Private ruling: Dual residency; permanent establishment; interest income
Published: April 2013
Ruling period: Income year ended 30 June 2009 | Income year ended 30 June 2010 | Income year ended 30 June 2011 | Income year ended 30 June 2012 | Income year ending 30 June 2013 | Income year ending 30 June 2014 | Income year ending 30 June 2015
Date scheme commenced: The scheme has commenced.

Ruling: Q1: Is Company A a resident of Country X for the purposes of the Double Tax Agreement between Australia and Country X ('the DTA') in respect of the income years ended 30 June 2009 to 30 June 2015 (inclusive)? | A1: Yes | Q2: Does Company A carry on its business through a permanent establishment situated in Australia, for the purposes of Article F of the DTA? | A2: Yes | Q3: Will interest income derived by Company A from Australian Financial Institutions be included in the assessable income of Company A pursuant to section 6-5 of the Income Tax Assessment Act 1997? | A3: Yes. | Q4: Will interest income derived by Company A from loans provided to Company A's subsidiaries be included in the assessable income of Company A pursuant to section 6-5 of the Income Tax Assessment Act 1997 ? | A4: No.

Relevant facts and circumstances: Background Company A was incorporated in Australia. Company A's registered office is located in Australia. Company A is also a resident of Country X under the domestic tax law of Country X. Company A has a number of wholly owned subsidiaries of which some are incorporated in Australia, the others are incorporated in either Country X or other jurisdictions. Business activities in Country X Company A carries on a number of business projects in Country X. Company A's business projects in Country X are all conducted by its subsidiaries in Country X. The majority of the assets in relation to the projects are owned by the subsidiaries. Around the beginning of the 20XX income year, a key director (finance director) of Company A's management team relocated from Australia to Country X. The finance director became actively involved in managing Company A's business in Country X. Since the beginning of the 20XX income year, the management of the Company A group is largely conducted from Country X. Company A's management team provides group management services to its subsidiary companies. Company A's Board of Directors The Board of Directors of Company A and shareholders regularly meet in Country X. During the 20XX to 20YY income years, the majority of the executive directors of Company A's Board have been based in Country X. The executive directors hold the positions of Managing Director, Chief Executive Officer and Finance Director and are responsible for the overall management of the Company A Group, Group Finances and maintaining relations with various Country X's stakeholders. One of non-executive directors of Company A is based in Australia. The non-executive directors of both Country X and Australia, carry out duties consistent with the normal role of a non-executive director, including providing an independent view in areas such as: · Offer constructive challenges and contributions to the development of corporate strategy; · Scrutinise the performance of management in meeting agreed strategic goals and objectives and monitoring senior management succession planning; · Assess the adequacy of the financial information produced by the company, the financial controls and systems of risk management; and · Consider appropriate levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, senior management and in succession planning. Board meetings The majority Board meetings held during the period between 200Z and 20YY were held in Country X. Business operations Company A has loaned significant funds (through interest-bearing intercompany loans) to its Country X incorporated subsidiaries to finance their operations in Country X. In the context of Company A's business proper, the day to day business decisions and the key management and commercial decisions as regards capital raising, loan funding, investment decision, acquisitions and disposals of equity investments, remuneration of employees and directors are all made by the management team based in Country X. In respect of financing Company A's subsidiaries in Country X all decisions commencing with pre-lending due diligence activities through to the signing of the loan rests with the management team. Decisions to write-off non-performing loans and commencing debt-recovery action are also carried out in Country X. All in all, activities regarding the creation and management of loans to group companies are carried out by the Finance Director and Group Finance Manager, both of whom are located in Country X. Business activities in Australia Company A has an office in Australia, in which the part-time company secretary and a bookkeeper are based and which the single Australian resident non-executive director ('Australian director') uses occasionally when on company business. Board meetings, agendas and notes are prepared and retained in Australia although the Board meetings are not normally held in Australia. The Australian director participates in Company A's board meetings and along with the other non-executive directors is responsible for contributing to the company's business strategy, assessing adequacy of the company's financial controls and systems of risk management and scrutinizing the performance of senior management among others. The Australian director is a signatory on the Australian bank account maintained by Company A from which loan funds are disbursed. In this capacity his role is largely limited to an 'execution only' signatory role to authorise the payment of funds from the account on the basis of instructions received from Country X. In other words once the loan creation tasks have been completed and the decisions made in Country X, from an administrative perspective the transfer of funds to creditors and group companies is triggered by the Australian director's signature on the bank papers. The Australian director has no power to make investing decisions. The administration in relation to company regulations in Australia is carried out by the company secretary from the Australian office. All administrative liaison with the