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SOME ASPECTS OF A PERMANENT ESTABLISHMENT IN AUSTRALIA
This article discusses the term "permanent establishment" ("PE") in Australian domestic tax laws and treaties. The Income tax Assessment Act 1936 (Cth) ("ITAA36") definition of a PE is contrasted with the concept of a PE under the OECD Model Convention ("OECD MC"), on which the tax treaties are generally based. The main features of a PE may be ascertained from an examination of the PE article in Australian tax treaties and evaluated with reference to the OECD MC commentaries. It is noted that Australia has adopted certain tests for a PE which the OECD MC did not incorporate. Other distinctive characteristics of the PE article in Australian tax treaty policy are also highlighted.
By Tan How Teck[*]
Under Art 7(7) of the OECD MC,[1] other articles are given primacy over the "business profits" article (Art 7) where the profits include items of income dealt with separately under those other articles. Based on Art 7(1), the profits of an enterprise are taxable only in the state of residence unless the enterprise carries on business in the source state through a PE situated therein. In that case, only so much of the profits which are attributable to the PE are taxable by the source state. The term PE, therefore, sets the threshold for a business presence which an enterprise may have in a country without being exposed to taxation by that country. In addition, where OECD MC Art 10(4), 11(4) and 12(3) apply, dividends, interest and royalties do not qualify for the reduced tax rates under the treaty. Instead, they may be taxed as business profits on a net basis.
This article examines some conceptual aspects of a PE in Australia. Part 2 examines the definition of a PE under s 6 of the ITAA36 and its relevance to other domestic tax provisions. Part 3 evaluates the main features of a PE in Australian tax treaties. The focus will be on the PE article in the OECD MC (Art 5).[2] Issues such as trusts,[3] the methods of attributing profits to a PE[4] and the implications of electronic commerce are outside the scope of this paper.
The term permanent establishment is defined in s 6(1) of ITAA36. The term, in relation to a person including the Commonwealth, a state or an authority of the Commonwealth or a state, means a place at or through which the person carries on any business. Without limiting the generality of the foregoing, the definition further includes a list of places which is discussed below.
OECD MC Art 5(1) defines a PE as a fixed place of business through which the business of an enterprise is wholly or partly carried on.
By contrast, the s 6(1) definition, which came into effect on 1 July 1968, omits the word "fixed". This suggests that the place of business need not be established with any degree of permanence.[5] Ambulatory activities which would escape the OECD MC Art 5(1) meaning of PE may thus be caught under the domestic rule. The s 6(1) definition also refers to "at or through", whereas the OECD MC uses the word "through". There may not be any practical distinction, however, as it seems that the word "at" connotes a specific place or time but the word "through" is not so limited in its meaning.
Under s 6(1)(b), a place where the person has, is using or is installing substantial equipment or substantial machinery will be a PE. The OECD MC does not contain this provision. Australia being a net capital importer, s 6(1)(b) is clearly aimed at preserving the Australian tax base. "Substantiality" is relative. It would appear that where the equipment or machinery required is not extensive, and the whole is involved, it is substantial.[6] Its value, size and weight are also relevant, though not decisive.[7] It would seem that the revenue-producing capacity of the equipment or machinery in relation to the total revenue of the enterprise may be less important. As the definition does not specify any time limit for the use of the asset, its use for just one day may amount to a PE.
Under s 6(1)(c), a place where the person is engaged in a construction project will be a PE. The term "construction project" is defined in s 221YHA(1) of the ITAA36 to include installation but only for the purposes of the prescribed payments system. Installation would arguably cover an assembly project, but not planning and supervisory activities which are carried on in connection with these projects.[8] Thus, if the s 221YHA(1) meaning of construction project can be applied in s 6(1), startup services which form installation work but are not strictly construction in nature will give rise to a PE.[9]
Section 6(1)(d) states that where a person is engaged in selling goods manufactured, assembled, processed, packed or distributed by another person for, or at or to the order of, the first-mentioned person and either person participates in the management, control or capital of the other person or another person participates in the management, control or capital of both of them, the place where the goods are manufactured, assembled, processed, packed or distributed will constitute a PE. Section 6(1)(d) overcame the decision in Case 110[10] which dealt with the old Australia-UK treaty.
Under s 6(1)(a), a place where the person is carrying on business through an agent will be a PE.
There are a few exceptions to this. Firstly, under s 6(1)(f)(i), there is no PE if the agent does not have, or does not habitually exercise, a general authority to negotiate and conclude contracts on behalf of the person. Secondly, under s 6(1)(f)(ii), there is no PE in Australia if the agent's authority extends to filling orders on the person's behalf from a stock of goods or merchandise situated in Australia but does not regularly exercise that authority. Thirdly, under s 6(1)(e), there will be no PE if 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 business as such and does not receive remuneration otherwise than at a rate customary for dealings of that kind. These exceptions are subject to the condition that the place is not one where the person otherwise carries on business.
