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On 11 December 2013, the Australian Taxation Office released, for public comment by 14 February 2014, a draft Taxation Ruling TR 2013/D8 (“draft Ruling”) that states that having a permanent establishment (“PE”) does not necessarily mean a business is carried in that PE.
Background
In brief, section 23AH of the Income Tax Assessment Act 1936 (“the Act”) treats certain foreign branch income derived directly or indirectly by Australian resident companies as non-assessable non-exempt for income tax purposes, it also provides similar rules for foreign branch capital gains, and contains rules to ensure that foreign branch capital losses are not taken into account.
According to section 23AH(2) of the Act, for Australian tax purpose, an entity may have a permanent establishment overseas either under paragraph (b) of section 6(1) of the Act or under a tax treaty.
Often, there is a discrepancy between paragraph (b) of subsection 6(1) of the Act and some tax treaties, in determining when a company is deemed to ‘carrying on a business’ at or through a permanent establishment because it has substantial equipment.
An issue therefore arises as to whether having a permanent establishment by virtue of the presence of substantial equipment, either under paragraph (b) of subsection 6(1) of the Act or under Australia’s tax treaties, means that the ‘carrying on a business’ requirement in section 23AH of the Act is automatically satisfied.
The draft Ruling
Accordingly, the draft Ruling considers the application of the requirement in section 23AH(2) of the Act.
Position where subsection 6(1) definition of PE applies
In particular, the draft Ruling considers whether a company that has a PE, under paragraph (b) section 6(1) of the Act, in a place because it is using or is installing substantial equipment of substantial machinery satisfies the ‘carrying on a business’ requirement in section 23AH of the Act.
The definition of PE in subsection 6(1) of the Act when construed jointly with section 23AH of the Act means a place at or through which the person carries on any business. This is the primary meaning of the expression PE. However, the definition expressly includes some other cases, without limiting the generality to the primary meaning such as circumstances arising from paragraph (b) of subsection 6(1) of the Act.
With the vast majority of cases it is likely to argue that having, using or installing substantial equipment or substantial machinery at a place will also entail the carrying on of business at or through that place so that the primary meaning of the term is met. However, where the presence of substantial equipment or machinery does not involve actual business activity, the expanded meaning of paragraph (b) of subsection 6(1) of the Act will apply. In this way, it enlarges the scope of the term to include as a permanent establishment, something that would not otherwise come within its primary meaning that is where no business is being carried on at or through the place. Nevertheless, there is no basis to read into the extended meaning of permanent establishment that a business must also be treated as being carried on at or through that place.
Accordingly, a company that has a PE because it satisfies paragraph (b) of subsection 6(1) of the Act does not thereby meet the carrying on a business requirement for the purpose of section 23AH of the Act. The requirement will only satisfied by the actual carrying on of business at or through the PE.
Position where a tax treaty definition of PE applies
Further, the draft ruling considers whether a company that is taken to ‘carry on business’ through the PE under an applicable tax treaty satisfies the ‘carrying on a business’ requirement in section 23AH of the Act.
Unlike the definition of PE in subsection 6(1) which includes the matters covered by paragraphs that follow, the tax treaties relevantly provide that an enterprise is ‘deemed’ to have a PE if it uses substantial equipment in the contracting state. Accordingly, where a tax treaty ‘deems’ there to be a PE merely because of substantial equipment is used in that contracting state, no inference can be drawn that a business must also be treated as being carried on at or through that place for the purposes of section 23AH of the Act.
Even where the applicable tax treaty also deems a company to ‘carrying on business’ through a ‘deemed’ PE, this has effect only in the context of the interpretation of the treaty and not for the purposes of section 23AH of the Act.
From the abovementioned Commissioner’s view, the draft Ruling concludes that the domestic exemption for foreign branch income in section 23AH of the Act will not apply merely because a company has a permanent establishment overseas, regardless of the presence of any treaty deeming provisions. The domestic exemption will apply only if the company is actually carrying on a business through a permanent establishment.
The Commissioner recognised that the view expressed in TR 2013/D8 contradict with his previous view as expressed in Interpretative Decision ATO ID 2011/34. Accordingly, one the same day, the Commissioner withdrew ATO ID 2011/34 and proposes not to undertake active compliance activities so as to apply that view in the current income year and for earlier years. The draft taxation ruling is open for public comment until 14 February 2014.
