Foreign assessable income and foreign allowable deductions

Are the expenses incurred by a resident taxpayer in the course of carrying on business as a placement agent allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The expenses incurred by a resident taxpayer in the course of carrying on business as a placement agent are allowable deductions under section 8-1 of the ITAA 1997.

The taxpayer company is a resident of Australia for income tax purposes.

The taxpayer is a placement agency operating in Australia.

The taxpayer wishes to attract qualified business and professional applicants for placement in Australia.

The taxpayer wishes to engage consultants in China to refer prospective applicants for placement to Australia.

The consultants in China operate their own independent businesses unrelated to the taxpayer.

The Chinese consultants target certain market segments (for example students, business people, and professionals) and advertise via newspapers, professional magazines.

Applicants express interest to the Chinese consultants.

The Chinese consultants forward the details of the applicant to the taxpayer.

The taxpayer completes an initial assessment. Once the applicant meets the criteria of the initial assessment, the taxpayer will send an engagement letter to the applicant via the Chinese consultants.

The engagement letter sets out the standard terms of engagement and statement of services to be provided by the taxpayer. The applicant signs the contract with the taxpayer.

Services to be provided by the taxpayer under the contract are: • advice on documents/forms preparation • review/assessment of documents • preparation and lodgment of assessment and applications • application procedure follow up • documents management • contact the relevant Australian government agencies on behalf of clients, and • fees are paid to the taxpayer for services provided by the taxpayer.

Applicants also pay for the visa application fees to the relevant government department.

The Chinese consultants then check the authenticity of documents and are responsible for coordinating with every level of Chinese government.

The Chinese consultants' expenses and fees will be paid by taxpayer from sources in Australia.

No office will be established in China by the taxpayer and no employees engaged.

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Subsection 8-5(2) of the ITAA 1997 provides that some provisions of the ITAA 1997 prevent a taxpayer from deducting an amount that could otherwise be deducted, or limit the amount that can be deducted.

The provisions which prevent or limit an otherwise deductible amount are listed in section 12-5 of the ITAA 1997. Included in this list is section 79D of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with limitations on deductions relating to foreign income.

Under section 79D of the ITAA 1936 where a taxpayer incurs foreign income deductions in relation to a class of assessable foreign income, and the amount of these deductions exceeds the amount of foreign assessable income of that class, then the deduction is limited to the amount of income received. The term 'foreign income deduction' has the same meaning as in section 160AFD of the ITAA 1936 (subsection 79D(2) of the ITAA 1936).

The term 'assessable foreign income' is defined in subsection 160AFD(9) of the ITAA 1936 as 'foreign income' that is included in the taxpayer's assessable income. Broadly, section 6AB of the ITAA 1936 defines 'foreign income' as income derived from sources in a foreign country. In determining whether, for the purposes of section 6AB, income has been derived from a source in a foreign country, no legislative rules are provided in section 6AB itself.

The question under consideration is whether the income derived by the taxpayer from the Chinese visa applicants is Australian sourced income or foreign sourced income.

As the term 'source' is not defined in the ITAA 1936 or ITAA 1997, reliance is placed on the general common law source rules as they relate to income.

Per Isaacs, Gavan Duffy and Rich JJ in Nathan v. Federal Commissioner of Taxation (1918) 25 CLR 183 at 190 'But the ascertainment of the actual source of a given income is a practical, hard matter of fact.'

Where the substantial element of the factual matrix is the performance of the contract, the place of performance is the only relevant factor. Jordan CJ in C of T (NSW) v. Cam & Sons Limited (1936) 4 ATD 32 at pp34 stated that: 'If the making of the contract is an insignificant factor, and the only substantial element is its performance, the place of performance is the only relevant locus of the source'. See also Sixsmith v. Commissioner of Taxation (1928) 28 SR (NSW) at pp461-464.

In the Commissioner of Inland Revenue v. Hang Seng Bank Ltd (1991) 1 AC 306, at pp322-323, Lord Bridge of Harwich stated: ....the question whether the gross profit resulting from a particular transaction arose in or derived from one place or another is always in the last analysis a question of fact depending on the nature of the transaction. It is impossible to lay down precise rules of law by which the answer to that question is to be determined. The broad guiding principle, attested by many authorities, is that one looks to see what the taxpayer has done to earn the profit in question. If he has rendered a service or engaged in an activity such as the manufacture of goods, the profit will have arisen or derived from the place where the service was rendered or the profit making activity carried on. But if the profit was earned by the exploitation of property assets as by letting property, lending money or dealing in commodities or securities by buying and reselling at a profit, the profit will have arisen in or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected.

The taxpayer intends to engage consultants in China to refer prospective visa applicants for placement to Australia. Consultants in China operating their own independent businesses unrelated to the placement, will refer prospective applicants to the taxpayer. These consultants in China will be paid for their services by the resident taxpayer.

An engagement contract between the visa applicants and the taxpayer for performing the placement advice services will be drawn up by the taxpayer in Australia. The performance of the services under the contract such as the preparation and lodgement of the skills assessment, preparation and lodgement of the visa application form, and dealing with any queries from the relevant government department, will all be carried out by the taxpayer in Australia. The resident taxpayer will be paid a fee for performing these services.

The services under the engagement contracts are performed in Australia. In this particular case, the activities of the resident taxpayer are essentially managed, controlled, organised and conducted in Australia. Only minimal activity is carried out in China. Therefore, it is considered that the income arising in respect of the visa applicants are attributed to sources in Australia and is therefore Australian sourced income according to common law. Hence, section 79D of the ITAA 1936 has no application and the restriction in that section imposed on foreign income deductions relating to foreign income does not apply.

In determining whether the income received by a taxpayer is foreign sourced, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreement Act 1953 (Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except for limited situations)

Schedule 28 to the Agreements Act contains the double tax agreement between Australia and China (the Chinese Agreement).

Generally a Double Tax Agreement's Source Article applies for the purposes of Australian domestic law and would be relevant if a permanent establishment existed. However, the Chinese Double Tax Agreement source of income Article 23(8) does not deem source for all purposes of Australian domestic law. It only has an impact on foreign tax credits and so is not relevant to determine source for section 160AFD of the ITAA 1936 purposes. Accordingly, the Double Tax Agreement and whether a permanent establishment exists is not relevant to this situation.

As the taxpayer's income is not assessable foreign income, we do not need to consider whether the payments to the consultants are 'foreign income deduction'.

Accordingly, the expenses incurred by a resident taxpayer in the course of carrying on business as a placement agent are allowable deductions under section 8-1 of the ITAA 1997.