It would appear that there be a "general authority" to negotiate and conclude contracts if, among other things, the terms and conditions are not exclusively set by the foreign principal.[11]
The OECD MC presupposes that an agent may constitute a PE of the foreign principal and requires the agent to make use of his authority repeatedly (habitually exercises).[12] By contrast, the s 6(1) definition refers to the place itself as a PE. The reference to customary rates in s 6(1)(e) presumably means an arm's length payment. Consistent with the OECD MC, the profits attributable to an agency PE in s 6(1)(e) would, in theory, be nil for the principal if the commission agent or broker is paid an arm's length amount.
Lastly, under s 6(1)(g), a PE excludes a place of business maintained by the person solely for the purpose of purchasing goods or merchandise. This provision is consistent with OECD MC Art 5(4)(d) which regards purchasing as an activity of a preparatory or auxiliary character and OECD MC Art 7(5) which requires that no profits be attributed to a PE for its mere purchase of goods or merchandise for the enterprise.
Under Australian domestic law, the PE concept is not generally relevant to determining the source of business profits.[13] The s 6(1) definition is, however, relevant to the s 23AH ITAA36 exemption, the source of royalty income derived by a non-resident under s 6C ITAA36, the withholding tax provisions in Div 11A, Pt III of ITAA36, the transfer pricing provisions in Div 13, Pt III of ITAA36, the active income test in s 432 ITAA36 under the controlled foreign company regime, and whether the disposal of an asset which has at any time been used by a taxpayer in carrying on a trade or business in Australia is the disposal of a "taxable Australian asset" for capital gains tax purposes under s 160T(1)(b) ITAA36. The term PE is also found in s 3(11) of the International Tax Agreements Act 1953 (Cth) ("ITAgtA") but s 3(12) ITAgtA states that this refers specifically to the PE in the relevant tax treaty.[14]
All the Australian tax treaties contain OECD MC Art 5(1).
The PE concept in OECD MC Art 5(1) and 5(2) presupposes the existence of an enterprise, its carrying on a business, and the existence of a place of business which is fixed and through which the business is carried on.[15] An "enterprise" may refer to an activity, and a framework within which activities are engaged in.[16] In the context of tax treaties, the words "carried on" do not require the enterprise to be engaged in a repetition of activity.[17] Professional activities are not enterprises in this respect. They are linked with the concept of "fixed base"[18] and professional income is generally taxable under the separate articles on independent personal services or artists and sportsmen.
In a Canadian case, the term PE was held to suggest something more substantial than a licence or a letterhead. The word "permanent" indicates permanence and stability.[19]
The term "fixed" implies that the place of business must not be purely temporary. A place of business which is intended to be more than temporary may be a PE even if unforseen circumstances cause it to be abandoned prematurely.[20] The activity carried on need not have a productive character.[21]
For a place of business to be a taxpayer's place of business, it has to be subject to control by the tax-payer or on the taxpayer's behalf.[22] It is sufficient for the taxpayer to have a legal right to use the place of business as a lessee; ownership or an exclusive right to use the place of business is not required.[23]
All the Australian tax treaties include as a PE a branch, office, factory, workshop and a place of management. Only the UK treaty refers to "management", although this term probably does not differ in meaning from a "place of management". A place of management is not necessarily an "office".[24] Based on Case 110, management predicates something less than central management and control, although it would involve managerial acts or a series of such acts.[25]
The treaties with Singapore and India include a "store or other sales outlet" as a PE. The Philippines treaty includes "premises used as a sales outlet" as a PE. A store would fall within the terms "branch" or "office".[26] For a sales outlet, a showroom used to secure orders may be included. The setting up of vending machines in itself would probably not qualify as a PE.[27]
Reflecting Australia's large agricultural sector, most treaties include "agricultural, pastoral or forestry property". Words to a similar effect are found in the Indian and Indonesian treaties, and "farm or forest" is found in the Chinese and Hungarian treaties. Income from such property will generally not be treated as business profits if it falls under the article as income from immovable property.
The terms "mine, quarry or other place of extraction of natural resources" are found in several treaties. "Oil well" and "gas well" are mentioned in the rest. These latter items may not be necessary as, it is submitted, the term "place of extraction" should not be read ejusdem generis with mine and quarry to refer only to minerals which can be unearthed. The Malaysian treaty also includes "timber or other forest produce".
Although not included in either the OECD MC or the UN MC, a "warehouse" will be a PE under the treaties with Thailand, India and the Philippines if it is in relation to a person providing storage facilities for others. The treaty with Singapore includes a warehouse except where it is used solely for any preparatory or auxiliary activity. The qualifications appear unnecessary since income from carrying on the principal business activity of providing storage for others would generally constitute a PE and would not be otherwise excluded under the equivalent of OECD MC Art 5(4) (see part 3.8).
