In the recent case of Tech Mahindra Limited v FCT, the Federal Court held that an Indian resident company which carried out IT services for Australian clients both from its Australian permanent establishment (PE) employees and by its Indian employees was liable to tax in Australia in respect of part of the income derived from the services provided from India.
For those technically minded, Article 7(1) of the Indian Agreement creates a general rule that the profits of an enterprise of one of the Contracting States is taxable only in that State, though Article 7(1)(b) creates two exceptions to that general rule, namely, sales within the other Contracting State of goods or merchandise of the same or a similar kind to those sold through the permanent establishment, and relevantly here, other business activities of the same or a similar kind as those carried on through the permanent establishment.
Article 12 provides that both Contracting States may tax royalties as defined in Article 12(3) where a resident of one of the Contracting States is beneficially entitled to the royalties and the royalties arise in the other Contracting State (the source State).
The court held that payments for certain categories of Indian Services provided to Australian Customers constituted royalties, and therefore that the relevant amounts were liable to Australian tax. Australia has capacity to tax profits under the limited force of attraction rule in Article 7 only where the services are (also) undertaken in Australia.
It should be noted that the taxpayer has appealed to the full Federal court.
Australia has been moving on multinational companies shifting profits through the continued reinforcement of the desire to maintain the integrity of Australia’s corporate tax base. This has been highlighted in the Diverted profits tax.
With the above case, it is becoming clearer that the ATO is also interested in structures involving foreign workers providing services into Australia.
Given the widespread practice of offshoring in place, and the many structures involved, the outcome of appeal to the Full Federal court will affect any foreign outsourcing company that has an Australian PE.
It may also affect Australian accounting firms who have a foreign establishment in other countries. If the Australian tax office is moving to tax Indian companies, it should be expected the Indian tax office will respond in kind.
It’s not much a leap from here to expect the ATO will be looking at Australian accounting firms with foreign workers in a related offshore entity to the Australian accounting firm. Certainly there are a number of “interesting” structures being touted by offshore professionals e.g. Australian Accounting firm setting up a Hong Kong entity which sets up a Philippines Entity. Remember Project Wickenby anyone?
Only time will tell whether the pressure will be removed when the Australian budget/Trade deficit is in balance, or whether this is a long term shift in taxing new business models.