When conducting international business operations in Australia, it is essential to understand the concept of a Permanent Establishment (PE) under Australian tax law. A PE is a critical element that can have far-reaching consequences on the international tax impact of your operations in Australia.
Why is a permanent establishment critical?
As international tax accountants in Perth, our first question for global family businesses is whether they operate a permanent establishment for offshore tax purposes and assess its business impact globally. Once your business is considered to have a PE in Australia, it triggers several tax consequences:
- The profits attributable to the PE are subject to Australian income tax. This can significantly impact your business’s overall tax liability.
- Australia has tax treaties with many countries to prevent double taxation. These treaties provide rules for allocating taxing rights between Australia and the foreign country. Your business should be aware of the specific provisions in these treaties.
- Payments made from your Australian operations to the foreign head office might be subject to withholding tax. This includes dividends, interest, and royalties.
- The ATO closely monitors transactions between the PE and the foreign head office to ensure they are conducted at arm’s length. Non-compliance with transfer pricing rules can lead to disputes and penalties.
- If your business provides goods or services in Australia through a PE, you may be required to register for Goods and Services Tax. This can impact pricing and the cost structure of your products or services.
- If your PE provides fringe benefits to employees, it may be subject to FBT in Australia.
Defining Permanent Establishment in Australian Taxation
A Permanent Establishment, commonly referred to as a “PE” or “branch,” is a place within a country where a business is conducted. It is part of the everyday dialogue for international tax accountants across Perth. This place must exhibit elements of permanence in geographic and temporal terms. The facts determine the level of permanence, and it is always unique. However, permanence does not mean forever.
Geographic permanence requires that the business operates in a distinct area, or a place viewed as a place of business. For instance, a stall set up at different locations within a market at various times demonstrates geographic permanence. Temporal permanence entails conducting business at a location for some time, typically six months or more.
And like any area of international taxation for Perth accountants, there are exceptions to the six-month rule. And The Commissioner of Taxation considers a presence in Australia for more than six months due to the COVID-19 pandemic as temporary, depending on the specific facts and degree of permanence in each case.
If your operations are structured so that you are a tax resident for Australian ATO purposes you will have a permanent establishment.
The definition of a permanent establishment for tax purposes includes several scenarios we commonly encounter as international tax accountants. These scenarios encompass:
- A place where a person conducts business through an agent, although if the person does not otherwise conduct business in that place, it does not qualify as a “permanent establishment.”
- A place where someone has, uses, or installs substantial equipment or machinery.
- A place where a person is engaged in a construction project.
- A place where a person sells goods manufactured, assembled, processed, packed, or distributed by another entity, and either entity participates in each other’s management, control, or capital.
Substantial Equipment Complexities
Determining what constitutes “substantial” equipment or machinery, as mentioned in scenario (b) above, can be challenging in practice for both Perth international tax accountants and their clients. The case of McDermott Industries (Aust) Pty Ltd v FC of T illustrates this challenge. It involved an Australian resident taxpayer entering a bareboat charter to use barges in Australian waters, leading to a debate about the meaning of “substantial equipment.”
The term “has, is using, or is installing” is also ambiguous. While “has” might imply ownership rather than physical possession, “is using” appears to encompass many situations. Issues may arise if machinery owned by one non-resident is used or installed by another non-resident.
Generally, double tax agreements specify that equipment must be used continuously for 12 months. The Commissioner has guided how this 12-month threshold applies, especially in exploring and exploiting natural resources.
Shipping and Aircraft Leasing under Double Tax Agreements
There is guidance discussing the treatment of shipping and aircraft leasing profits of US and UK enterprises under the “substantial equipment” provision in the Permanent Establishment articles of the Australia-US and Australia-UK double tax agreements. It emphasises that whether an item qualifies as “substantial equipment” is a matter of fact and degree, focusing on both absolute and relative substantiality.
The guidance delves into interpreting the term “maintains… for rental or other purposes… within Australia” and applying the 12-month test for determining continuous use. It also addresses the scope of the hire-purchase exclusion.
The Australian Taxation Office (ATO) has issued Taxpayer Alerts regarding cross-border leasing arrangements involving mobile assets and arrangements involving tax-consolidated groups with PEs. These alerts aim to scrutinise whether interposed companies are used for gaining favourable tax treaty treatment and whether the taxation of income aligns with the contributions made by Australian operations.