Australian regulator for companies is via the Australian office. Bookkeeping for all Australian subsidiaries is provided by the part-time bookkeeper. The bookkeeper is required to post certain journals in relation to loans (e.g. revaluations, foreign exchange movements and recording interest) made to Company A's subsidiaries. The relevant analysis is prepared by Country X finance team and the journal entries are provided to the bookkeeper by the finance team in Country X. Director's insurance and some travel arrangements are organised by the Australian office. Additionally, the Australian office Iiaises with the Australian based external auditors although the group finance function is located in and led from Country X. Company A's Australian bank account Company A maintains an interest bearing bank account with a financial institution in Australia. The funds included in the account were raised predominantly outside of Australia, and on the strength of Company A's business operations in Country X. As for the basis for retention of the bank account in Australia, the nature of usage of funds from that account and the responsibilities of the Australian office in respect of that account, the ruling application provides that: · The funds are maintained in Australia primarily to manage Country X's requirements in respect of funds borrowed overseas; · The funds included in the account were raised to finance the operations of Country X's business and the funds have historically been used in this way; · The funds from the account in question are not used to directly pay the expenses of the Australian office. A separate bank account is maintained for this purpose; · The performance of the funds invested does not, in any way, impact the remuneration of the staff based in Australia; · The Australian office does not take on any significant commercial risks and requires minimal 'free capital' funding; and · The Australian staff's responsibilities towards the bank account are largely administrative in nature. During the period under consideration, Company A's only source of income in Australia is the interest earned on the Australian bank account. In Country X, Company A derives income in the nature of intra group management fees charged to its non-Australian subsidiary companies, interest earned on intercompany loans and dividend income.


Reasons for decision: Summary: In relation to companies, the term resident of Australia is defined in subsection 6(1) of the Income Tax Assessment Act 1936 ('the ITAA 1936') to mean: '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.' Because Company A is incorporated in Australia, it will be a resident of Australia pursuant to subsection 6(1) of the ITAA 1936. As advised in the ruling application, Company A is also a resident of Country X under Country X's domestic tax law. Accordingly, Company A is a resident of both Australia and Country X for the purposes of the domestic tax laws of each country. In such a case, it is necessary to consider the applicable agreement as defined in section 3AAA or section 3AAB of the International Tax Agreements Act 1953 ('Agreements Act') to determine Company A's residency. The applicable agreement in these circumstances is the Agreement X ('the DTA'). Article E of the DTA will deem the company to be a resident of only one of the two countries for the purposes of the DTA. In terms of Article E of the DTA a company which is a resident of both countries is deemed to be a resident solely of the country in which its place of effective management is situated. The term 'effective management' is not defined in the DTA. In interpreting the wording of the DTA, the Commissioner in Taxation Ruling TR 2001/13 accepts that it is appropriate to have reference to the OECD Commentary on the Model Tax Convention on Income and on Capital ('the OECD Commentary'). The OECD Commentary states at paragraph 24 on Model Article 4 that: · the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity's business are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management. · various factors need to be taken into account to determine the residence of a legal person such as where the meetings of its board of directors or equivalent body are usually held, where the chief executive officer and other senior executives usually carry on their activities, where the senior day to day management of the person is carried, etc. In the present circumstances, Company A's business activities include raising capital, investing in shares in its subsidiary entities in Country X and making loans to those entities to finance their ongoing business operations in Country X. Since the beginning of the 20XX income year, the management of the Company A group is largely conducted from Country X where key members of the management team are based. The Board of Directors of Company A and shareholders regularly meet in Country X. The day to day business decisions and the key management and commercial decisions as regards capital raising, loan funding, acquisitions and disposals of equity investments, remuneration of employees and directors are all made by the management team based in Country X. The decision to enter into loans commencing with pre-lending due diligence activities through to the signing of the loan rests with the management team. Decisions to write-off non-performing loans and commencing debt-recovery action are also carried out in Country X. As the key management and commercial decisions in respect of Company A's business are carried out in Country X, it is considered that Company A's place of effective management is in Country X and the company will be deemed to be a resident solely of Country X for the purposes of the DTA. The Commissioner, in Taxation Ruling TR 98/17 , accepts that where the tie-breaker test in a double tax agreement provides that a dual resident be treated solely as a resident of the treaty partner country for the purposes of the agreement, Australian resident status is not lost for purposes of the general operation of the domestic law. However the terms of the relevant double tax agreement should be referred to when determining tax liability. Hence, even though Company A will be considered a resident of Country X for the purposes of the DTA, it will continue to be treated as an Australian resident for the purposes of Australian domestic tax law. For instance, Company A will be regarded as an Australian resident when deciding whether interest withholding tax should be imposed in terms of section 128B of the ITAA 1936. According to Article G of the DTA, the business profits of an enterprise of Country X shall be taxable only in Country X unless the enterprise carries on business in Australia through a permanent establishment situated in Australia. The term 'permanent establishment' is defined in Article F of the DTA as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Paragraph 2 of the OECD Commentary on Article F of the OECD Model Tax Convention explains that the definition of permanent establishment contains the following requirements: · 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. