Australia: Overseas supply to Australian resellers - taxation of the suppliers

In brief - Consequences of draft taxation determination TD 2018/D1 for companies in distribution chains

It is becoming increasingly common for businesses to arrange multinational supply chains, and obtain components of goods or disaggregate production/creation between different countries, especially where efficiencies, skills or path dependency generate efficiency and profit maximisation. The growth in online commerce has exacerbated this trend.

As this has happened, countries have become increasingly concerned at the erosion of the domestic tax base. The OECD has been working on BEPS (base erosion and profit shifting) for some years now, and Australia has been an integral participant in that process.

Australia's tax legislation has provisions for schemes that erode domestic taxable profit. Australia will (we expect) shortly legislate the OECD BEPS Convention into domestic law, which we wrote about recently in our article, The OECD Multilateral Instrument has widespread tax implications.

In early May 2018, the ATO issued a Draft Taxation Determination (TD 2018/D1) to assist taxpayers to determine when an arrangement can be a scheme that limits taxable presence in Australia.

Current legislation - the general anti-avoidance rule for income tax

Part IVA of the Income Tax Assessment Act 1936 (Cth) imposes the well-known General Anti-Avoidance Rule.

Section 177F of Part IVA permits the Commissioner to cancel or disallow tax benefits as the result of a scheme.

Section 177DA provides that "schemes that limit a taxable presence in Australia" are a scheme for the purpose of Part IVA. A scheme that limits a taxable presence in Australia requires the following features to exist under or in connection with the scheme:

  1. a foreign entity makes a supply to an Australian customer
  2. activities are undertaken in Australia "directly in connection with" the supply
  3. some or all of those activities are undertaken by an Australian entity who are undertaken at or through the Australian permanent establishment of an entity who is an associate of, or is commercially dependent on, the foreign entity, and
  4. the foreign entity derives ordinary or statutory income from the supply, some or all of which is not attributable to an Australian permanent establishment under foreign entity

BEPS Convention on Avoidance of Permanent Establishment Status

Article 12 of the OECD BEPS Convention, which will likely pass into Australian law shortly, provides:

Article 12 – Artificial Avoidance of Permanent Establishment Status through Commissionnaire Arrangements and Similar Strategies
1. ... where a person is acting ...on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are:
(a) in the name of the enterprise; or
(b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; or
(c) for the provision of services by that enterprise,
that enterprise shall be deemed to have a permanent establishment respect of any activities which that person undertakes for the enterprise unless these activities, if they were exercised by the enterprise through a fixed place of business of that enterprise situated in that Contracting Jurisdiction, would not cause that fixed place of business to be deemed to constitute a permanent establishment under the definition of permanent establishment included in the Covered Tax Agreement (as it may be modified by this Convention).
2. Paragraph 1 shall not apply where the person acting in a Contracting Jurisdiction to a Covered Tax Agreement on behalf of an enterprise of the other Contracting Jurisdiction carries on business in the first-mentioned Contracting Jurisdiction as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise.

In March 2018, the OECD issued Additional Guidance on the Attribution of Profits to Permanent Establishments pursuant to Action 7 in the 15 point Action Plan arising from the February 2013 report Addressing Base Erosion and Profit Shifting. The guidance provides various examples of how the Convention will affect multinational supply chains.

Meaning of "directly in connection with"

Against the background of the OECD's recent report, and the imminent incorporation of the OECD BEPS Convention into Australian Law, the ATO's draft determination provides assistance in determining the meaning of "directly in connection with" under section 177DA (and hence whether an arrangement passes the threshold into "scheme" territory).

The ATO considers that the "directly in connection with" test will be satisfied by a wider range of activities than simply executing a supply contract. It provides the following examples of what can be "directly" connected with a supply:

  1. contributing to bringing about the contract for the supply
  2. attracting new customers or maintaining existing customer relationships
  3. relating to the ability to supply the goods or service, or the manner in which it is supplied
  4. supporting the ongoing execution of a supply under an existing supply arrangement, and
  5. actively procuring demand for sales

The "directly in connection with" test may be satisfied even when a foreign entity makes a supply to an independent distributor who is returning sales income in Australia, including where:

  1. the Australian entity has increased demand from customers of the independent distributor, or
  2. the supply by the independent distributor to its customers is "inextricably" linked with the supply by the foreign entity to the independent distributor

The draft TD provides examples of direct connections with the supplies between a foreign company and Australia.

Consequences for companies in distribution chains

The draft determination provides guidance to companies in distribution chains as to how the ATO will approach the question of permanent establishment in Australia, and the calculation of income attributable to that permanent establishment.

The process will likely then involve issues of transfer pricing and (assuming the supply comes from a country with which Australia has negotiated a DTA (double taxation agreement) the application of Article 5 (Permanent Establishment) and Article 7 (Business Profits) of the OECD Model Taxation Agreement (which Australia generally uses when negotiating DTAs).

Although conceptually distinct, in that whether or not an arrangement is a scheme to avoid the establishment of a permanent establishment in Australia is determined independently, properly negotiated pricing pursuant to the transfer pricing regime may assist parties in convincing the Commissioner that there is no "scheme" to which Part IVA applies.

As supply chains get more sophisticated, and more disintermediated/digitised, it is likely that the Commissioner will scrutinise in further and more detail arrangements that have the effect of limiting permanent establishment (and hence taxable income) in Australia.
As always, the TD will provide guidance on its terms. If a scheme is structured in accordance with the TD but is not in fact bona fide, the TD will unlikely be of assistance.

Toby Blyth
Regulatory and financial services
Colin Biggers & Paisley

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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