In TD 2018/12 (Tax Determination), released on 4 July 2018, the ATO has clarified the Commissioner’s view on the meaning of the expression ‘directly in connection with’ in subparagraph 177DA(1)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 36).
Section 177DA comes within the anti-avoidance provisions of Part IVA of the ITAA 36 and is targeted at schemes that are entered into or carried out to limit a ‘taxable presence in Australia’, where the scheme has the purpose or effect of enabling foreign multinational entity’s to avoid the attribution of business profits in Australia.
A foreign entity may have entered into or carried out a scheme to limit its taxable presence in Australia under section 177DA where:
- the foreign entity makes a supply to an Australian customer
- activities are undertaken in Australia ‘directly in connection with’ the supply
- some or all of those activities are undertaken by an Australian entity who is an associate of, or who is commercially dependent on, the foreign entity and
- the foreign entity derives ordinary or statutory income from the supply, of which some or all is not attributable to an Australian permanent establishment of the foreign entity.
The Tax Determination states that the phrase ‘directly in connection with’ is intended to be broadly construed on its ordinary meaning. While the question of whether the requisite connection exists will depend on the facts and circumstances of each particular case, in essence, the meaning of this phrase in relation to section 177DA is as follows:
- the activities undertaken in Australia must have a connection or factual relationship with the supply made by a foreign entity to an Australian customer and
- this connection or relationship must be ‘direct’, in the sense that the connection is sufficiently close and not indirect or merely incidental.
The Tax Determination provides the following examples of situations in which activities will be directly connected to a supply, such as where the activities:
- contribute to the entering in of the contract for the supply
- attract new customers or maintain existing customer relationships
- relate to the ability to supply the goods or service in the manner in which it is supplied
- support the ongoing execution of a supply under an existing supply arrangement or
- actively procure demand for sales.
Ultimately, it is necessary to examine the circumstances surrounding the supply in the context of the entire supply chain.
The Tax Determination will apply retrospectively, but will not apply to taxpayers to the extent to which it conflicts with the terms of a settlement of a dispute with the ATO agreed to before the date of publication on 4 July 2018.