Private ruling: Income – transfer pricing and cfc
Date of advice: 17 December 2018
Published: April 2019
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021
Date scheme commenced: 1 July 2017

Ruling: Questions and Answers | 1. Does the payment of a Z% royalty from Company A to the Trust B result in Trust B getting a transfer pricing benefit pursuant to section 815-120 of the Income Tax Assessment Act 1997 (ITAA 1997)? | No | 2. Will the income be attributed to Trust B regardless of whether any amounts are held as working capital in Country C? | No | 3. Is the management fee paid form Company A to Trust B assessable income in Australia? | Yes

Relevant facts and circumstances: Background –business operations The business is a business operated by the Trust B, an entity controlled by Person D. The business provides general advice and is not specific to individuals. Its operations concentrate on five strategic topics It receives commissions from 3 rd parties – it promotes their products/services with links to their web sites. If a client ultimately uses the services, the business receives a commission. The commission is around X% on what the 3 rd party receives. The business has no employees – it employs contractors as freelance writers. Commissions paid compared with approximate turnover were: ● 2017 $ – approx. turnover $ ● 2018 $ – approx. turnover $ Apart from these contractors, Person D does X on a full time basis. Person D’s spouse does X for the business. Establishment and operation of Company A As a condition of receiving commissions, the business was required to obtain an X Licence in Country C. This type of licence can only be held by Country C based companies. In order to register, some requirements were needed, such as professional qualifications. Moreover the business had to spend considerable time to be up to date on the products from partners. The existence of the Licence was expected to lead to greater commission as the business will be able to generate more detailed content and making general recommendations. The Country C partners (affiliates) will not deal with an Australian company – all payments are made to a Country C bank account. As a result of the above Company A was established to hold the relevant licence and to receive the income (commissions). Company A has now been trading in Country C for over X. Trust B is the sole shareholder and Person D is the sole director of Company A. Company A’s turnover in the six months January to June 2018 was $X. Tax has been paid in Country C on this. This amount has been retained in Country C – no dividends have been paid. Company A does not employee any staff in Country C. Person D largely runs the company’s business from Australia with occasional trips to Country C. As director, they liaise with the intermediaries in Country C. There are paid contractors (eg, tax expert, accountant) in Country C to ensure its operations comply with regulations. Company A is responsible and bears the risk for any errors in information, and will be insured appropriately for this. Trust B takes responsibility for all other website content. Fee structure between Company A and Trust B About X% of the business income generated by the business will be earned by “Company A” through the payment of commissions; however, the proprietary information is being sourced from Australia and all content is being written in Australia. A Z% royalty will be paid from Company A to Trust B. The calculation of the Z% fee is as follows: A return on investment of % for the use of existing resources and a % cost to Trust B to assist in covering ongoing provision of services. There is nothing in writing about how the royalty of Z% was calculated. However, it was estimated having regard to Company As’ requirement for a return on risk, plus a % profit, which left Z% as the royalty. There were no direct comparisons, but the parties looked at a number of things to determine the royalty. In addition, it is intended that Y% of the Country C profit (income less royalties and other expenses) will be paid as a dividend with the remaining % retained in Country C to provide capital for the operations of the company. A Country C tax expert has indicated that the Country C Tax Authorities will permit a smaller management fee being charged by the Australian business, resulting in greater tax obligation in Country C. There is no written agreement between the business and Company A – there is a draft agreement which is a work-in-progress. There is a verbal understanding about who does what. This verbal agreement will be put in writing once the appropriate advice has been received from the Australian and Country C revenue authorities. Other matters Person D is based in Australia (permanent resident) and is applying for citizenship. Person D controls both entities, making all decisions. Person D and their spouse only receive trust distributions as remuneration for their contribution to the business.