Australia adopts the "substantial equipment" test for a PE. This test is not present in the OECD MC or the UN MC. The test is invariably found in a separate paragraph equivalent to OECD MC Art 5(1) and (2), reflecting its distinct status from the "fixed place of business" test. The use of substantial equipment is a business activity in itself and need not be of an extended duration to be a PE. In many of the treaties with regional countries, the "use of substantial equipment in Australia by, for or under contract with the enterprise" will constitute a PE in Australia.[28] To satisfy this test, it seems sufficient if the equipment belongs to the enterprise.[29] In many of the treaties with European countries, the use of substantial equipment must be related to the exploration for, or exploitation of, natural resources.[30] Australia has reserved its right to treat the use of such equipment for more than 12 months as a PE.[31] The minimum period of use is usually 6 or 12 months. The Irish treaty, however, refers to an installation used for the exploration (only) of natural resources and does not stipulate a minimum period.
The treaty with the US is unique in that it deems an enterprise as having a PE if the enterprise maintains substantial equipment for rental or other purposes (excluding equipment let under a hire-purchase agreement) for a period exceeding 12 months.[32]
By contrast, s 6(1)(b), the domestic provision on substantial equipment, does not indicate any duration for its use in Australia for a PE in Australia to arise. This, therefore, gives Australia some leverage in its tax treaty negotiations.
"An installation, a drilling rig or a ship used for the exploration for or exploitation of natural resources" for more than a minimum period also constitutes a PE under the treaties with the US, China, Spain and Indonesia.[33] Consequently, every exploration activity will lead to a PE after the lapse of the time limit, no matter whether the natural resources discovered are subsequently exploited by the enterprise itself or some other party.[34]
As they are found in the equivalent of OECD MC Art 5(2), these assets have to satisfy the "fixed" criterion in the "fixed place of business" test to qualify as PEs. An installation which rests on the seabed or is anchored to it meets the fixed criterion. Conversely, an installation which does not rest on the seabed or a floating facility at sea is not fixed.[35] The minimum period ranges from 3 months for China to 6 months in any 24 month period for the US. The Maltese treaty extends this provision to include supervisory activities in connection with the use of such equipment as a PE.
It is submitted that the bareboat charter of a rig would not constitute a PE for the rig owner as the charterer is responsible for both bunkers and the technical operation of the rig. The time charter lease of a rig would, however, constitute a PE. The reason is that the rig owner or manager would also be responsible for the crew and operation of the vessel.[36]
Although the above provisions refer to a "ship", profits from the operation of a ship in international traffic by an enterprise resident in a treaty country would be dealt with in OECD MC Art 8 on shipping and air transport.
In almost all the tax treaties, "a building site, construction, assembly or installation project" is included under Art 5(2). Only the 1995 revised treaty with New Zealand ("NZ") shows it as a separate paragraph, which the OECD MC does in Art 5(3). It is submitted that this difference in presentation is significant. It would appear that in the NZ treaty, the stipulated 6 month duration substitutes the permanence test in OECD MC Art 5(1) and (2).[37] A shorter period may still give rise to a PE if this satisfies the earlier paragraphs. Whereas if the item is listed among the specific examples in Art 5(2), it may arguably be implied that a shorter period will not result in a PE.
The term "building site or construction project" includes the construction of buildings, roads, sewer systems, bridges or canals, excavating, dredging and laying of pipelines.[38] A "building site" should be regarded as a single unit, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically.[39] The term "installation project" would seem to refer to the putting together or regrouping of pre-fabricated elements.[40] A site exists from the date the contractor begins his work, including any preparatory work, to the date the work is completed or permanently abandoned. The minimum period required for a PE to exist varies. It is usually 6 or 12 months. The shortest is 90 days for PNG. The 9 month period for the US reflects a compromise. Art 5(5) of the NZ treaty contains a unique provision for counting the minimum period.
Australia has reserved its position on the OECD MC with regard to designated supervisory activities carried on by an enterprise for more than 12 months.[41]
Most of the treaties include supervisory activities in connection with a building site, construction, assembly or installation project. The minimum period for supervisory activities to constitute a PE is normally the same as that for the site or project in each treaty.[42]
Australia adopts the "furnishing of services" provision found in UN MC Art 5(3)(b) in the treaties with the Czech Republic and several non-OECD countries in the region.[43] The usual minimum period for a PE is 90 days. This applies to India, PNG and Kiribati. The longest is 183 days or 6 months in any 12 month period. The treaties with China and the Philippines, however, explicitly require the furnishing of services to be for the "same or a connected project". Interestingly, Art 5(7) of the UK treaty defines "industrial or commercial profits" to include income derived by an enterprise from the furnishing of services of employees or other personnel but not remuneration for personal services and income of public entertainers and athletes. It would, however, still appear to be necessary to establish that such profits are profits of a PE, as Art 5(7) does not itself treat the enterprise as a PE.
