Assessable income: United Kingdom double tax agreement - trust income

Is income derived by a United Kingdom (UK) entity from an Australian theatrical production carried out by an Australian resident company (Ausco) as trustee, assessable under the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The income derived by the UK entity will be assessable to Ausco (as trustee) under subsection 98(3) of the ITAA 1936. The income will also be assessable to the UK entity as a beneficiary under section 98A of the ITAA 1936, but a deduction is allowed against the income tax assessed to the UK entity for the tax paid by Ausco as trustee.

The UK entity is a resident of the UK for tax purposes.

The UK entity enters into a contract with Ausco to invest funds in a theatrical production (the production) in Australia.

Ausco carries on the business of staging the production in Australia.

The production is staged in an Australian theatre for at least 6 months.

Ausco acts as trustee for the UK entity. The UK entity is presently entitled to a share of the net profits derived from the production.

In determining 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).

Schedule 1 of the Agreements Act contains the UK Convention respectively between Australia and the UK. The UK Convention operates to avoid the double taxation of income received by Australian and UK residents.

Where the UK Convention gives Australia the right to tax an amount, Article 21 will deem the amount to have an Australian source for the purposes of the ITAA 1936 and Income Tax Assessment Act 1997 (ITAA 1997). Accordingly, it is necessary to turn to the application of the UK Convention. It should be noted that section 4 of the Agreements Act provides that the ITAA 1936 and ITAA 1997 will have no application if Australia does not have taxing rights under the relevant Convention.

Article 7 of the UK Convention provides that the business profits of a UK enterprise shall be taxable only in the UK unless the enterprise carries on business in Australia through a permanent establishment (PE) situated in Australia. For the income derived by the UK entity to be taxable in Australia, it is necessary to establish that the UK entity is an enterprise that carries on business in Australia through a PE.

By entering into the contract to invest in the production, the UK entity has an enterprise within the meaning of that word as considered by the High Court in Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; (1990) 90 ATC 4717; (1990) 21 ATR 531.

As to whether a business is being carried on in Australia through a PE, subsection 3(11) of the Agreements Act is relevant. For subsection 3(11) to apply, the following requirements must be satisfied: • a beneficiary is presently entitled under a trust • the beneficiary is a resident of a country that Australia has concluded a tax treaty; and • the trust derives income from carrying on a business through an Australian PE • the income is to be dealt with under the business profits article of the relevant tax agreement.

In the present case, the first requirement is satisfied because the UK entity is a beneficiary who is presently entitled under a trust.

The second requirement is satisfied because the UK beneficiary is a resident of the UK. Australia has concluded a tax treaty with the UK.

The third requirement is satisfied because Ausco as trustee derives business income from staging a play in an Australian theatre for 6 months which amounts to a PE.

The term 'permanent establishment' in subsection 3(11) of the Agreements Act takes its meaning from the UK Convention (see subsection 3(12) of the Agreements Act). Article 5(1) of the UK Convention defines a PE to mean a fixed place through which the business of an enterprise is carried on.

Taxation Ruling TR 2002/5 considered what is a place at or through which a person carries on any business for the purposes of the PE definition in subsection 6(1) of the ITAA 1936. The discussion in TR 2002/5 applies equally to the meaning of PE under Article 5(1) of the UK Convention because the subsection 6(1) definition of PE is based on the concept of PE used in Australia's tax treaties (paragraph 9 of TR 2002/5). Under the principles discussed in TR 2002/5 in respect of temporal and geographic permanence of a PE, Ausco has a PE as it stages the production in a theatre for 6 months.

The fourth requirement is satisfied because the income to which the UK entity is presently entitled has the character of business profits by the operation of subsection 3(4) of the Agreements Act. The subsection deems the UK entity which is presently entitled to trust income to derive that trust income, which is income from carrying on the business of theatrical production.

Subsection 3(11) of the Agreements Act is therefore satisfied and has the effect of deeming the business conducted by the trustee to be a business carried on by the UK entity through a PE in Australia. The UK entity's share of the income is also deemed to be attributable to that PE.

As a result, Article 7 of the UK Convention applies to give Australia the right to tax the business profits to which the UK entity is presently entitled to under the trust. Article 21 of the UK Convention also operates to deem the income to be sourced in Australia.

The UK entity will be presently entitled to trust income when it receives or has the right to receive an amount of net profit pursuant to the contract. As the UK entity is a non-resident at the end of the year of income, Ausco, as trustee is liable to be taxed upon the UK entity's share of the trust income that is deemed by Article 21 of the UK Convention to be sourced in Australia (subsection 98(3) of the ITAA 1936).

Subsection 98(3) of the ITAA 1936 applies to assess Ausco as the trustee. Section 98A of the ITAA 1936 also assesses an amount to the UK entity as beneficiary, however, a deduction is allowed for the tax paid by Ausco as trustee against the income tax assessed to UK entity.