Assessable income: United States double tax agreement - trust income

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

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

The US 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 US entity. The US entity is beneficially entitled to a share of the net profits derived from the production.

The US entity is also 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 2 and 2A of the Agreements Act contains the US Convention and Protocol respectively between Australia and the US. The US Convention and Protocol operate to avoid the double taxation of income received by Australian and US residents.

Where the US Convention gives Australia the right to tax an amount, Article 27(1)(a) 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 refer to the application of the US Convention and Protocol. 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 US Convention provides that the business profits of a US enterprise shall be taxable only in the US unless the enterprise carries on business in Australia through a permanent establishment (PE) situated in Australia. For the income derived by the US entity to be taxable in Australia, it is necessary to establish that the US entity is an enterprise that carries on business in Australia through a PE.

By entering into the contract to invest in the theatrical production, the US entity has an enterprise in accordance with 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 by the US entity through a PE, Article 7(9) of the US Convention is relevant. For Article 7(9) to apply, the following requirements must be satisfied: • a resident of a Contracting State is beneficially entitled under a trust to a share of business profits of an enterprise carried on in the other Contracting State by the trustee of the trust; and • in relation to that enterprise the trustee has a PE in the other Contracting State in accordance with the principles of Article 5 of the US Convention.

In the present case, the first requirement is satisfied because the US entity is a resident of the US and is beneficially entitled to a share of the business profits carried on by Ausco as trustee.

The second requirement is satisfied because Ausco derives business profits from staging a play in an Australian theatre for 6 months which amounts to a PE. Article 5(1) of the US Convention defines a permanent establishment 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 US Convention because the subsection 6(1) definition 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.

Article 7(9) of the US Convention is satisfied and has the effect of deeming the enterprise carried on by the trustee to be a business carried on by the US entity through a PE in Australia. The US entity's share of business profits is also deemed to be attributed to that PE.

The income to which the US entity is beneficially entitled will have the character of business profits because subsection 3(4) of the Agreements Act deems the US entity which is presently entitled to trust income to derive that trust income, which is income from carrying on the business of theatrical production.

As a result, Article 7 of the US Convention applies to give Australia the right to tax the business profits to which the US entity is beneficially entitled to under the trust. Article 27(1)(a) of the US Convention also operates to deem the income to be sourced in Australia.

The US 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 US entity is a non-resident at the end of the year of income, Ausco as trustee is liable to be taxed upon the US entity's share of the trust income that is deemed by Article 27 of the US 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 US entity as beneficiary, however, a deduction is allowed for the tax paid by Ausco as trustee against the income tax assessed to the US entity.