OECD MC Art 5(4) on preparatory or auxiliary activities acts as an exclusion not only to the PEs in Arts 5(1) to 5(3), but also in Art 5(5). Preparatory or auxiliary activities do not form an essential and significant part of the activities of the enterprise as a whole.[44] However, this principle is clearly enshrined only in the treaties with the US, Finland, Malta, Sri Lanka and more recently, Spain.[45]
OECD MC Arts 5(4)(a) to (e) is generally adopted in Australian tax treaties with minor differences:
(a) The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
(b) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
(c) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
(e) The maintenance of a fixed place of business solely for the purpose of carrying on activities which have a preparatory or auxiliary character for the enterprise, such as advertising or scientific research.
Most treaties adopt sub-para (a) above. It is submitted that the term "goods or merchandise" means all finished and semi-finished goods and raw materials which constitute stock-in-trade of the enterprise. This view is supported by the fact that under OECD MC Art 5(4)(c), goods or merchandise were the subject of "processing".[46]
However, in the treaties with Singapore, India and Indonesia, the term "delivery" was omitted from sub-para (a). UN MC Art 5(4)(a) also omits "delivery". The omission reflects the view that the presence of a stock of goods for immediate delivery facilitates sales and hence the earning of profits in the source country.[47] The Sri Lankan treaty uses the words "occasional delivery" instead of "delivery". This appears to steer a middle course. An isolated instance of delivery will still be protected from source state taxation, whereas something more frequent than occasional will not be.
In sub-para (b), the term "stock" refers to the trading stock of the enterprise. Both sub-paras (a) and (b) reflect the principle that the mere existence of a stock of goods in a country without sale does not give rise to any taxable presence.
In sub-para (c), the stock is stored on the premises of another enterprise for processing by the latter. Such premises do not constitute a PE of the enterprise owning the goods stored. The stock itself would also not give rise to a PE.[48]
With regard to sub-para (d), OECD MC Art 5(4)(d) likens collecting information to a form of "mere purchase" of goods or merchandise.[49]
To come within sub-para (e), the activity must be solely for the enterprise to which the place of business belongs and not also aim at directly benefiting any third party. The supply of spare parts and maintenance services for machinery supplied to customers and management activities are not activities of a preparatory or auxiliary nature.[50] It is noted that OECD MC 1963 Art 5(3)(e) refers to "the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for similar activities which have a preparatory or auxiliary character, for the enterprise." The words in italics were, however, omitted in OECD MC 1977 on the ground that it is not clear whether the ejusdem generis rule would apply to the preparatory or auxiliary activities.[51] Australian tax treaties usually include advertising and scientific research as specific examples of preparatory or auxiliary activities and are, therefore, clear in this respect.[52]
Australia does not adopt the position in OECD MC Art 5(4)(f) that any combination of the preparatory or auxiliary activities in OECD MC Arts 5(4)(a) to (e) would also not give rise to a PE, if the combined activities are of a preparatory or auxiliary character. The equivalent of OECD MC Art 5(4)(f) is found only in a few treaties, notably the US and Korea.[53] Australia being a net capital importer in relation to the US, the US treaty clearly reflects the stronger bargaining position of the US.
OECD MC Art 5(4) states that "... the term PE shall be deemed not to include ...". By contrast, the equivalent provision in most Australian treaties usually begin with "[an] enterprise shall not be deemed to have a PE merely by reason of...". Therefore, in Australia, the fact that the activities of an enterprise fall within one of the sub-paragraphs on preparatory or auxiliary activities does not in itself imply that the enterprise will not have a PE in Australia.[54] Only the treaties with the UK, Japan and Italy follow the wording in the OECD MC.
OECD MC Art 5(5) gives an alternative test of PE to the "fixed place of business" test. If an enterprise has a PE within the scope of Art 5(1) and (2), subject to Art 5(4), it will not be necessary to show that the person in charge constitutes an agency PE of the enterprise under Art 5(5).[55]
The authority to conclude contracts must cover contracts which constitute the business proper of the enterprise. A person who is authorised to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise such an authority.[56] It would appear that an agent's authority to conclude contracts based only at prices and on terms set in advance by the foreign principal will not per se make him a dependent agent.[57]
The reference in OECD MC Art 5(5) to a person having an authority to conclude contracts in the name of the enterprise means that the agent has authority to conclude contracts binding on his principal. It is not limited to an agent acting for a disclosed principal.[58] The term "in the name of" refers to direct representation under civil law whereby an agent binds the principal but not himself to the third party. By contrast, under indirect representation in civil law, an agent acts in his own name and binds himself, not the principal, to the third party. Under common law, on the other hand, an agent generally binds his principal even though the principal may be undisclosed, so long as the agent acts within his actual authority.[59]
Cases where the principal is not bound by the agent's contracts fall outside both Art 5(5) and 5(6) and do not create a PE, whether or not the agent is acting in the ordinary course of his business.[60]
The equivalent of OECD MC Art 5(5) in Australian treaties sets out various situations which would give rise to a PE. Summing these up, a person acting in Australia on behalf of an enterprise resident in the treaty country, other than a broker, general commission agent or an agent of an independent status who is acting in the ordinary course of its business, will be deemed to be a PE of that enterprise in Australia if:
(a) the person has, and habitually exercises in Australia, 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;
(b) the person has no such authority, but habitually maintains in Australia a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise;
(c) in so doing, the person manufactures or processes in Australia for the enterprise-goods or merchandise belonging to the enterprise;
(d) the person's activities consist wholly or principally of securing orders in Australia for the enterprise or for the enterprise and other enterprises which are controlled by it or have a controlling interest in it.