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the state in which the fixed place is situated. Article F of the DTA contains a list of examples each of which can be regarded as constituting a permanent establishment such as an office, a place of management, a branch, a factory or a workshop. In this instance, Company A has an office in Australia, where the company secretary, the Australian director and a bookkeeper are permanently based and which the Australian director uses occasionally when on company business. The Australian director participates in Company A's board meetings and along with the other non-executive directors is responsible for contributing to the company's business strategy, assessing adequacy of the company's financial controls and systems of risk management and scrutinising the performance of senior management among others. As a signatory to Company A's Australian bank account, he is responsible for authorising payments from that account which have been approved by Company A's management team in Country X. Company A's company secretary deals with the company's business in relation to the Australian regulations as set out by the Australian regulator for companies. Finally, the part time bookkeeper carries out all the administrative duties in relation to the maintenance of Company A's loan accounts with its group companies and its bank accounts in Australia. It is understood that the bookkeeper's administrative services in terms of maintaining accounts is also extended to the Australian subsidiaries in the group. Accordingly, Company A's office in Australia is considered to be a fixed place of business in Australia through which its business is carried on in terms of Articles F. Article F of the DTA also lists a number of business activities which are treated as exceptions to the general definition in Article F and which are not permanent establishments, even if the activity is carried on through a fixed place of business. The common feature of these activities is that they are, in general, preparatory or auxiliary activities. The term 'preparatory or auxiliary' is not defined. Paragraph 4 of the OECD Commentary on Article F of the OECD Model Tax Convention explains that the decisive criterion as to whether an activity has a preparatory or auxiliary character is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole. Paragraph 26 of the OECD Commentary states that, to be considered as preparatory or auxiliary activities, the activities of the fixed place of business must be carried on for the benefit of the enterprise itself. In other words, a fixed place of business which renders services not only to its enterprise but also directly to other enterprises, for example to other companies of a group to which the company owning the fixed place belongs, would not fall within the scope of a preparatory or auxiliary activity. In the present circumstances, the responsibilities of the non executive director in Australia and the provision of services by the bookkeepers to Company A's subsidiaries are for the direct benefit of Company A and Company A's subsidiaries. Accordingly, the business activities carried out through the Australian office would not fall within the scope of a preparatory or auxiliary character for the purposes of Article F of the DTA In conclusion, Company A has a fixed place of business situated in Australia and the employees of Company A are carrying on the business of the company through that fixed place of business. As such the fixed place of business in Australia constitutes a PE of Company A for the purposes of Article F of the DTA. Under Article G of the DTA, any business profits derived from carrying on a business through the PE in Australia will be taxable in Australia to the extent that they are attributable to the PE. As a resident of Australia for Australian income tax purposes, Company A's assessable income for the purposes of section 6-5(2) of the Income Tax Assessment Act 1997 ('the ITAA 1997') will include, in the first instance, income from all sources worldwide unless an exception applies. However, as Company A is solely a resident of Country X for the purposes of the DTA Company A is liable to tax in Australia only in limited situations. Therefore, Company A will remain, in relation to each country, a resident for the purposes of its domestic law and subject to each country's tax insofar as the DTA allows. Interest income derived by Company A in respect of funds held in an Australian financial institution ('passive interest income') is subject to Australian income tax pursuant to Article H (the Interest Article) of the DTA. However, pursuant to Article H, if the derivation of that interest income is 'effectively connected' to Company A's Australian PE, the interest will form part of the business profits of the PE and therefore assessable under the provisions of Article G (the Business Profits Article) of the DTA. Accordingly, it needs to be considered whether the passive interest income is 'effectively connected' to the business of Company A's Australian PE. The term 'effectively connected' used in Article H of the DTA is not defined by the DTA under the General Definitions Article. It is therefore relevant to consider the interpretation of this term by the OECD Commentary. The OECD Commentary (as it read on 22 July 2010) on paragraph 4 of the Interest Article provides at paragraph 25.1 that a 