Private ruling: Permanent establishment
Published: July 2012
Ruling period: 1 July 2009 to 30 June 2013
Date scheme commenced: The scheme has commenced.

Ruling: Q1: Are the profits of the Company from its business activities under the contract (Contract) entered into with the Australian Customer regarding the information management system, not taxable in Australia except to the extent that: · the Company carries on business in Australia through a 'permanent establishment' in Australia as defined in the double tax agreement (DTA) between Australia and Country X for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (Country X DTA); and o those profits are 'attributable' to that permanent establishment within the meaning of the Business Profits Article of the Country X DTA; or o those profits are to be dealt with otherwise in accordance with the business profits article of the Country X DTA? | A1: Yes. | Q2: Does the entry into the Contract, and the carrying out by the Company of its obligations under the Contract, including by virtue of the performance by the Australian subsidiary, under a subcontract between the Company and the Australian subsidiary give rise to or form part of a 'permanent establishment' of the Company in Australia for the purposes of the Country X DTA? | A2: No. | Q3: Even if any of the activities of the Company referred to in Question 2 were part of a 'permanent establishment' in Australia, are the profits of the Company from: · providing commercial-off-the-shelf software to the Australian Customer under the Contract; · arranging licences of 'Third Party Intellectual Property' as defined in the Contract; and · performing other work in Country X in the course of carrying out its obligation under the Contract; 'attributable to that permanent establishment' within the meaning of the Business Profits Article of the Country X DTA? | A3: No. | Q4: If the amounts received by the Company under the Contract, to the extent they are consideration for providing commercial-off-the-shelf software to the Australian Customer under the Contract, are 'royalties' as defined in the Country X DTA, are they paid in respect of rights or property that is not effectively connected with a permanent establishment of the Company situated in Australia, so that the amounts are dealt with under the royalties article of the Country X DTA? | A4: Yes.

Relevant facts and circumstances: The Company is a company incorporated in Country X Its head office is located in Country X and management and control of the Company is carried out in Country X. Shareholders in the company are mostly, or entirely, not residents of Australia for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997). The Company has contracted with an entity, the Australian Customer. The Contract has a defined duration. The Contract was signed in Australia by both parties. The Company and all its subsidiaries (the Company group) conduct a system technology business comprising a number of divisions. The Company does not have any branch or office in Australia. However, the Company has an Australian incorporated subsidiary, the Australian subsidiary. The Australian subsidiary is primarily responsible for the Company group business in Australia and the Pacific. The arrangement at issue in this application involves the division of the Company which provides software solutions for use in management. Part of the role of the Australian subsidiary is to seek out opportunities in the Australian region for the various business divisions of the Company group. Normally, if those opportunities come to fruition, and involve the performance of work, the Australian subsidiary will enter into the contractual arrangements with the customer. The Australian subsidiary would carry out much of the work and subcontract the balance of the work to members of the Company group. Where the opportunity is merely the licensing of existing software, the licence will be granted by the Company as the owner of that software. The Australian subsidiary does not enter into the software licence contract itself, and does not enter such contracts as agent for the Company. In those circumstances the Australian subsidiary is compensated by commission. In this application the arrangement in question resulted from the Australian subsidiary identifying and pursuing the opportunity with the Australian Customer. However, in this case the Australian subsidiary has not entered into the main contract with the Australian Customer. The Company and the Australian Customer have entered into a contract (Contract) under which the Company group is to design, build and install an information management system. The Company will also provide some related testing, training and on-the-job support services to the Australian Customer. When the system is fully established it will be located at the Australian Customer's premises in Australia. The work under the Contract will be performed partly by the Company and partly by its Australian subsidiary including in part at the Australian subsidiary's premises in Australia. Most of the work performed in Australia will be performed by the Australian subsidiary's personnel rather than the Company's personnel. As the Australian subsidiary will perform most of the work done in Australia under the Contract the Company would have preferred that the Australian subsidiary enter into the Contract. In such a situation the Company would enter into subcontracts as necessary for its contribution to the project. However, the Australian Customer wished to ensure that all its relationship with the Company group was with the Company because it is the head company of the Company group. The Australian Customer insisted that the Contract be made with the Company. The Contract was executed by the Australian Customer and the Company in Australia. The Company will, with the knowledge and consent of the Australian Customer, subcontract some aspects of the project to its Australian subsidiary and to some other entities not related to the Company group. The terms of the subcontract (Subcontract) between the Company and its Australian subsidiary provide that the Australian subsidiary has no authority to bind the Company by contract or otherwise and is not an agent of the Company. In addition another term of the Subcontract provides that the Company and the Australian subsidiary may enter into a further subcontracting arrangement in relation to support services to be performed. Details concerning the arrangement The project consists of three components namely hardware, software, and services. Hardware