Paragraph (c) was one of Australia's reservations to the OECD MC.[61] Paragraphs (a) and (c) are found in almost all the Australian tax treaties. Paragraph (b) resembles UN MC Art 5(5)(b) and is present in many treaties. The Thailand and Sri Lankan treaties contain para (d). The corresponding provision in the Indian treaty also covers enterprises which are subject to common control.
The US treaty contains a unique provision, Art 5(4)(d). Article 5(4)(d) is intended to achieve the same result as para (c) above but it is more specific. It deems a person to be a PE in Australia of a US enterprise if the person has goods or merchandise belonging to the enterprise that:
(i) were purchased by it in Australia, and not subject to prior substantial processing outside Australia; or
(ii) were produced by it or on its behalf in Australia,and are, after such purchase or production, subject to substantial processing in Australia by an enterprise where either enterprise participates directly or indirectly in the management, control or capital of the other enterprise, or where the same persons participate directly or indirectly in the management, control or capital of both enterprises.
Under this provision, the purchase and smelting of alumina by a US-Australia joint venture company in Australia for the joint venture members would render the company a deemed PE in Australia of its members.[62]
Australia has consistently used the terms "binding" or "for or on behalf of" instead of the term "in the name of" in the equivalent of OECD MC Art 5(5) in its tax treaties.
The general view is that OECD MC Art 5(6) operates as an exception to Art 5(5).[63] It excludes from the PE definition an independent agent if the principal is bound by contract made by him, so long as the agent is acting in the ordinary course of his business. If an independent agent concludes a contract which is outside the ordinary course of his business, he will not constitute a PE of the enterprise unless he had also an authority to conclude such a contract. If the activity is merely preparatory or auxiliary in character, it will not result in the enterprise having a PE.[64]
Factors which determine whether an agent is a dependent or an independent agent include the degree of control the enterprise exercises over the agent and the extent of any enterpreneurial risks to be borne by the agent or by the enterprise he represents.[65]
A person cannot be said to act in the ordinary course of his business if, in place of the enterprise, he performs activities which, economically, belong to the sphere of the enterprise rather than to that of his own business operations.[66] It would appear that whether an activity is carried on in the ordinary course of business depends on whether the activity is, by the common consent of those in the business, within the competence of the line of business concerned.[67] A narrow definition of an agent's business could, therefore, result in a PE where a wider definition would not. It is submitted that the mere fact that the volume of business from a particular activity is small would not preclude it from being a part of the ordinary course of the business.[68]
Based on the UK case of Fleming v London Produce,[69] a "general commission agent" must have sufficient broker-like qualities. The word "general" in the term suggests that the commission agent must be one who holds himself out as being ready to work for clients generally and who does not confine his activities to one principal or an insignificant number of principals. This view was adopted in Case 23/93.[70]
An agent will come within OECD MC Art 5(6) only if he is independent of the enterprise both legally and economically, and he acts in the ordinary course of business when acting on behalf of the enterprise.[71] Either legal or economic dependence of the agent on the principal will render the agent a PE of the principal. Based on the US case of Taisei Fire and Marine Insurance Co Ltd et al v Com,[72] the level of dependence must rise above that of basic instructions regarding the tasks to be accomplished. If an agent has discretion over the details of its work and the principal has no control over the agent through ownership, the agent is likely to be legally independent.
It is submitted that an agent's economic independence would depend on, among other factors, the extent that the agent's total turnover is earned from a particular principal, or from a group of principals who are able to act in concert with one another.
The UN MC envisages that an agent whose activities are devoted wholly or almost wholly on behalf of the enterprise may still qualify as an independent agent.[73] In this respect, the treaties with China, India, Thailand and Indonesia specifically state that such an agent will not be regarded as an independent agent. Art 5(6) of the Philippines treaty states that such an agent will not be treated as an independent agent if the transaction between the agent and the enterprise is not at arm's length.
Partners are agents of one another at common law. On one view, the agency test is not necessary for partners as the fixed place of business of the domestic partner or partnership will be attributed to the foreign partner or partnership.[74] An alternative proposition is that a PE under Art 5(5) implicitly assumes that the agent acts for someone else and does not himself become a part of the deal.[75] Further, all agents are subject to the principal's instructions. It could not, however, be said that a partner is similarly dependent on the other partners. In addition, agents usually earn a commission for their services while partners normally share the partnership profits. All these differences would seem to distinguish agents under the PE article from partners.[76]
It would seem, therefore, that partners will have to fulfil the conditions under OECD MC Art 5(5) and 5(6) separately to qualify as agents. This view is further supported by the fact that modern treaties do not require the agent to maintain a place of business to be a PE.[77]
A subsidiary is a separate taxable entity. The mere fact of its ownership by the parent company does not make it a PE of the parent or the parent its PE under OECD MC Art 5(7).[78] The subsidiary will be a PE of its parent company only if it satisfies the conditions in Art 5(5) and 5(6).[79] Thus, a subsidiary, if it is an independent agent, will be a PE of its parent company if it concludes contracts for the latter based on authority which is outside the ordinary course of its business.
