Assessability of profits from carrying on a business as a share trader by a non-resident

Are the profits derived by a non-resident taxpayer from carrying on a business as a trader in shares and options in Australian entities, assessable under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The profits derived by a non-resident taxpayer from carrying on a business as a trader in shares and options in Australian entities are assessable under subsection 6-5(3) of the ITAA 1997.

The taxpayer is a company and a non-resident of Australia for income tax purposes. Australia has no double tax agreement with the taxpayer's country of residence.

The taxpayer company is in the business of buying and selling shares and options listed on various stock exchanges. The company regularly buys and sells shares and options listed on the Australian Stock Exchange (ASX). It is the practice of the company to buy and sell the shares within a short period of time.

The taxpayer company has no office or staff in Australia. The company engages the services of an Australian stockbroker for the purpose of buying and selling the shares of Australian entities listed on the ASX. The stockbroker acts on the verbal instructions from one of the directors of the company located in a foreign country. The initial research and decision on which shares to purchase and sell are made by the same director of the company.

The stockbroker executes the orders in Australia on behalf of the taxpayer company. The stockbroker has no power to conclude contracts binding the company without the approval of the director. The taxpayer derives substantial profits from the sale of shares and options.

Subsection 6-5(3) of ITAA 1997 provides that the assessable income of a non resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year, as well as other ordinary income included by a provision on a basis other than having an Australian source.

For subsection 6-5(3) of the ITAA 1997 to apply, it is necessary to determine whether the profits from the trading of shares and options are ordinary income from Australian 'sources'.

The term 'source' is not defined in the ITAA 1997. Other than certain rules prescribed for statutory income (for example, royalties, interest), the ITAA 1997 relies on the common law 'source' rules.

In Nathan v. FC of T (1918) 25 CLR 183 at 189-190, Isaacs J said that the term 'source' meant not a legal concept, but something which a practical man would regard as a real source of income. In Federal Commissioner of Taxation v. Efstathakis (1979) 38 FLR 276 at 280; 79 ATC 4256 at 4259; 9 ATR 867 at 870 Bowen CJ stated 'the answer is not to be found in the cases, but in the weighting of the relative importance of the various factors which the cases have shown to be relevant.'

In Australian Machinery and Investments Company Ltd v. Deputy Commissioner of Taxation (WA) (1946) 180 CLR 9; 3 AITR 359; (1946) 8 ATD 81, it was held that where shares are situated outside Australia and sold outside Australia, the profit on sale is derived wholly from a source outside Australia. Starke J said at 180 CLR 9 at 27; 3 AITR 359 at 378; 8 ATD 81 at 95-96: The question is from what source or sources these various profits arise or to use Lord Atkin's phrase in Smidth & Co v. Greenwood (Surveyor of Taxes) ([1921] 3 KB 583, at p593) "where do the operations take place from which the profits [or for the purpose of the Income Tax Act 'the income'] in substance arise".

One rule deducible from the decided cases is that where the essence of the business ordinarily consists in making certain classes of contracts and in carrying those contracts into operation with a view to profit or income then for the purposes of Income Tax Acts, such as here under consideration, the business is carried on within the locality where such contracts are habitually made which is the source of the profit or income.'

Where, as in this case, the business is one of buying and selling shares and options, the relevant processes which contribute to the earning of the profit are the making of contracts for the purchase and sale of shares and options.

In such cases, it may be that more weight should be put on the place of the contract for the purchase and sale. Although the skill and judgement exercised by the director in the purchase and sale of shares and options contributed to the profits, they are immaterial in determining the source, since the question is not why but where the profits are made - D & W Murray Ltd v. Commissioner of Taxation (WA) (1929) 42 CLR 332.

The purchase and sale of shares normally involves entering into contracts and the contract is formed where the final act regarded as completing the contract occurs - Tallerman and Co Pty Ltd v. Nathan's Merchandise (Vic) Pty Ltd (1957) 98 CLR 93. Thus, where the postal acceptance rule applies, the contract is considered to be made in the place where the acceptance is posted, and in other cases the contract is made at the place where acceptance is communicated to the offeror.

When the process of purchase and sale of shares and options are examined, weighting needs to be given to the following factors in determining the source of the profits: • the essence of the taxpayer's business. In this case, the essence of the taxpayer's business is regularly entering into contracts for the purchase or sale of shares and options • activities that actually realise the profit, that is, sale of shares and options • place where the contracts for purchase or sale of shares and options are concluded, that is, contracts are concluded in Australia • location of the stockbroker who concludes the buy or sell order: the location of the stockbroker is in Australia • location of the entities whose shares or options are traded ,that is, in Australia

Though the director of the taxpayer company makes the decision as to when to purchase or sell the shares and options, this has minimal weighting in determining the source. The source is determined by where the profits are made. It is the buying and selling of shares and options undertaken in Australia, where the contracts are concluded, that actually realise the profit.

As all the important factors relating to the realisation of the profit take place in Australia, it follows that the source of the profit is in Australia.

Accordingly, the profits from the sale of shares and options in Australian entities are assessable as ordinary income under subsection 6-5(3) of the ITAA 1997.