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Tax issues: A tax on aliens

Every Issue

Cite as: (2004) 78(9) LIJ, p. 78

A new withholding tax regime aims to overcome the problem of foreign residents avoiding paying tax on income derived in Australia.

Foreign residents are, generally, subject to income tax in Australia on their Australian source income. However, tax may be avoided if the taxpayer leaves Australia without lodging a return.

To combat this, the Taxation Laws Amendment Act (No 4) 2003 introduced a new regime for withholding tax to apply to certain types of payments made to foreign residents.

The Taxation Administration Amendment Regulations 2004 (No 1) (the Regulation) prescribe some types of payments that will be covered by the new withholding regime. The Regulation is likely to have a significant impact on the construction, infrastructure and resources sector.

Payments for construction and related activities

The Regulation prescribes that withholding will be required from a payment made by an Australian resident under a contract entered into after 30 June 2004 for works or related activities where the recipient is a foreign resident. The rate of withholding is 5 per cent.

“Works” is broadly defined to include the construction, installation and upgrading of buildings, plant and fixtures. As the definition is inclusive, it will also have its ordinary meaning as it is used and understood in the construction, infrastructure and resources sectors. The Explanatory Statement to the Regulation indicates that this is, broadly, “the activity of creating or altering a physical asset such as a building or structure, changing the form of the earth such as earthworks, or a combination of these activities”.

“Related activities” are also defined broadly and include activities associated with the construction, installation and upgrading of buildings, plant and fixtures.

Payments to or for foreign residents

The payer will be required to withhold where the payer:

  • actually knows that the recipient is a foreign resident;
  • believes, or has reasonable grounds to believe, that the recipient is a foreign resident; or
  • has no reasonable grounds to believe that the recipient is an Australian resident and either:
(a) the recipient has an address outside Australia; or
(b) the payer is authorised to make the payment at a place outside Australia.

A foreign resident for these purposes is any person who is not a resident of Australia for tax purposes and can include a natural person, company, trustee or a limited partnership (which is taxed as a company).

A payment made to an agent on behalf of a foreign resident is subject to withholding as if it were made directly to the non-resident, even if the agent is resident in Australia.

If a payment is made to an agent or other intermediary on behalf of a foreign resident and no tax has been withheld, the intermediary may be required to withhold. The obligation to withhold in these circumstances arises only if the intermediary is a person in Australia or an Australian government agency, and a foreign resident is or becomes entitled to receive the payment, or the amount of the payment, from the intermediary or to have the intermediary credit the payment to the foreign resident or otherwise deal with the payment on the foreign resident’s behalf or as the foreign resident directs.

Again, withholding will be required where the intermediary actually knows, believes or has reason to believe, that the other party is a foreign resident or has no reasonable grounds to believe that the recipient is an Australian resident and one of the additional criteria set out above is satisfied.

To ensure that foreign residents do not avoid withholding by entering into partnerships or joint ventures with residents, the withholding obligation will apply to payments to two or more entities jointly, where one of the entities is a foreign resident (e.g. a partnership if one or more of the partners is a foreign resident or a joint venture if one or more of the joint venturers is a foreign resident). Withholding will apply to the whole payment, regardless of the level of the non-resident’s interest, unless a variation or exemption is obtained (see below).

Failure to withhold will result in a penalty for the entity required to withhold equal to the amount that should have been withheld, as well as general interest charges.

Exemption and variation

There are two situations in which a recipient may apply to the Commissioner of Taxation for an exemption from withholding or a variation to the rate of withholding.

Previous record of compliance
Foreign residents who have an established record of compliance with their tax obligations in Australia will be able to apply for an exemption from withholding. The Commissioner may grant an exemption from withholding if he is satisfied that the recipient:

  • has an established history of compliance with Australian tax laws; and
  • is likely to continue to comply with those obligations.

Relief under a double tax agreement or other exemption
The Commissioner may also grant a variation of the amount required to be withheld (including to nil) for the purposes of meeting the special circumstances of the case. The variation must be made by written notice to the entity required to withhold.

