Case X69

Members:
YFR Grbich SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 7 August 1990.

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Dr Y.F.R. Grbich (Senior Member)

This case concerns the application of the old 1953 United States/Australia double tax treaty. It concerns a corporate trustee carrying on business in Australia and a beneficiary of that trust who is resident in the United States. If there is a permanent establishment in Australia, industrial or commercial profits are taxed in Australia. The issue to be decided is whether the terms of the treaty operate to relieve an enterprise, wholly owned and operating in the the United States, from tax on industrial or commercial profits distributed by an Australian trust.

2. The taxpayer is a $2 company which is incorporated in Australia and controlled by Australian shareholders. For the sake of anonymity we shall call it ``Man of Straw Pty. Ltd.''. The two shares are held by W, the managing director of the company, and by a company which is nominee for the solicitor acting in the matter. Man of Straw Pty. Ltd. is trustee of a non-exhaustive income discretionary trust.

3. We shall call the objects of the Man of Straw discretionary trust Mr Straw, Mr Straw's wife and his children, who are all United States residents. Mr Straw's enterprises conduct an extensive business in the United States and

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world-wide. The business is in the services area. None of that business is carried on in Australia. Man of Straw Pty. Ltd. carries on a similar service business in Australia. In the relevant income year, ended 31 December 1983, the taxpayer company, in its capacity as trustee, made a net income in Australia of $95,390. All this income was from Australian sources. All of it was appointed to Mr Straw. The Commissioner assessed the trustee company to tax under sec. 98(4). The trustee company objected, the Commissioner rejected the objection and that objection has now been referred to this Tribunal.

4. The issue in dispute is whether this amount is taxable under sec. 98(4) of the Income Tax Assessment Act 1936 or whether it is relieved from tax under the terms of the United States/Australia double tax treaty. There was some initial doubt about whether the original 1953 United States/Australia double tax treaty applied or whether the 1983 double tax treaty was applicable. These problems were resolved at the hearing and there was consensus between the parties that it was the 1953 treaty which applied. Both the United States and Australian taxpayers used an accounting period running from 1 January 1983 to 31 December 1983, in substitution for the normal Australian tax year ending 30 June 1984. There was an uncontested submission that the 1983 treaty came into force on 31 October 1983, the date when instruments of ratification were exchanged. Under Article 28(2)(b), the new treaty applied only to taxable years commencing on or after the first day of the second month following the date on which the treaty came into force. Accordingly, it is the 1953 treaty which is relevant for the purposes of this case.

5. Under the operation of Australian domestic tax law, it is clear that the taxpayer company would be liable for taxation. The relevant provisions of sec. 98(4) of the Income Tax Assessment Act 1936 read as follows:

``Where -

• (a) a beneficiary of a trust estate who is presently entitled to a share of the income of the trust estate -
  • (i) is not a company and is not, in respect of that share of the income of the trust estate, a beneficiary in the capacity of a trustee of another trust estate;
  • (ii) is a non-resident at the end of the year of income; and
  • (iii) is not a beneficiary to whom sub-section 97A(1) or (1A) applies in relation to the year of income; and
• (b) the trustee of the trust estate is not assessed and is not liable to pay tax in pursuance of sub-section (1) or (2) in respect of any part of that share of the net income of the trust estate,

the trustee of the trust estate shall be assessed and is liable to pay tax in respect of -

• (c) so much of that share of the net income of the trust estate as it attributable to a period when the beneficiary was a resident; and
• (d) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia,

as if it were the income of an individual and were not subject to any deduction other than the concessional deductions (if any) that would have been allowable to the beneficiary if the beneficiary had been assessed in respect of the amount, or the sum of the amounts, applicable by virtue of paragraphs (c) and (d).''

No dispute arose in this case about the present entitlement of Mr Straw. This was clearly normal taxable income of the taxpayer. The trustees made a resolution on 2 December 1983 purporting to distribute the projected income of the discretionary trust to Mr Straw. No technical points were taken on the validity of this distribution and I accordingly find that Mr Straw was ``presently entitled'' to the income of the discretionary trust at the end of the relevant income year. That being so, the relevant terms of sec. 98(4) were satisfied. There was a beneficiary of a trust estate who was presently entitled, that beneficiary was a non-resident at the end of the relevant income year and none of the other disqualifying conditions in sec. 98(4) applied. Accordingly the trustee of the trust estate is prima facie liable to pay tax in respect to net income of the

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trust estate attributable to Australian sources in the manner laid down by sec. 98(4). This means that, for most practical purposes, the trustee pays tax as agent for the non-resident beneficiary and, with some minor exceptions, at the rates appropriate to that beneficiary.

6. But, of course, under the terms of sec. 4(2) of the Income Tax (International Agreements) Act 1953, the terms of the double tax treaties will generally override domestic laws and, if the treaty applies, will do so in this case.

7. The main issue in dispute is whether the industrial and commercial provisions of the 1953 Australia/United States treaty will operate to relieve the taxpayer from Australian tax in this case. Article 3(2), so far as relevant, reads:

``A United States enterprise shall not be subject to Australian tax in respect of its industrial or commercial profits unless it is engaged in trade or business in Australia through a permanent establishment in Australia.''

8. A number of specific problems must be resolved. First, did Mr Straw's operations in the United States constitute ``a United States enterprise''? Second, if so, was the service business of Man of Straw Pty. Ltd. in Australia part of Mr Straw's United States enterprise? Third, if the income of the Australian operations could not be ascribed to the United States enterprise, were the commercial profits earned in Australia earned ``in respect of its [the United States enterprise's]... commercial profits''. Fourth, were the income distributions by the trustee to Mr Straw profits of that ``enterprise'' or were they to be characterised as a distribution to Mr Straw personally, a distribution which was quite distinct from the operations of his main ``enterprise'' and one that did not satisfy that term in Art. 3(2)? Fifth, do the profits derived by the trustee keep their character as commercial profits when they are distributed to the beneficiary?