Relevant legislative provisions: Section 6 Income Tax Assessment Act 1936 | Section 332 Income Tax Assessment Act 1936 | Section 340 Income Tax Assessment Act 1936 | Section 456 Income Tax Assessment Act 1936 | Section 6-5 Income Tax Assessment Act 1997 | Division 815 Income Tax Assessment Act 1997 | Subdivision 815-B Income Tax Assessment Act 1997 | Regulation 19 Income Tax Assessment (1936 Act) Regulations

Reasons for decision: Detailed Reasoning - Explanation of the law: Division 815 of the ITAA 1997 addresses cross-border transfer pricing. Subdivision 815-B effectively requires taxpayers engaging in cross border dealings or transactions with another entity to apply arm's length principles when calculating the tax consequences of the dealings or transactions. For subdivision 815-B to apply, section 815-115 requires that an entity (in this case Trust B) must get a transfer pricing benefit. Under section 815-120, for an entity to get a transfer pricing benefit, there are a number of conditions to be met. One of these is that the cross-border test must apply. Relevantly, under subsection 815-120(3), the cross-border test is met if: ● one (or both) of the parties to a dealing or transaction is an Australian resident, and ● conditions operate between the parties in connection with their commercial or financial relations at or through an overseas permanent establishment of that party. Permanent establishment is defined in section 6 of the ITAA 1936 as: …a place at or through which the person carries on a business and, without limiting the generality of the forgoing, includes: (a) a place where the person is carrying on business through an agent … but does not include: (e) a place where the person is engaged in business dealings through a bona fide commission agent or broker who, in relation to those dealings, acts in the ordinary course of his or her business as a commission agent or broker and does not receive remuneration otherwise than at a rate customary in relation to dealings of that kind, not being a place where the person otherwise carries on business; (f) a place where the person is carrying on business through an agent; (i) who does not have, or does not habitually exercise, a general authority to negotiate and conclude contracts on behalf of the person… The Agreement also includes, at Article 5, a definition of permanent establishment for the purposes of the agreement. Relevantly, 5.1 states that a permanent establishment is ‘a fixed place of business through which the business of the enterprise is wholly or partly carried on.’ Article 5.6 deems a permanent establishment where A person acting in a Contracting State on behalf of an enterprise of the other Contracting State - other than an agent of an independent status to whom paragraph 7 applies - shall be deemed to be a permanent establishment of that enterprise in the first-mentioned State if: a) the person has, and habitually exercises in that State, an authority to conclude contracts on behalf of the enterprise, unless the person’s activities are limited to the purchase of goods or merchandise for the enterprise … For the purposes of the definition in section 6 a ‘place’ must be geographically permanent, and not be temporary (TR 2002/5, paragraphs 29 to 32). | Detailed Reasoning - Application to the taxpayer: As set out above, Company A is an Australian resident company. Consequently, the cross-border test (and transfer pricing provisions) will apply only if it has a permanent establishment in Country C. We have concluded Company A does not have a permanent establishment in Country C, either under the definition in the Tax Act or under the tax agreement between Country C and Australia. You have stated that Company A does not employee any staff in Country C, and that Person D, Company A’s director, largely runs the company’s business from Australia with occasional trips to Country C. There are paid contractors in Country C to ensure its operations are compliant with regulations (eg, tax expert, accountant). As such there is no permanent place in Country C through which the business of Company A is carried on. Rather, the business of Company A is carried out by Person D in Australia. The occasional trips to Country C are not sufficient to establish a place of business that has either geographic or time-based permanence. The paid contractors in Country C are not agents by which the business of Company A is carried on for the purposes of permanent establishment – they are simply paid to carry out specific and limited tasks on behalf of Company A. Therefore, Company A does not meet the cross-border test in subsection 815-120(3) of the ITAA 1997. For completeness, we also observe that Trust B is an Australian resident trust which does not operate through an overseas permanent establishment. Therefore it does not meet the cross-border test in subsection 815-120(3) of the ITAA 1997. As neither entity meets the cross-border test, we conclude that there are no conditions, transactions or dealings to which Division 815 transfer pricing provisions apply. Trust B does not get a transfer pricing benefit under section 