'debt-claim' (which is defined to include cash deposits, see paragraph 18) will be effectively connected with a PE and will therefore form part of its business assets, if the 'economic ownership' of the debt-claim is allocated to that PE. It is further explained that, in this context the 'economic ownership' of a debt claim means the equivalent of ownership for income tax purposes by a separate enterprise with the right to the interest attributable to the ownership of the debt-claim and the exposure to gains or losses from the appreciation or depreciation of the debt-claim. Merely recording the debt claim in the books of the PE does not satisfy the 'effectively connected' requirement. Taxation Ruling TR 2001/11 deals with the operation of Australia's PE attribution rules and introduces the PE concept in the sourcing of income and allocation of expenditure under subsection 136AE(4) of the ITAA 1936. Under paragraph 136AE(7)(b) of the ITAA 1936, such sourcing and allocation produce tax outcomes that are generally consistent with treating the PE as separate from the rest of the enterprise and dealing with it on arm's length terms. TR 2001/11 clarifies that the Interest Articles in Australia's tax treaties and the OECD Model Convention use the phrase 'effectively connected with' to describe the attribution concept of the Business Profits Article. In this regard the term 'effectively connected with' refers to the property giving rise to the income in question. TR 2001/11 provides that paragraph 136AE(4)(e) of the ITAA 1936 limits the subsection to applying only if, in the Commissioner's opinion, some part of the relevant income or expenditure is attributable to the activities conducted at or through the PE. Paragraph 3.18 of TR 2001/11 explains that income is attributable to activities conducted at or through a PE to the extent that those activities are, in substance, a contributing factor in generating the income or giving rise to benefits from expenditure incurred. In this regard, for each activity involving the PE it is necessary to identify the assets used and the risks assumed by the PE. In the present circumstances, the property giving rise to the income in question is the 'debt-claim' or the funds maintained by Company A in the Australian bank account which gives rise to interest. The funds maintained in the account have been and continue to be employed to finance the operations of Company A's subsidiaries in Country X. It is considered that the economic ownership of the funds will therefore rest with the entity that is responsible for: · raising the funds to enable loans to be made, making the funds available and managing the overall funding position; · providing loan support including collecting interest, monitoring repayments and value of any collateral given by the borrower; and · assuming the risks of having to repay the monies borrowed in the first instance and receive regular repayments of the moneys on lent. It has been concluded that Company A's business is effectively conducted through its offices in Country X. The funds held in Company A's Australian bank account were raised predominantly outside of Australia, and on the strength of Company A's business operations in Country X. The funds are maintained in Australia primarily to assist Company A with managing the regulations of the authority in Country X regarding the funds raised. The day to day business decisions and the key management and commercial decisions as regards capital raising, loan funding, acquisitions and disposals of equity investments, among others, are all made by the management team based in Country X. The decision to make loans to Company A's subsidiaries commencing with pre-lending due diligence activities through to the signing of the loan rests with the management team in Country X. Decisions to write-off non-performing loans and commencing debt-recovery action are also carried out in Country X. As all activities in relation to the raising of funds and the lending of those funds are carried out by the Finance Director and Group Finance Manager, both of whom are based in Country X, it is considered that all risks associated with the raising of funds and the making of loans are borne by Company A's office in Country X. The Australian based non-executive director is a signatory on the bank account, his activities in relation to the bank account are restricted to simply executing decisions made by Country X's based directors. The Australian PE of Company A is not considered to have 'economic ownership' of the funds held in Company A's Australian bank account (debt-claim) as it is not involved in the creation of the debt-claim, the use of the debt-claim, the maintenance of the debt-claim and does not assume any risks associated with the debt-claim. Consequently, the passive interest income is not 'effectively connected' to Company A's PE in Australia and will not therefore form part of its business profits for the purposes of Article G of the DTA. In the present circumstances, it is considered that the interest derived from the Australian bank account was effectively connected to Company A's PE in Country X. As the interest income is not effectively connected with Company A's Australian PE, it is subject to Australian tax under Article H of the DTA. | Detailed Reasoning - DTA -Taxation of interest: Article H of the DTA deals specifically with the taxation of interest income. It provides that the country where interest arises may also tax the interest income provided that the tax is not more than 10% of the gross amount. Article H further provides that interest is deemed to arise in the Contracting State where the payer is a resident. In the present case, interest is paid by an Australian resident financial institution and arises in Australia. Therefore Australia has the right to tax the passive interest income derived by Company A. The limitation of Australian tax rate to 10% accords with the general rate of interest withholding tax applicable under Australia's domestic law. | Detailed Reasoning - Domestic Law - Taxation of interest: Australia meets its obligations under the DTA by incorporating the various terms of the DTA directly into its domestic law (subsection 4(1) of the International Tax Agreement Act 1953 . Accordingly, it is necessary to determine the extent of Company A's liability to tax in respect of the passive interest income under the relevant domestic law provisions. Subsection 128B(2A) of the ITAA 1936 provides that where a resident pays another resident interest income withholding tax will apply if the recipient derives that interest in carrying on a business at or through a permanent establishment outside of Australia. It has been concluded above that the business of Company A, an Australian resident for domestic law purposes, is effectively conducted through its offices in Country X and that the interest derived from the Australian bank account is effectively connected to Company A's PE in Country X - not its Australian PE. In the present case, the terms of subsection 128B(2A) of the ITAA 1936 are satisfied because interest was paid by a resident Australian financial institution to Company A (which remains a resident for the purposes of the general operation of the domestic law) which in turn derived that interest through the activities of its PE in Country X. Accordingly subsection 128B(2A) of the ITAA 1936 can operate to impose withholding tax of 10% on the interest income paid by the Australian financial institution to Company A. As withholding tax is a final tax, section 128D of the ITAA 1936 generally makes amounts non-assessable when they are subject to withholding tax. However, the exemption in section 128D of the ITAA 1936 does not apply in a case, such as the present, where withholding tax is imposed under subsection 128B(2A) of the ITAA 1936. Accordingly, as an Australian resident, Company A will be assessable on the interest income under section 6-5 of the ITAA 1936. As Company A will be liable to interest withholding tax under subsection 128B(2A) of the ITAA 1936 in respect of the interest payment by a resident Australian financial institution, section 12-255 of Schedule 1 to the Taxation Administration Act 1953 ('TAA') requires a borrower to withhold from an interest payment on a loan where the interest is payable in Australia, but is derived by an Australian resident lender in carrying on a business through a permanent establishment in a country outside Australia. Note also that section 12-260 of Schedule 1 to the TAA requires the lender to facilitate this by giving a notice in writing to the borrower that the loan originated from a foreign branch of the lender. However, as the interest will be included in Company A's assessable income (as explained above), a credit will be allowed to Company A for the withholding tax which is deducted pursuant to section 18-30 of Schedule 1 to the TAA. | Detailed Reasoning - Question 4: As a resident of Australia for Australian income tax purposes, Company A's assessable income for the purposes of section 6-5(2) of the ITAA 1997 will include, in the first instance, income from all sources worldwide unless an exception applies. However, as Company A is solely a resident of Country X for the purposes of the DTA Company A is liable to tax in Australia only in limited situations. Therefore, Company A will remain, in relation to each country, a resident for the purposes of its domestic law and subject to each country's tax insofar as the DTA allows. Company A is a company which primarily invests in shares in subsidiary entities and makes loans to its subsidiaries to finance their ongoing business operations in Country X. Company A's management team in Country X provides group management services to its subsidiary companies. Company A has loaned significant funds (through interest-bearing intercompany loans) to its subsidiaries in Country X to finance their business operations and derives interest income from the loans. In those circumstances the interest income could conceivably be described as business profits or alternatively as interest. In the first instance it needs to be considered whether the interest is subject to taxation under the Interest Article (Article H). However, in the present circumstances payers of the interest are a resident of Country X. Therefore, Article H of the DTA will not deem the interest as arising in Australia and it is therefore will have no application. Article G (the Business Article) of the DTA allocates exclusive rights to tax business profits to the country of residence unless the profits are attributable to a PE, in which case the country where the PE is situated may also impose tax. In the present case, Company A has derived interest business income. Company A is a resident of Country X for the purposes of the DTA with a PE situated in Australia. Article G provides that the profits to be attributed to the PE are profits which the PE might reasonably be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a PE or with other enterprises with which it deals. Accordingly, it needs to be considered whether the interest business income derived by Company A is 'attributable' to Company A's PE in Australia. The interest business income would be considered as part of the business profits of Company A as they are profits arising from carrying on the business of the company. However, the interest business income is not attributable to Company A's permanent establishment in Australia under Article G of the DTA on the basis that: · All activities in relation to the raising of funds and the lending of those funds are carried out by the Finance Director and Group Finance Manager, both of whom are based in Country X, · All risks associated with the raising of funds and the making of loans are borne by the management team in Country X, · The Australian based non-executive director has no involvement in the loan creation or management activities. As a signatory to Australian bank account, the Australian director will execute some documents at the direction of the Country X based directors, and · The Australian director's activities are limited to the mere formal process of executing decisions made by the directors based in Country X. Accordingly, Article G of the DTA does not confer upon Australia a right to tax the interest business income arising from loans made by Company A. Consequently, the interest business income will not be included in the assessable income of Company A pursuant to section 6-5 of the ITAA 1997.