All the hardware will be delivered by an Australian dealer 'directly' to the Australian Customer. The Contract indicates that hardware will be supplied to the Australian Customer's premises in state capitals with a small amount supplied to premises elsewhere. The Company will provide services at all locations. The Australian dealer will supply the hardware. The Company will not perform any role in Australia concerning the provision to the Australian Customer of the hardware. It is envisaged that the Company will not have any involvement in the provision of hardware. The hardware installation will be 'coordinated' by the Australian subsidiary of the Company. To the extent, if any, that the Company did anything concerned with the hardware that would only be work done by the Company's personnel in Country X related to general supervision of the entry into the contract with the Australian dealer which will supply the hardware. Any work done by the Company group in Australia in connection with the provision of the hardware will be carried out by the personnel of the Australian subsidiary of the Company. Under the Subcontract the Company has engaged its Australian subsidiary to perform the work. The work that the Company's Australian subsidiary will do under the Subcontract will be similar to work that it does in the course of its other activities. Software The software comprises: · commercial-off-the-shelf software supplied by the Company; and · commercial-off-the-shelf software supplied by persons other than the Company group. Under the Contract the Company grants the Australian Customer a licence over the commercial-off-the-shelf software supplied by the Company, and undertakes to get licences granted to the Australian Customer for use of the 'commercial-off-the-shelf software supplied by other parties. The formal grant of the licence over the Company commercial-off-the-shelf software occurred in Australia by virtue of the signing of the Contract in Australia. It did not otherwise involve any activity in Australia by the Company or any Company personnel. The Australian Customer has downloaded some of the software from a server in Country X operated by the Company. Neither the Company nor any of its personnel have engaged, or will engage, in any activity in Australia in relation to getting the third party commercial-off-the-shelf software licences granted to the Australian Customer. Any activity of the Company in relation to the granting of those licences will be carried out in Country X by the Company personnel in Country X. The Australian subsidiary will not perform any work connected with commercial-off-the-shelf software licences granted to the Australian Customer, except under the terms of the Contract as noted below. The Company has not, and will not, perform any activity in Australia involved in creating or improving the commercial-off-the-shelf software. A term of the Contract and the Subcontract have the effect that, broadly speaking, intellectual property created by the Company's Australian subsidiary in the course of performing the Subcontract would be transferred to the Australian Customer. The work to be performed by the Australian subsidiary is described in the Contract. That work includes 'documentation' of some aspects of the project. The applicant considers that there may be 'intellectual property' rights in such documentation. However, it is expected that the Australian subsidiary will not produce any intellectual property of any significant value in performing the Subcontract. Services As noted above the Company's Australian subsidiary will perform work in relation to the Contract. That work will be performed as a subcontractor to the Company, with the approval of the Australian Customer. All of the work to be performed by the Australian subsidiary is of a kind that it performs in its own business activities where it contracts directly with customers. The Contract provides a more detailed breakdown of what work will be performed by the Australian subsidiary's personnel, what work will be performed by the Company's personnel in Country X, and what work will be performed by the Company's personnel in Australia. The Contract also shows that: · there will be about S Company personnel involved in performing work in Australia under the Contract, each of whom will spend an average total period of about Z days in Australia - that is a total of approximately ZZ days of Company personnel time spent in Australia over the duration of the Contract; and · this will comprise approximately T individual trips with an average duration of Q days per trip. A schedule showing the projected visits of the Company personnel was provided. It is envisaged that about P Company employees will visit Australia. Each visit by an employee will be for a period of a week or two, or up to about C months. Part of their work will be training the personnel of the Australian subsidiary in relation to work to be performed for the Australian Customer. In the first year of the Contract M employees of the Company made a total of R trips to Australia with a total duration of MMM days. It is expected that a similar pattern of trips to Australia by Company personnel will be made in the following year. Company personnel in Australia will do some work related to the Contract at the Australian subsidiary premises and some at the Australian Customer's premises. For example, 'Testing' will be performed. The Contract provides for payment for 'Support Services' for some time after the initial years. It is envisaged that 'Support Services' will to some extent be delegated to the Australian subsidiary. For example, it is expected that Helpdesk support during Australian business hours will be provided by the Australian subsidiary personnel working in Australia, whereas Helpdesk support during Country X business hours would be done by Company personnel in Country X. The Company uses its own computing equipment and servers in Country X in order to perform services. The Company personnel will not use any large scale equipment in performing the services in Australia (except to the extent that they are working on the hardware or other equipment belonging to the Australian Customer). Likewise, the Australian subsidiary will use its own computing equipment in Australia in performing the Subcontract. Apart from that, the Australian subsidiary personnel will not use any large scale equipment in performing the services in Australia (except to the extent they are working on the hardware or other equipment belonging to the Australian Customer).


