/D8 provides that where a PE is deemed to exist under either Australia’s domestic tax law
or under the definition contained in a (comprehensive) double tax agreement (“DTA”), it does not automatically follow that a business is being carried on.
An example of where a PE can be deemed to exist is where substantial equipment is used in a ontracting State.
Australia’s domestic tax law defines a PE to include “a place where the person has, is using or is installing
substantial equipment or substantial machinery”. This PE definition is applicable for those countries with whom Australia does not have a DTA. Australia’s International Tax Agreements Act 1953 operates to substitute the domestic tax law definition of PE with that contained in an applicable DTA. With the exception of Germany and Austria, the Permanent Establishment Article of each of Australia’s DTAs contain a sub-article deeming a PE to exist where substantial equipment is used, operated or maintained. (The substantial equipment sub-articles in
Australia’s DTAs contain a number of variations but this is not relevant for present purposes.)
Where the substantial equipment is being used, operated or maintained, some of Australia’s DTAs not only
deem a PE to exist but also deem the enterprise to be carrying on a business through that PE. Two examples include the Singapore and UK DTAs. Where a DTA deems an enterprise to be carrying on a business through a PE, the draft ruling provides that this has no application to the section 23AH exemption. For the section 23AH exemption to apply, the taxpayer must be actually carrying on a business in the Contracting State. Whether or not a taxpayer is carrying on a business is a question of fact, having regard to the activities of
the taxpayer. The draft ruling points out that leasing transactions for substantial equipment will invariably
involve the carrying on of a business because of the complexities of managing the lease (negotiating
and dealing with legal contracts, financing, insurance and invoicing).
A couple of examples in the draft ruling illustrate the point.
An Australian company leases equipment [ship] to a UK resident company under a bareboat lease entered into in the UK. The Australian company would be deemed to have a PE in the UK pursuant to sub-article 5.3(b) of the Australia / UK DTA. Notwithstanding the Australia / UK DTA deems the Australian company to be carrying
on a business through a PE, the section 23AH exemption won’t apply. The Australian company will be taxable in Australia on the leasing income but a foreign tax offset will be allowed for any tax paid in the UK.
Assume facts similar to Example 1 but an office is maintained in the UK to actively manage the leasing contract. The Australian company would have a deemed PE in the UK and also be carrying on a business in the UK which in itself would likely result in a PE). The leasing income derived from the UK would be exempt from Australian tax but no foreign tax offset would be allowed.