Foreign Resident Contractor, Treaty and CGT Withholding
Sora Ltd is a Japanese engineering firm with no Australian permanent establishment. It sends engineer Tanaka to Australia for 8 months to supervise a $40m project for an Australian client, which pays Sora $2m. Tanaka is present in Australia 190 days and is paid by Sora's Tokyo payroll. Sora also owns a 30% stake in an Australian company, ReefCo, which it sells for a $12m gain. ReefCo's value is 80% attributable to Australian land. The Australian client did not withhold on the $2m payment. Sora claims the Japan-Australia treaty exempts the $2m because it has no PE. Separately, Tanaka claims his salary is exempt because he is a foreign resident.
1. Advise on the source and treaty treatment of the $2m service fee and Tanaka's salary.
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Service fee. Under the Japan-Australia treaty, business profits are taxable only in the residence state unless the enterprise has a PE in Australia. Sora has no fixed place of business, but the treaty's PE definition includes a 'service PE' where employees furnish services in Australia for more than 183 days in any 12-month period. Tanaka is present 190 days, so a service PE exists and Australia may tax the profit attributable to it. Practically, the ATO will look at whether the project is a single contract; the 190 days exceeds the 183-day threshold. Sora must lodge an Australian return and claim the treaty's non-discrimination and business profits articles to limit tax to the PE-attributable profit.
Withholding. Payments for services to a foreign resident are not subject to dividend, interest or royalty withholding unless the payment is a royalty. However, from 1 July 2017, the ATO requires withholding at 47% on payments to foreign residents for certain services where the payee fails to provide a declaration (s 12-315 Sch 1 TAA 1953). The client should have withheld 47% of $2m ($940,000) unless Sora provided a valid declaration. The client faces a withholding liability and penalties.
Tanaka's salary. Under the treaty's employment income article, remuneration is taxable in Australia if the employment is exercised here for more than 183 days and the employer is an Australian resident or the cost is borne by an Australian PE. Tanaka is here 190 days; the cost is borne by Sora, not an Australian PE. The 183-day test is met, so Australia may tax the salary. Tanaka is a foreign resident for Australian tax purposes, so he is taxed on Australian-source income only, at foreign resident rates (32.5% from $0), with no tax-free threshold. Sora should consider a shadow payroll and PAYG withholding.
2. Analyse the CGT treatment of the ReefCo share sale and any withholding obligation.
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Is there a CGT asset with the necessary connection? A share in an Australian company is not itself taxable Australian property. However, under s 855-5 ITAA 1997, a foreign resident makes a capital gain on a CGT event involving a share in a company that is an 'indirect Australian real property interest' if the company's assets are 50% or more Australian real property and the foreign resident holds at least 10%. ReefCo is 80% Australian land and Sora holds 30%, so the shares are taxable Australian property and the $12m gain is assessable.
Discount. Sora is a company, so the 50% CGT discount is not available. The gain is $12m (assuming a nil cost base for simplicity; the actual cost base must be deducted). Tax at 30% = $3.6m, subject to treaty relief.
Treaty. The Japan-Australia treaty permits Australia to tax gains on shares deriving their value principally from Australian immovable property. The 80% land test means Australia may tax the gain. Sora cannot rely on the business profits article.
Withholding. Under s 14-200 Sch 1 TAA 1953, the purchaser must withhold 12.5% of the purchase price (not the gain) where the vendor is a foreign resident and the shares are indirect Australian real property interests. If the price is, say, $40m, withholding is $5m. Sora can apply for a variation to reduce withholding to the expected tax liability. If the purchaser fails to withhold, the purchaser becomes liable. Sora should obtain a clearance certificate only if it is an Australian resident - it is not, so the variation route applies.