Assessability of income received by a US resident company with an employee in Australia

Is the income derived by a taxpayer, a company resident in the United States of America (US), from the sale of the company's products in Australia, assessable under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The income derived by a taxpayer company from the sale of the company's products in Australia, is assessable under subsection 6-5(3) of the ITAA 1997.

The taxpayer is a company and is a resident of the US. The taxpayer is not a resident of Australia for income tax purposes.

The taxpayer develops, sells and maintains specialist publication and document management software and sells their products to Australian customers. However, all contracts are written and signed in the US, including maintenance contracts.

The taxpayer is registered for Goods and Service Tax (GST) in Australia and pays GST on all sales to Australian customers.

The taxpayer holds no substantial equipment or goods for sale in Australia.

The taxpayer has an Australian resident employee who is required to undertake work duties at their home. The employee has maintained a home office for a number of years and this will continue on an ongoing basis. Separate office machines and communications devices are available for the employee to undertake their activities. The taxpayer reimburses the employee for these costs.

The duties performed by the employee at the home office include attending calls and emails from customers regarding support queries and performing consultancy jobs for customers. The employee is also responsible for the installation and on site support for Australian customers. The employee works forty hours per week and spends approximately one day per month at the customer sites.

The employee has no sales authority and cannot enter into contracts on behalf of the taxpayer.

The taxpayer engages an accounting firm in Australia to perform the necessary compliance and administration functions and to act as registered agent for Australian Securities & Investment Commission purposes.

The taxpayer has an Australian bank account which is administered by the accounting firm.

The employee has no access to the taxpayer's Australian bank account.

Subsection 6-5(3) of the ITAA 1997 provides that the assessable income of a non-resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources.

The income derived by the taxpayer from the sale of their company's products to Australian consumers is ordinary income under subsection 6-5(3) of the ITAA 1997.

In determining liability to Australian tax on Australian sourced income received by a non-resident, 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 both Acts are read as one. The Agreements Act effectively overrides the ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Schedule 2 to the Agreements Act contains the tax treaty between Australia and the US (the US Convention). Schedule 2A to the Agreements Act contains the protocol amending the US Convention (the US Protocol). The US Convention and the US Protocol operate to avoid the double taxation of income received by Australian and US residents.

Article 7 of the US Convention governs the taxation of business profits derived from Australia by a resident of the US. Under Article 7, the business profits of an enterprise of the US shall be taxable only in the US unless the enterprise carries on business in Australia through a permanent establishment situated in Australia.

The term 'permanent establishment' is defined in Article 5(1) of the US Convention as a fixed place of business through which the business of an enterprise is wholly or partly carried on.

The United States Tax Court held that a well-known author's home office was their fixed place of business through which the business of an enterprise was carried on and that office therefore was a permanent establishment ( Georges Simenon v. Commissioner of Internal Revenue (1965) 44 T.C. 820).

The taxpayer's business has a permanent establishment in Australia under Article 5(1) of the US Convention, as the taxpayer has an employee that is carrying on the taxpayer's business in Australia through a fixed place, being the home of the employee, and the employee has been performing their duties from their home for a number of years.

As it has been established that the taxpayer is carrying on the business through a permanent establishment situated in Australia under Article 5(1), the deeming provision within Article 5(4) of the US Convention does not need to be considered. Therefore, the fact that the employee cannot enter into contracts on behalf of the taxpayer is not relevant.

Article 5(3)(e) of the US Convention provides that an enterprise shall not be regarded as having a permanent establishment solely as a result of maintaining of fixed place of business for the purpose of activities which have a preparatory or auxiliary character.

The term 'preparatory or auxiliary' is not defined. Paragraph 4 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that the decisive criterion as to whether an activity has a preparatory or auxiliary character is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole.

It is considered that the activities performed by the employee for the taxpayer are customer relationship activities and are an essential and significant part of the service of the taxpayer to its Australian customers. Article 5(3)(e) of the US Convention, therefore, does not apply.

Accordingly, Article 7 of the US Convention applies, and the profit of the business, so much of them as is attributable to that permanent establishment, is taxable in Australia. The income from the sale of the taxpayer's products attributable to the permanent establishment is therefore assessable under subsection 6-5(3) of the ITAA 1997.