All the Australian tax treaties include this provision.
Australian treaties do not adopt UN MC Art 5(6) which treats an insurance enterprise resident in a contracting state as having a PE in the other contracting state under certain conditions. However, Australian treaties typically have a provision in the "business profits" article on insurance with non-residents.[80] Its effect is to preserve Australian domestic rules of taxing income derived by non-resident insurers from providing non-life insurance in Australia.[81] In relation to a UK resident carrying on film business in Australia which is controlled abroad, income derived by the UK resident under any contract or agreement with any person will also be taxable under Australian domestic law.[82] A similar provision is found in the protocol to the Japanese treaty.
The PE article in many Australian treaties contains a unique provision which requires the principles in the PE article to be applied in determining whether there is a PE outside both the contracting states and whether an enterprise, not resident in either contracting state, has a PE in one of them. The determination is for the purpose of either the whole treaty or a specific provision in the interest or royalty articles. These provisions deem the interest or royalty to arise in the state where the PE is situated if the payer, wherever he is resident, has in one of the contracting states or outside both of them, a PE in connection with which the indebtedness or liability to pay was incurred, and the payments are deductible in computing the profits attributable to that PE.[83] Consequently, where such a PE is situated in a contracting state, that state will have a right to tax the interest or royalty, regardless whether the payer is resident in the other contracting state or a third country.
Article 4(8) of the 1967 revised UK treaty was inserted to overcome the decision in Case 110.[84] A UK enterprise which sells to a person in Australia goods manufactured, assembled, processed, packed or distributed in Australia by another enterprise for, at or to the order of, the UK enterprise will be deemed to have a PE in Australia, if either enterprise participates directly or indirectly in the management, control or capital of the other enterprise, or if both enterprises are subject to common control. It appears that even a small degree of participation is sufficient for this provision to apply.
A similar provision is otherwise found only in Art 3(8) of the Japanese treaty which was concluded on 20 March 1969. A similar provision found in the 1969 Singapore treaty was omitted by the 1989 Protocol. It is apparent that this provision, as worded, no longer characterises Australian tax treaty policy. A possible explanation may be that Art 4(8) of the UK tax treaty is merely a more specific provision which was intended to achieve the same result as para (c) (see part 3.9.1).
Tan How Teck BEc (Hons) (Adel), ACCA and CPA (Singapore) is a lecturer at Nanyang Business School at the Nanyang Technological University of Singapore. He previously worked at the Singapore Inland Revenue and Deloitte & Touche in Singapore and is currently pursuing a Master of Tax degree at the University of Sydney.
[*] This paper is adapted from a research essay which the author prepared as part of his M Tax course at the University of Syd-ney. The author is grateful for the comments of the anonymous referee who reviewed this article.
[1] Unless otherwise stated, OECD MC refers to the OECD MC 1996 (OECD, Model Tax Convention on Income and on Capital, Paris, September 1996). The changes which have been incorporated in the latest version of the OECD MC (November 1997) do not affect this paper.
[2] For an analysis of the relationship between the PE article and the articles on business profits and capital gains, see R Vann and L Burns, "Tax Treaties, the One-Shot Deal and Capital Gains: Thiel v FCT" (1990) 2 Tax Notes International 1137 and I Gzell, "Double Talk: Emerging Trends in Tax Treaties" Taxation in Australia Intensive Seminar (28 October 1992).
[3] See the International Tax Agreements Act 1953 (Cth) ("ITAgtA"), ss 3(3), (4), (11) and (12); J Avery Jones, H Depret and M van de Wiele, M Ellis, P Fontaneau and P Fontaneau, J Killius, R Lenz, T Magney and D Orrock, S Roberts and S Goldberg, V Uckmar and G Maisto and D Ward, "The Treatment of Trusts Under the OECD Model Convention - I" (1989) 2 British Tax Review 41–60 and "The Treatment of Trusts Under the OECD Model Convention - II" (1989) 3 British Tax Review 65–102.
[4] See T Magney, Australia's Double Taxation Agreements: A Critical Appraisal of Key Issues (1994) 27–42.
[5] OECD MC Commentary 5.2.
[6] Case 98, 7 CTBR (NS) 652 (per Mr Fletcher) ("Case 98"). An issue in that case was whether machinery used in Australia was "substantial" in the context of Art II(1)(o) of the old Australia-US tax treaty.
[7] Case 98, 653–654.
[8] Compare OECD MC 1963 and 1977 in K van Raad, Model Income Tax Treaties (2nd ed, 1990) 16.
