As the internet is global, businesses using it will typically become involved in international transactions and the specific tax ramifications which flow from that. For e-commerce businesses inexperienced in this area, there will be a risk of non-compliance simply arising through a lack of knowledge. And even for businesses experienced with existing international dealings, the electronic aspect of these transactions raises a number of specific issues.
The general rule in relation to international transactions is that Australia can assess its own residents on worldwide income. However, Australia’s ability to tax the income of non-residents will generally depend on the income having some physical connection with Australia.
So, for example:
- Capital gains are assessable to non-residents if the asset has the relevant connection with Australia (such as real estate).
- Withholding tax applies to dividends, royalties and interest flowing from Australia, and
- Other income is assessable if it has a source in Australia.
The tax position will therefore largely depend on questions of tax residency and source. These issues are discussed below and for practical reasons concentrate on e-commerce businesses structured as companies.
Residence of a company
A company is resident in Australia if:
- It is incorporated in Australia, or
- It carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents.
Central management and control of a business is part of carrying on a business. Accordingly, a business is carried on in the place of central management and control. It is not necessary that any of the trading or investment activities from which the business endeavours to profit occur in a place for it to be carrying on a business in that place.
The ATO considers that “central management and control” involves the high-level decision-making processes that set general operating and transactional policies. The ATO acknowledges the power to control and direct a company’s operations (such as by a majority shareholder) is not determinative of actual control and it is a question of “facts and degree”.
It is also important to note that the ATO considers that:
- A company may be “carrying on business” even if its main activity is the management of its investment assets, and
- The place of business of a large industrial concern is wherever its offices or production facilities are located.
Some guidance exists to assist with ascertaining residency in relation to foreign incorporated companies.
Source of trading or business income
The source of business income is typically where the business trades or renders services.
This is determined according to the practical realities of the situation. In general, the following rules apply:
- If the business consists substantially of the making of contracts, the place where the contracts are made may be the most significant factor in determining the source of the business income.
- If the business consists of first making contracts then carrying them out, so that both elements are significant factors, an apportionment must be made.
- If the making of the contract is an insignificant factor, and the only substantial element is its performance, the place of performance is the source.
Generally, where operations in one place have neither produced a merchantable commodity, nor given or added value to things marketed in another place, then that place is not a source of profit.
Other factors may include the place of payment and the place where the contract was negotiated.
In the case of personal services, the place of performance will generally be decisive. However, if there is a large creative element to the services, it may be that the customer is more concerned with obtaining the benefit of the person’s knowledge or expertise, and the place where that is provided is relatively unimportant. This may apply in the case of services which are delivered electronically. In such cases, the place where the contract was negotiated or the remuneration paid, may assume more importance.
These rules are subject to applicable transfer pricing rules and double tax agreements which operate between the relevant jurisdictions.
Permanent establishments – the theory
Under its Double Tax Agreements, Australia can generally tax business profits made by non-residents who carry on business through a “permanent establishment” in Australia. Those profits can only be taxed to the extent that they are attributable to the permanent establishment. Obviously, reciprocal arrangements apply to Australian residents doing business overseas with Double Tax Agreement countries.
Typically, a permanent establishment (PE) is defined to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on. This would include, for example, a place of management, a branch, an office, a factory or a workshop. A typical example of a permanent establishment is a subsidiary or foreign branch.
However, activities which are only preparatory and auxiliary do not constitute a permanent establishment. These include:
- The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise.
- The maintenance of a stock of goods or merchandise solely for the purpose of storage, display or delivery, or for processing by another enterprise.
- The maintenance of a fixed place of business solely for the purpose of purchasing merchandise, for collecting information for the enterprise or for the purpose of activities with a preparatory or auxiliary character (such as advertising or scientific research).
Permanent establishments and internet trading
The ATO considers that a non-resident does not have a permanent establishment in Australia solely as a result of selling trading stock through an internet website hosted by an Australian resident internet service provider.
It also makes a distinction between computer equipment and the data and software used or stored on that equipment. It considers that “the server on which a website is stored is a piece of equipment with a physical location and may constitute a ‘fixed place of business’ of an enterprise which has that server at its disposal.
However, the fact that an enterprise has a certain amount of space on the server of an internet service provider allocated for it to use to store software and data does not result in the server being at the disposal of the enterprise. The enterprise is not considered to have acquired a place of business by virtue of the hosting arrangements. It is also important to note that the mere fact that a taxpayer maintains a relatively small computer system overseas that is used to trade in securities would not mean that it had an overseas permanent establishment.
Whether a supply is made “through” a permanent establishment will depend on the facts. It appears that if software is sold and transmitted directly from an overseas supplier to an Australian customer, there will be sufficient connection if the sale was negotiated and promoted by an employee of the permanent establishment in Australia.
A relative jurisdiction’s tax obligations for e-commerce business largely depend on questions of tax residency and source. This article covered the basic principles of tax residency for companies and the important concept of permanent establishment to determine whether tax profits are taxable in a relevant jurisdiction and the removal of double or non-taxation via Double Tax Agreements.
The advent of the Internet and proliferation of e-commerce has led many to question the OECD’s (and ATO’s) use of permanent establishment as the defining nexus by which a country may tax the business profits of a non-resident entity. These arguments are based on the idea that while permanent establishment was an effective criterion in the pre-digital age when cross-border commerce required a physical presence to conduct business, this criterion is no longer viable in an age where technology allows buyers and sellers to conduct cross-border business without ever establishing a physical presence in a non-resident state
If an e-commerce business faces uncertainty about whether any arrangements could trigger “permanent establishment” issues, then it should engage qualified advisors and consider approaching the ATO and/or other jurisdictions’ tax regulatory bodies for guidance as early as possible.