Reasons for decision: Summary: The Business Profits Article of the Country X DTA prescribes that specific conditions must exist in order for that Article to apply. The question posed effectively restates those conditions and seeks confirmation that the Article will apply in the manner stated. The profits of the Company from its activities performed under the Contract in Australia will be taxed in Australia where the conditions of the Article are met. That is where the Company has a permanent establishment in Australia the profits of that permanent establishment are taxable in Australia. | Detailed Reasoning - Detailed reasoning: The Business Profits Article of the Country X DTA prescribes that specific conditions must exist in order for that Article to apply. The question posed here has a similar structure and uses terms that are parallel to those that appear in the Business Profits Article. In accordance with that Business Profits Article it is confirmed that where the Company carries on business in Australia through a permanent establishment, as defined in the Permanent Establishment Article of the Country X DTA, the Business Profits Article would apply only to render taxable in Australia only the profits that are 'attributable' to that permanent establishment. The term 'attributable' is not defined in the Country X DTA or in the International Tax Agreements Act 1953 so it is necessary to look elsewhere for a definition. The Commentary on the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention on Income and on Capital Condensed Version, 22 July 2010 (the 2010 OECD Commentary) at paragraph 15 of the commentary on Article 7, explains that 'attributable' profits are those profits that the permanent establishment might be expected to make if it were a separate and independent enterprise; see also paragraphs 35 to 37. Taxation Ruling TR 2001/13 titled Income tax: Interpreting Australia's Double Tax Agreements at paragraphs 101 to 105 explains the Commissioner's view that the OECD Model Tax Convention and Commentaries are relevant to interpreting Australia's tax treaties. The question posed also correctly recognises that the Business Profits Article has limited application as it does not override or extend to other items of income that are dealt with separately by other Articles of the Country X DTA. In other words if the Company has a permanent establishment in Australia the profits attributable to that permanent establishment will be taxable in Australia. However, note that in answer to Question 2 below it has been determined that the Company does not have a permanent establishment in Australia. | Summary: This question concerns the existence of a fixed place of business of the Company in Australia in which the Company carries on business, in other words, a permanent establishment. The work is to be performed variously at the sole premises of the Australian subsidiary and at premises of the Australian Customer. It is envisaged that there will be S Company personnel involved in performing work in Australia under the Contract who will make a total of approximately T individual trips with an average duration of Q days per trip and have a total presence in Australia of approximately ZZ days. In the first year of the Contract there were Company employees who made a total of R trips to Australia with an average duration of HH days per trip and they had a total presence in Australia of HHH days. The actual and proposed presence of the Company employees in Australia means that the Company does not carry on business at a fixed place for a period that constitutes a permanent establishment. | Detailed Reasoning - Detailed reasoning: The definition of a "permanent establishment" is given in the Permanent Establishment Article of the Country X DTA. The activities, which the Company carries on in Australia in connection with the Contract, such as training the staff of the Australian Customer, mean that its business is partly carried on in Australia. The issue then becomes a question as to whether those activities are conducted at a fixed place of business in Australia. The Company's employees who either have visited or will visit Australia will perform their work in Australia at Y different locations. These are given as the sole premises of the Company's Australian subsidiary and three premises of the Australian Customer. Various facts were noted in respect to 'Services'. It is further contended that a permanent establishment exists by reference to a fixed place only if it is "more than merely temporarily" at the disposal of the enterprise. This is in accordance with the decision in Unisys Corporation Inc v FC of T [2002] NSWSC 1115. The Company personnel will visit Australia only temporarily. The average stay in Australia of Company personnel will be a few weeks. In order to consider the presence of the Company's employees in Australia in terms of the Permanent Establishment Article of the Country X DTA it is proposed to refer to the OECD Model Tax Convention Commentary on the relevant article in the Model Tax Convention. Accordingly the OECD Model Tax Convention on Income and on Capital July 2010 in the Commentary on Paragraph 1 of Article 5, which is the Permanent Establishment Article, states: Paragraph 1 gives a general definition of the term 'permanent establishment' which brings out its essential characteristics of a permanent establishment in the sense of the Convention, i.e. a distinct 'situs', a 'fixed place of business'. The paragraph defines the term 'permanent establishment' as a fixed place of business through which the business of an enterprise is wholly or partly carried on. This definition therefore, contains the following conditions: · the existence of a 'place of business', i.e. a facility such as premises or, in certain instances, machinery or equipment; · this place of business must be 'fixed', i.e. it must be established at a distinct place with a certain degree of permanence; · the carrying on of the business of the enterprise through this fixed place of business. … ' These conditions are considered with respect to the activities of the employees visiting Australia during the course of the Contract. The presence in Australia of the visiting