In the absence of a variation, withholding may be required from payments to foreign residents who will ultimately have no tax liabilities in Australia.

A payee may apply for a variation where it believes that the rate of withholding is too high (i.e. higher than the actual amount of Australian tax payable on its Australian taxable income).

Foreign residents deriving income in the construction and resources industries may be able to obtain relief from Australian tax under the business profits or independent personal services articles in a double tax agreement (DTA). A variation will be particularly relevant to recipients resident in a country with which Australia has a DTA, who would otherwise not be subject to income tax in Australia by virtue of the operation of the DTA.

Broadly, under a DTA business profits of a resident of the other country are only taxable in Australia if the enterprise is carried on through a permanent establishment in Australia (which in most DTAs includes a building site or construction, assembly or installation project which exists for more than a specified period). Independent personal services income is generally only taxable in Australia in certain circumstances (e.g. the income is attributable to a fixed base in Australia or the services are performed for 183 days or more).

Impact of changes for the construction and resources industry

The broad definition of “works” will capture most projects undertaken by the construction, infrastructure and resources industries. The impact of the new regime on this sector is therefore likely to be significant.

For example, payments made to foreign residents (or to partnerships or joint ventures that include non-residents) will be subject to withholding under the new regime if they are made under a contract for:

  • mine site development;
  • natural gas field development;
  • natural resource infrastructure;
  • oilfield development;
  • pipeline construction;
  • construction of power generation infrastructure;
  • railway or road development;
  • residential building, resort development or retail and commercial development;
  • upgrading airports or telecommunications equipment; or
  • construction of water treatment plant.

Further, any payments made under contracts for activities related to such contracts, such as payments for administration, assembly, costing, fabrication, project management, site management and warranty repairs, will also be caught.

Participants in the Australian construction, infrastructure and resources sectors will therefore need to be aware of the following:

  • Australian residents making payments to foreign residents will be required to withhold an amount of 5 per cent from payments due to the foreign resident under a works or related activities contract and to pay the amount to the Australian Taxation Office (ATO) unless an exemption or variation is obtained by the recipient.
  • In addition, they will be required to provide payment summaries to the recipient and annual reports to the ATO. These obligations will also apply to resident agents or intermediaries who receive payments on behalf of foreign residents.
  • Foreign residents who receive such payments will only receive the net, rather than the gross, amount of the payment, unless they obtain an exemption or variation.

Not a final tax

The new withholding requirements do not represent a final tax (unlike withholding tax on interest, dividends and royalties) and do not affect the existing tax obligations of the foreign resident. The foreign resident is still assessable to Australian tax on their Australian source income and is required to furnish a tax return to the ATO.

The foreign resident will be entitled to a credit for amounts withheld but will need to lodge a tax return in Australia to claim a credit for these amounts.

Conclusion

The new foreign resident withholding regime is likely to increase compliance costs for Australian residents in the construction, infrastructure and resources industries who make payments under works and related activities contracts. These entities will need to have systems in place to deduct the withholding tax from relevant payments, remit the amounts to the ATO and provide payment summaries to the recipient and annual reports to the ATO.

For foreign residents providing services under such contracts, amounts will be deducted from payments due under the contract and can only be claimed back later as a credit when an income tax return is furnished.

Foreign residents who have a record of compliance with Australian tax laws, or who would otherwise be exempt from Australian income tax on the payments, should consider applying to the ATO for an exemption from the withholding. This will reduce the compliance burden for their Australian counterparty and ensure that the foreign resident receives the gross amount of payments due to them, rather than the payment net of withholding.


JANE TRETHEWEY is a partner in the Tax Group of Blake Dawson Waldron, practising in corporate and international tax. SANJAY WAVDE is a lawyer in the Tax Group of Blake Dawson Waldron, practising in all areas of direct tax. LEN HERTZMAN is a special counsel in the Perth office of Blake Dawson Waldron, practising in direct tax, stamp duty and GST.

tax@liv.asn.au

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