Assessablility of income derived by an Australian resident performing independent personal services in Germany

Is income derived by an Australian resident taxpayer from independent personal services performed in Germany assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. Income derived by a taxpayer from independent personal services performed in Germany is assessable under subsection 6-5(2) of the ITAA 1997.

However, there may be an entitlement to claim a foreign tax credit in Australia where German tax has been paid.

The taxpayer is a resident of Australia for tax purposes.

The taxpayer left Australia and commenced performing independent personal services in Germany. The taxpayer has no employment contracts with any of the clients that work is performed for.

The taxpayer's work is undertaken in a room in a rented share house which the taxpayer also resides in.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

However, in determining any liability to Australian tax 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 (Agreements Act) that exists between Australia and Germany.

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and 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 in some limited situations).

Schedule 9 to the Agreements Act contains the tax treaty between Australia and the Federal Republic of Germany (the German Agreement). The German Agreement operates to avoid the double taxation of income received by Australian and German residents.

Article 13 of the German Agreement provides that income derived by an individual who is a resident of Australia in respect of professional services, or other independent activities of a similar character, shall be taxable only in Australia unless the taxpayer has a fixed base regularly available to them in Germany for the purpose of performing their activities. If the taxpayer has such a fixed base, the income may also be taxed in Germany but only so much of it as is attributable to that fixed base.

The taxpayer is performing independent personal services within Article 13 of the German Agreement.

To assist in the interpretation of the German Agreement reference is made to Taxation Ruling TR 2001/13 - Income tax: Interpreting Australia's Double Tax Agreements.

Under this ruling, regard may be had to the OECD Model Tax Convention on Income and on Capital (the OECD Model) and the Commentaries on the Articles of the OECD Model (the OECD Commentary) including any subsequent revisions to that OECD Commentary to assist in the interpretation of double tax agreements. This approach was also accepted by the High Court in Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4717; (1990) 21 ATR 531 ( Thiel ) (see paragraph 102 of Taxation Ruling TR 2001/13). Unless specified otherwise, references to the OECD Model and OECD Commentary are to the version published on 28 January 2003.

Article 13 of the German Agreement is the same in substance as the former Article 14 of the OECD Model published on 23 October 1997.

Paragraph 3 of the OECD Commentary published on 23 October 1997 on Article 14 stated that 'the provisions of the Article were similar to those for business profits and rest in fact on the same principles as those of Article 7' of the OECD Model concerning the taxation of business profits. Moreover, 'the provisions of Article 7 and the Commentary thereon could therefore be used as guidance for interpreting and applying Article 14'.

Article 7 of the OECD Model permits the source country to tax the profits of an enterprise where that enterprise carries on business through a permanent establishment in that country.

Article 5 of the OECD Model defines permanent establishment to be 'a fixed place of business through which the business of an enterprise is wholly or partly carried on'.

Paragraph 2 of the OECD Commentary on Article 5 of the OECD Model explains that this definition provides three conditions necessary for a permanent establishment to exist: • there must be a place of business • the place of business must be fixed so that there is a distinct location with a certain degree of geographical and temporal permanence, and • the business of the enterprise must be conducted through that fixed place.

Paragraph 4 of the OECD Commentary on Article 5 of the OECD Model notes that the term 'place of business' covers any premises, facilities or installations used for carrying on the business whether or not they are used exclusively for that purpose. Paragraph 4 also notes that a place of business may exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by the enterprise or are otherwise at its disposal.

Paragraph 6 of the OECD Commentary on Article 5 of the OECD Model suggests that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency and is not of a purely temporary nature. A place of business may, however, constitute a permanent establishment even though it exists, in practice, for a very short period of time because the nature of the business is such that it will only be carried on for that short period of time.

Paragraph 6 of the OECD Commentary on Article 5 of the OECD Model further provides that 'experience has shown that permanent establishments have normally not been considered to exist in situations where a business has been carried on in a country through a place of business that was maintained for less than six months'.

This is also the approach generally taken by the Commissioner as set out in Taxation Ruling TR 2002/5. Paragraph 33 of TR 2002/5 states that 'Whether temporal permanence exists is a matter of fact and degree. However, as a guide, if a business operates at or through a place continuously for six months or more that place will be temporally permanent'.

However, paragraph 34 of TR 2002/5 also notes that in some situations a period of less than six months may be sufficient to lead to the conclusion that temporal permanence exists.

The independent personal services are conducted in a room in rented premises, which is also a place of business of the taxpayer, that room is fixed geographically, and the taxpayer has been conducting those services for a considerable period of time and there is an intention to continue those services (that is, there is temporal permanence), the taxpayer satisfies the requirements for having a permanent establishment in Germany and therefore a fixed base for the purposes of Article 13 of the German Agreement. Accordingly, Germany has a right to tax this income, but only so much of it as is attributable to that fixed base.

As the taxpayer is a resident of Australia for Australian income tax purposes the income derived by the taxpayer from the independent personal services in Germany is subject to Australian income tax under subsection 6-5(2) of the ITAA 1997 as Article 13 of the German Agreement permits Australia to tax this income.

In circumstances where tax is paid in Germany, then a foreign tax credit may be available in Australia. Article 22(1) of the German Agreement provides that, subject to the provisions of the law of Australia, a credit for German tax paid will be allowed against Australian tax payable on income from German sources. Note. With effect from 1 July 2008 the foreign tax credit system is replaced by the foreign income tax offset system. However, the position stated in this ATO ID in relation to a credit for German tax paid still applies after that date. In addition, the OECD Model and the OECD Commentary were amended on 17 July 2008, but the position stated in this ATO ID in relation to those publications still applies after that date. This ATO ID is still current.