Assessability of income derived by a Japanese resident company from activities in Australia

Do the activities undertaken by a branch of a Japanese resident company in Australia constitute a permanent establishment in Australia within the meaning of Article 3(1) of the Australia/Japanese Double Tax Agreement, such that the income attributable to that permanent establishment is included in the assessable income under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. Under Article 3(1) of the Australia-Japan Double Tax Agreement (Japanese Agreement), the activities undertaken by a branch of the Japanese resident company do not constitute a permanent establishment in Australia, such that no income is assessable under subsection 6-5(3) of the ITAA 1997.

The taxpayer is a Japanese resident company that is an exporter of goods into Australia.

The Japanese resident company has a minority interest in an associated United States resident company.

The Japanese resident company has a branch in Australia, staffed by one employee who provides product advice to customers.

The activities of the Australian branch of the Japanese resident company are exclusively performed on behalf of the United States resident company.

The Japanese resident company has an Australian Business Number (ABN).

The Australian branch of the Japanese resident company does not habitually exercise the authority to conclude contracts.

Subsection 6-5(3) of the ITAA 1997 provides that the assessable income of a foreign resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year, and other ordinary income that a provision includes as assessable income on some basis other than having an Australian source. Subsection 995-1(1) of the ITAA 1997 defines a foreign resident to mean a person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936).

In determining liability to tax on Australian sourced income, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1997 so that those Acts are read as one.

Schedule 6 to the Agreements Act contains the tax treaty between Australia and Japan (the Japanese Agreement. The Japanese Agreement operates to avoid the double taxation of income received by Australian and Japanese residents.

Under Article 4 of the Japanese Agreement, the business profits of an enterprise of Japan shall be only taxable in Japan unless the enterprise carries on business in Australia through a permanent establishment situated in Australia.

The term 'permanent establishment' is defined in Article 3(1) of the Japanese Agreement as a fixed place of trade or business in which the trade or business of the enterprise is wholly or partly carried on.

Taxation Ruling TR 2001/13 discusses the Commissioner's views about interpreting tax treaties. Paragraph 104 states that the Commentaries on OECD Model Tax Convention on Income and on Capital (OECD Commentary) provide important guidance on interpretation and application of the OECD Model and will often need to be considered, as a matter of practice, in interpreting tax treaties, at least where the wording is ambiguous.

Paragraph 2 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that the definition of permanent establishment contains the following requirements: • the existence of a place of business such as premises, machinery or equipment; • fixed place of business which means that the place of business must be established at a distinct place with some degree of permanence even though it may have existed for only a very short time; and • personnel to conduct the business from that place.

Article 3(2) of the Japanese Agreement contains a list of examples each of which can be regarded as constituting a permanent establishment such as place of management, an office, a branch, a factory or a workshop. The Japanese resident company has a branch office in Australia. Article 3(2)(c) of the Japanese Agreement is therefore satisfied.

However Article 3(3) of the Japanese agreement further provides that a permanent establishment shall not be deemed to include maintenance of a fixed place of trade or business solely for the purpose of purchasing goods or merchandise, or for collecting information for the enterprise; or solely for the purpose of activities which have a preparatory or auxiliary character for the enterprise, such as advertising or scientific research. The activities of the Australian branch of the Japanese resident company are considered to be in the nature of collection of information and of auxiliary character.

Article 3(5) of the Japanese Agreement provides that a permanent establishment is deemed to exist if a Japanese enterprise carries on a business in Australia through a person (other than an independent agent) who has authority to conclude contracts on behalf of the enterprise and habitually exercises that authority in Australia.

The Commissioner considers that Article 3(5) of the Japanese Agreement is not satisfied as the authority to conclude contracts is not habitually exercised by the sole employee of the Japanese resident company's branch in Australia.

The Commissioner is of the view that the Japanese resident company does not have a permanent establishment in Australia. The Japanese resident company's income is therefore not assessable under subsection 6-5(3) of the ITAA 1997.