[9] J Hadaway, "Supervisory Activities as Permanent Establishments: The Australia/Japan Treaty" (1993) 3 Revenue Law Journal 48, 55.
[10] Case 110, 5 CTBR (NS) 656 ("Case 110"). In that case, the taxpayer, a UK resident company, sold goods in Australia through agreements with related companies in Australia. Under the agreements, goods were manufactured by an Australian company, purchased by the taxpayer and delivered to distributors in NSW and Victoria. These distributors sold the goods in Australia at prices fixed by the taxpayer. Orders for the goods were placed with the manufacturer by the distributors and paid for by anoth-er related company in Australia. The taxpayer had a representative in Australia who was a director of the manufacturer and the chairman of the NSW distributor. The Board held that the taxpayer did not have a PE in Australia. There was no "management" in Australia as the representative had no managerial duties. The taxpayer did not have a "factory" in Australia as the manufac-turer owned the factory. Moreover, the manufacturer was not an agency of the taxpayer as it did not fill orders on the taxpayer's behalf from a stock of goods in Australia.
[11] This would appear to be at least the US position. See Revenue Ruling 1955– 1 CB, 55–282 (Canadian Treaty), cited in R Williams, "Permanent Establishments in the United States" (1976) 29(2) Tax Lawyer 277, 340.
[12] OECD MC Commentary 5.32.
[13] Magney, above n 4, 34.
[14] The effect of ITAgtA, s 3(11) is that a non-resident beneficiary of a trust estate, not being a prescribed trust estate under s 3(1) of the ITAgtA, will have a deemed PE in Australia if the beneficiary is resident in a treaty country and the trustee is carry-ing on business in Australia through a PE. The deeming is for the limited purpose of determining whether the beneficiary's share of the income of the trust estate is taxable in Australia.
[15] OECD MC Commentary 5.2 and 5.12.
[16] Thiel v FC of T 90 ATC 4717, 4720 ("Thiel"). In the context of the whole OECD MC, the term "enterprise" would appear to refer variously to a person, a business and sometimes both a person and business. K van Raad, "The Term "Enterprise" in the Model Double Taxation Conventions - Seventy Years of Confusion" in K van Raad; H Alpert and K van Raad (ed), Essays on International Taxation (1993) 317, 318–319.
[17] Thiel, 4724.
[18] J Huston, "The Case Against Fixed Base" (1988) 10 Intertax 282.
[19] Consolidated Premium Iron Ores Ltd 57 DTC 1146.
[20] OECD MC Commentary 5.6.
[21] OECD MC Commentary 5.7.
[22] MNR v Sunbeam Corp (Canada) Ltd [1961] Can TC 45.
[23] K Vogel, Double Taxation Conventions (1991) 155. The leased asset under a finance lease would not normally be a PE of the lessor as the lessor does not have a right to use the place of business during the lease. In an operating lease, the lessor's employ-ees who are operating the leased asset may constitute a PE unless their responsibility is limited to the operation or maintenance of the leased assets under the lessee's direction, responsibility or control; OECD MC Commentary 5.8.
[24] OECD Commentary 5.13.
[25] Case 110, 668 (per Mr Burke).
[26] Williams, above n 11, 321.
[27] OECD MC Commentary 5.10.
[28] Treaties with Taiwan, Fiji, India, Malaysia, NZ, the Philippines, PNG, Sri Lanka, Thailand, Vietnam, France, Ireland, Nor-way and Poland.
[29] Case 98.
[30] Treaties with Belgium, Denmark, Finland, Italy, Hungary, Netherlands, Sweden, Switzerland, Canada and Korea. The treaties with China, Malta and Spain include an "installation, drilling rig and ship" in the provision on substantial equipment. This is elaborated in part 3.4 of this article.
[31] OECD MC Commentary 5.46.
[32] US treaty, Art 5(4)(b).
[33] This clause is found in the US MC 1981 but not in the OECD MC or UN MC. K van Raad, above n 8, 17.
[34] Vogel, above n 23, 225.
[35] A Skaar, Permanent Establishments: Erosion of a Tax Treaty Principle (1991) 137.
[36] Ibid 194.
[37] Ibid 343.
[38] OECD MC Commentary 5.16.
[39] OECD MC Commentary 5.18.
[40] Vogel, above n 23, 221.
[41] OECD MC Commentary 5.46.
[42] If an enterprise carrying out purely planning and supervisory activities has an office, the office will not be a fixed place of business if the site or project itself does not constitute a PE. OECD MC Commentary 5.17.
[43] Treaties with China, Fiji, India, Indonesia, Kiribati, the Philippines, PNG, Sri Lanka, Taiwan and Thailand.
[44] OECD MC Commentary 5.24.
[45] US treaty, Art 5(4)(a); Finland treaty, Art 5(5)(a); Malta treaty, Art 5(5)(a); Spanish treaty, Art 5(5)(a).