employees and the work performed to date and to be performed in the future at various locations by the Company employees represents the carrying on of business in Australia by the Company. Yet given the short duration of the visits and the Y locations at which the work may be performed the employees' presence does not have the necessary degree of permanence in order to be said to be 'fixed'. Thus it is concluded that the Company does not have a fixed place of business in Australia. As the Company does not have a fixed place of business in Australia it therefore does not have and will not have a permanent establishment in Australia in terms of the Permanent Establishment Article of the Country X DTA. A permanent establishment can also exist if the Company has a dependent agent in Australia who has authority to enter into contracts and who habitually exercises that authority in terms of the Permanent Establishment Article. It is considered that the presence in Australia, for a short period of time, of the Company's representative for the purpose of signing one contract, should not be regarded as the habitual exercise of authority to enter into contracts: see for example, Unisys Corporation v FC of T [2002] NSWSC 1115. | Summary: Activities performed in Country X by the Company under the Contract need to be considered in order to determine whether the profits from those activities are attributable to a permanent establishment in Australia. This requires an examination of the specific terms of the Business Profits Article of the Country X DTA. | Detailed Reasoning - Detailed reasoning: The Business Profits Article of the Country X DTA prescribes that specific conditions must exist in order for that Article to apply. In the Relevant facts above it is stated that each of the first two activities listed in this question being the provision of commercial-off-the shelf software to the Australian Customer and the arranging of licences of commercial-off-the-shelf software supplied by persons other than the Company group is to be performed entirely in Country X. The third category of activity, described as 'other work' in the question posed, is also said to be performed in Country X. In view of the nature of the first two activities they do not have any inherent characteristic which would link them to a permanent establishment in Australia. The third activity of unspecified 'other work' in connection with the Contract also has nothing to suggest an inherent connection to a permanent establishment in Australia. As all three activities are to be performed in Country X they do not have a physical connection to Australia because they take place overseas. Performance of the activities overseas likewise means that the profits from such services could not be said to be attributable to a permanent establishment located in Australia. Accordingly the Business Profits Article of the Country X DTA does not apply. | Summary: If the amounts received by the Company under the Contract, to the extent they are consideration for providing commercial-off-the-shelf software to the Australian Customer under the Contract, are 'royalties' as defined in the Country X DTA, are they paid in respect of rights or property that is not effectively connected with a permanent establishment of the Company situated in Australia, so that the amounts are dealt with under the Royalties Article of the Country X DTA? | Detailed Reasoning - Detailed reasoning: Royalties derived by a non-resident from an Australian source are subject to withholding tax. Section 128B(2B) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that, subject to certain exclusions, section 128B of the ITAA 1936 will apply to income derived by a non-resident that consists of a royalty paid by an Australian resident. Section 128B(5A) of the ITAA 1936 provides that a person who derives royalty income to which to which section 128B of the ITAA 1936 applies, is liable to pay withholding tax on that royalty income. The withholding rate applicable is generally 30% of the royalty amount (Regulation 42 of Taxation Administration Regulations 1976). In determining the liability to Australian tax on Australian source income derived by a non-resident it is necessary to consider both domestic income tax law and the relevant double tax agreement which in this case is the Country X DTA. The Royalties Article of the Country X DTA contains a definition of 'royalties'. For the purposes of the present ruling, it is not necessary to decide whether the payments received under the Contract by the Company from the Australian Customer as consideration for providing commercial off-the-shelf software comes within the terms of the definition of "royalties" in the Royalties Article of the Country X DTA. The Royalties Article provides that royalties derived from an Australian source by a resident of Country X may be taxed in Australia, but the tax is not to exceed a specific percentage of the gross amount of the royalties. However, turning to the second part of this question it is necessary to consider the terms of another paragraph of the Royalties Article of the Country X DTA. Where the royalties are effectively connected with a permanent establishment of the Company that is located in Australia then the abovementioned percentage limit on the rate of tax will not apply and the Business Profits Article of the Country X DTA will apply. The Business Profits Article gives taxing rights to Australia if the profits of the Company, in the form of royalties in this case, are connected to a permanent establishment of the Company in Australia. It provides for such profits to be taxed on a net basis. In the circumstances of this case where all of the activities, that give rise to the right or property in respect of which the royalties are paid, are performed in Country X the royalties are not effectively connected with a permanent establishment or fixed place situated in Australia. Therefore the Business Profits Article does not apply. The Royalties Article of the Country X DTA applies to the royalties received by the Company for providing commercial-off-the-shelf software to the Australian Customer under the Contract.

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