815-120 of the ITAA 1997. | Detailed Reasoning - Attributed Income: Section 456 of the ITAA 1936 will attribute income where a Controlled Foreign Company (CFC) has attributable income in respect of an attributable taxpayer based on the attributable taxpayer's attribution percentage of the attributable income. Section 340 of the ITAA 1936 provides a company is a CFC at a particular time if, at that time, the company is a resident of a listed country or of an unlisted country and the other conditions of section 340 apply. According to section 332 of the ITAA 1936 a company is a resident of a particular listed country at a particular time if, and only if, both of the following conditions are satisfied at that time: (a) the company is not a Part X Australian resident; (b) the company is treated as a resident of the listed country for the purposes of the tax law of the listed country. Under regulation 19 of the Income Tax Assessment (1936 Act) Regulations, Country C is a listed country. Part X Australian resident is defined in section 317 of the ITAA 1936 as a resident within the meaning of section 6 of the ITAA 1936, but does not include an entity where: (a) there is a double tax agreement in force in respect of a foreign country; and (b) that agreement contains a provision that is expressed to apply where, apart from the provision, the entity would, for the purposes of the agreement, be both a resident of Australia and a resident of the foreign country; and (c) that provision has the effect that the entity is, for the purposes of the agreement, a resident solely of the foreign country. A company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia is a resident or resident of Australia within the meaning of section 6 of the ITAA 1936. It is not necessary for any part of the actual trading or investment operations of the business of the company to take place in Australia. This is because the central management and control of a business is factually part of carrying on that business (TR 2018/5 paragraph 8). The Full High Court recently clarified the issue of central management and control in Bywater Investments Ltd & Ors v FC of T ; Hua Wang Bank Berhad v . FC of T 2016 ATC 20-589. There the taxpayers had sought to rely on Esquire Nominees v. FC of T 73 ATC 4114 to support the proposition that, because all the directors resided abroad and all directors meetings were held abroad, the central management and control of each taxpayer was thus exercised abroad. The High Court unanimously found otherwise, stating that, as a matter of long-established principle, the residence of a company was first and last a question of fact and degree to be answered according to where the central management and control of the company actually abided. As a matter of long-established authority, that was to be determined not by reference to the constituent documents of the company but upon a scrutiny of the course of business and trading. As Person D controls and makes all decisions for Company A from their base in Australia, Company A both has its central management and control in Australia and carries on a business in Australia; therefore, it is a resident within the meaning of section 6 of the ITAA 1936. Article 4 of the Convention between the Government of Australia and the Government of Country C for the Avoidance of Double Taxation with respect to Taxes on Income and the Prevention of Fiscal Evasion and Protocol (the Agreement) specifies that for the purpose of the Convention: 1. The term “resident of a Contracting State” means: a) in the case of Australia, a person who is a resident of Australia for the purposes of Australian tax; and b) in the case of Country C, a person who is domiciled in Country C for the purposes of Country C tax. A Contracting State or a political subdivision or statutory body or a local authority thereof is also a resident of that State. 2. A person is not a resident of a Contracting State if the person is liable to tax in that State in respect only of income from sources in that State. …….. 4. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, it shall be deemed to be a resident solely of the Contracting State in which its place of effective management is situated. 5. Where that State is Country C, any partnership or group of persons which has its place of effective management in Country C and all partners, shareholders or other members of which are personally liable to tax therein in respect of their part of the profits of those partnerships or groups of persons pursuant to Country C domestic laws. Assuming Company A is a domiciled in Country C for the purposes of Country C tax, it is a resident of Country C. However, paragraph 4 would deem Company A to be a resident of Australia because its place of effective management is in Australia. Therefore Company A is a Part X Australian resident. As Company A is a Part X Australian resident it is not a CFC. Additionally, as Trust B is a resident of Australia, its worldwide income is assessable in Australia and deductions necessarily incurred or incurred in carrying on the business are allowed against that income.