[46] A process connotes a substantial measure of uniformity of treatment or system of treatments: Vibroplant Ltd v Holland [1980] STC 671.
[47] UN MC Commentary, UN Model Double Taxation Convention Between Developed and Developing Countries (1980) 67.
[48] Vogel, above n 23, 234.
[49] OECD MC Commentary 5.22.
[50] OECD MC Commentary 5.24 and 5.25.
[51] K van Raad, above n 8, 18; Vogel, above n 23, 233–234.
[52] One reason for treating advertising and scientific research as preparatory or auxiliary activities is that it is often hard to allo-cate a part of profits to the enterprise based on activities which may not give any return for some time: Skaar, above n 35, 307–309.
[53] OECD MC, Art 5(4)(f) was added in the OECD MC 1977: K van Raad, above n 8, 18.
[54] Magney, above n 4, 20.
[55] OECD MC Commentary 5.35.
[56] OECD MC Commentary 5.33.
[57] Williams, above n 11, 340.
[58] It has been noted that the UK added an observation to the OECD MC 1992 commentary. OECD MC 1992 Commentary 5.45 states that the UK considers that an agent who is not an agent of independent status within Art 5(6) and who has the character-istics described in paras 32 and 33 of the commentary will represent a PE of an enterprise if he has the authority to conclude con-tracts on behalf of that enterprise whether in his own name or that of the enterprise (emphasis added). J Avery Jones and D Ward, "Agents as Permanent Establishments Under the OECD Model Tax Convention" (1993) 5 British Tax Review 341, 351.
[59] An exception applies where the terms of the contract specifically exclude the liability of the undisclosed principal. See Avery Jones et al, above n 58, 344–346 for a fuller discussion.
[60] The ordinary course of business test assumes that an agent is considered dependent if his activity is the principal's business and that an otherwise independent person who performs an activity within the ordinary course of his business is not conducting the principal's business. An agent who performs a business which does not belong to the ordinary course of his business is likely to be a dependent agent. The ordinary course of business test raises some issues: Avery Jones et al, above n 58, 370–372.
[61] OECD MC Commentary 5.46.
[62] Magney, above n 4, 40.
[63] See Avery Jones et al, above n 58, 343. For a different view based on civil law, see S Roberts, "The Agency Element of Per-manent Establishment: The OECD Commentaries from the Civil Law View (Part One)" (1993) 9 Intertax 396 and "The Agency Element of Permanent Establishment: The OECD Commentaries from the Civil Law View (Part Two)" (1993) 10 Intertax 488, 500–501.
[64] Vogel, above n 23, 259.
[65] OECD MC Commentary 5.38.
[66] OECD MC Commentary 5.37.
[67] See the Bundesfinanzhof Decision of September 23 1983, Ill R 76/81 (1984) BStBl, II 94, in P Baker, Double Taxation Con-ventions and International Tax Law (2nd ed, 1994) 149.
[68] L Burns, "Australia Tribunal Considers Independent Agent Exception in Treaty's Permanent Establishment Definition" (1993) Tax Notes International 234, 236.
[69] (1968) 2 All ER 975, 985–986 (per Megarry J).
[70] 93 ATC 288, 295–296.
[71] OECD MC Commentary 5.37.
[72] 104 TC 535 (1995), cited in D Davison, "Agents as Permanent Establishments: Avoiding the US Income Tax for Foreign Busi-nesses" (1996) Taxes 101, 106–109. In that case, the plaintiffs were four Japanese publicly traded property and casualty insur-ance companies. Two of the companies were licensed to sell insurance in the US, but not the other two. Each company main-tained offices in the US to gather information on the US insurance market, and to assist its US clients. The representative offices could not, however, write any insurance. Besides these US business activities, the companies engaged Fortress Inc in North Car-olina to obtain and service reinsurance contracts in the US. Fortress Inc bore its own costs of operations. It used outside insur-ance brokers, rather than serve as a broker itself. The US Tax Court held that the plaintiffs had no PE in the US as Fortress Inc was not economically or legally dependent on them.
[73] UN MC, Art 5(7).
[74] The US position is that a non-resident alien in either a general or limited partnership operating in the US would have a PE within the US. See No. 630 v MNR 59 DTC 300; Johnston v Com 24 TC (US) 920; Donroy Ltd v US (1962) 301 F 2d. 200, cited in Baker, above n 67, 151 and Williams, above n 11, 322.
[75] OECD MC Commentary 5.31.
[76] Skaar, above n 35, 164–165.
[77] Ibid 166 and 474.
[78] OECD MC Commentary 5.40.
[79] In Firestone Tyre and Rubber Co Ltd v Lewellin [1957] 1 All ER 561–569, a UK company was held to be a PE of its US par-ent.
[80] See Australia's reservation on OECD MC, Art 7 in OECD MC Commentary 7.53.
[82] UK treaty, Art 5(8); Div 14 Pt III, ITAA36.
[83] See eg, NZ treaty, Arts 11(5) and 12(5).
[84] Case 110, 656.
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