The definition of a permanent establishment in Australian tax law also provides exclusions. These exclusions encompass:
- A place where a person’s business dealings are conducted through a bona fide commission agent or broker, acting in the ordinary course of business and receiving customary commissions.
- A place where a person conducts business through an agent who does not have a general authority to negotiate and conclude contracts on their behalf or whose authority is limited to filling orders from a stock of goods in the country where the place is located.
- A place of business maintained solely for purchasing goods or merchandise.
These exclusions often apply in the context of Australia’s double tax agreements, which typically contain similar provisions concerning agents and their roles in determining the existence of a PE.
To illustrate the application of these principles, we can look at real-life cases such as the one involving a husband-and-wife resident in New Zealand who invested in Australian ASX shares through an Australian share dealer. The Australian Administrative Appeals Tribunal (AAT) determined their share trading enterprise was not carried out through a broker or general commission agent. Instead, the dealer was deemed to be little more than an extension of the taxpayers’ share trading enterprise, resulting in the creation of a PE in Australia.
Moreover, a general authority to conclude contracts is insufficient to establish a PE. In the Unisys Corporation Inc v FC of T case, it was ruled that there must also be a habitual exercise of that authority. This case emphasised that mere repetition of contractual activity may not suffice.
As international tax accountants diving into the range of real-life tax cases is of significant help to apply them to clients with international tax affairs who require tax advice from us in Perth or across Australia.
Board of Taxation Report
The Board of Taxation released a report in 2015 that examined tax arrangements related to PEs. The report delved into the concepts of “relevant business activity” (RBA) and the “functionally separate entity” (FSE) approaches in determining profits attributable to a PE under the OECD Model Tax Convention on Income and Capital. The report’s findings shed light on how the taxation of PEs is evolving and how businesses should approach their international operations considering these changes.
Permanent establishments and capital gains tax
If you are understanding capital gains tax then the concept of a permanent establishment for tax purposes is essential for both clients and their international tax accountants. When a capital gain or loss arises from an asset utilised while conducting business via a permanent establishment in Australia, the amount is adjusted if the asset was used this way for only a portion of the period between purchase and sale.
The asset in question must not fall under the category of taxable Australian real property, a CGT asset categorised as an indirect Australian real property interest, or a CGT asset covered by s 104-165(3), which allows for the option to disregard a gain or loss when ceasing to be an Australian resident.
The adjustment to the gain or loss is calculated using the following fraction:
Number of days the asset was not used in carrying on a business through a permanent establishment in Australia/Total number of days in that period.
For instance, consider this example:
A non-resident taxpayer purchased an asset on 1 January 2005 for $21,000. On 1 October 2005, the taxpayer first employed the asset in conducting business at the taxpayer’s permanent establishment in Perth. Later, the asset was sold on 10 January 2006 for $10,000. The period during which the asset was appropriately used amounts to 102 days (from 1 October 2005 to 10 January 2006), while the total ownership period covers 375 days (from 1 January 2005 to 10 January 2006). So, the capital loss is calculated as $11,000 multiplied by 102 (qualifying use days) divided by 375 (total ownership days), equalling $2,992.
Understanding the concept of Permanent Establishment is crucial for businesses engaged in international operations in Australia and their international tax accountants. It has significant implications for the taxation of these operations. This guide has provided an in-depth exploration of the definition of a PE, including the complexities surrounding geographic and temporal permanence, inclusions, exclusions, and the challenges of substantial equipment. Real-life cases and the Board of Taxation report highlight PE’s practical implications and evolving nature in Australian taxation. By grasping these concepts and staying informed about the latest developments, businesses can navigate the Australian tax landscape effectively and ensure compliance with tax regulations.
The impact of a permanent establishment also has more than the Australian tax issues. The international tax issues of the home country must be considered, which is where an international tax network like Geneva Group International is important so that your business can enjoy a single source of tax advice covering both Perth, Australia and your home country.
If you are thinking about structuring your business into Australia – call Westcourt today. We are deeply skilled at simplifying and streamlining the tax impact of structuring into Australia so you can minimise your upfront costs of structuring your new business venture into this country.