9. On the first problem, I find that Mr Straw did carry on a United States enterprise. Affidavit evidence was given by the chief executive of, what we might call, ``Man of Straw Associates International Inc.''. The chief executive, R, gave evidence that Mr Straw's United States business was carried on by, what we might refer to as ``Man of Straw and Associates'' which was registered in California under what our American cousins quaintly call a ``ficitious business name''. This is a term used to denote an unincorporated business which is run by a person in some name other than his personal name. It grants an official name to the enterprise without bestowing legal personality. The operation was on a large scale, employing 350 people throughout the United States and having revenues of approximately $35m. and Mr Straw personally directed its activities. The nature and scale of the activity can leave us in little doubt that Mr Straw did operate a United States enterprise.

10. The second problem, whether the Australian service business of Man of Straw Pty. Ltd. was part of Mr Straw's United States enterprise, might have been expected to cause more problems. But counsel at the hearing displayed a rare degree of unanimity on this potentially contentious question and neither was prepared to assert that the Australian operation was merely the alter ego of the American Mr Straw or to attempt to lift the company veil. The managing director of Man of Straw Pty. Ltd., M, was cross-examined in the witness box. Under cross-examination, while agreeing that the Australian service operation was very similar to the operation in the United States, she gave evidence that Mr Straw was not a director of the Australian company, that the Australian company considered itself quite distinct from Mr Straw, that she never spoke to Mr Straw about managing the business or on how the business should be conducted. She considered Mr Straw to be the owner but asserted that the Australian business was run quite separately by the Australian management and was an Australian company. Accordingly I find that Man of Straw Pty. Ltd. ran a distinct commercial operation in Australia and it was not part of the United States enterprise. Mr Straw was potentially beneficially entitled to the proceeds of the Australian business in his capacity as object of the discretionary trust and did in fact receive the income of the trust in the relevant tax year but the Australian business was not his enterprise.

11. Given that the Australian business and the United States enterprise were distinct, we come to the third and critical problem. Can it be said that the commercial profits earned in Australia were ``in respect of its [the United States enterprise's]... commercial profits''?

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12. The parties examined the definitions in Art. 2(1)(n) and (k) of the treaty. Counsel for the taxpayer argued that the definition of ``industrial or commercial profits'' did not require that the profits result from the carrying on of a business by the United States enterprise in Australia. The Commissioner contested this. He argued that the construction of Art. 3(2) required just such a construction. He emphasised the fact that the provision exempting the United States enterprise from Australian tax spoke of ``its'' commercial profits, referring to the commercial profits of the United States enterprise.

13. Such a conflict should be resolved by locating the words of the relevant articles in the framework of the treaty. What job does the industrial or commercial profits relief from Australian tax do in the scheme of the treaty? In resolving the conflicting tax claims of the country of residence and source, in the case of industrial or commercial profits, the treaty prima facie gives exclusive jurisdiction to the country of residence. This rule gives way where there is a permanent establishment in the country of source. The rule is directed at situations, and is designed to act as a demarcation provision, where a United States commercial enterprise operates in Australia.

14. The taxpayer would have us read this more widely and read Art. 3(2) as operating positively to exclude income of a wholly United States enterprise receiving Australian source income from an Australian commercial enterprise in cases where the permanent establishment conditions are not satisfied. Of course the 1983 treaty is carefully constructed (and differs from most of the other United States treaties in this respect) so that the country of source has a general residuary right to tax income sourced within it. Article 21(2) gives an express right for the country of source to tax income originating in its jurisdiction. No such provision appears in the 1953 treaty. So we are forced back to general context to derive a construction.

15. It is a fair inference, putting the provisions of Art. 3(2) into context, that they are meant to operate only where the United States enterprise itself engages in business in Australia. To elevate it into a provision which gives a general exemption to all passive income from Australian industrial and commercial sources is reading more into the article than it communicates. My reading of the treaty is that the underlying rule is that profits are taxed in the source country and that the treaty departs from this norm only if specific articles clearly communicate an intention to give relief. For example, where Australian enterprises distribute passive income to the United States, a number of specific provisions dealing with interest, dividends and royalties are triggered. These all give the country of residence primary taxing power and give the source country a limited right to withhold tax. No similar provision exists for trusts and there is no compelling policy reason to infer one. Of course, 1985 provisions dealing with this subject were inserted by sec. 3(11) of the Income Tax (International Agreements) Act 1953. Section 3(11) operates by deeming the Australian trustee to operate through a permanent establishment in Australia. These provisions have no operation in the present case.

16. The taxpayer relied on
Thiel v. F.C. of T. 89 ATC 4015 in support of his contention that the United States enterprise derived Australian commercial profits in this case. Based on this reasoning he argued for a wide definition to be given to ``enterprise''. He relied mainly on the reasoning of Sheppard J. (at pp. 4035-4037) and that reasoning does support a wide reading. Thus the fourth problem is answered by holding that Mr Straw was an ``enterprise'' for the purposes of Art. 3(2). But, of course, that wide definition was not enough to exempt the profits in that case under the business provisions of the Swiss treaty. Thiel concerned the Australia-Switzerland double tax treaty. The taxpayer was a Swiss resident who engaged in speculative investments in Australia involving high risk energy research. The taxpayer prospered and made $590,307 income in just over a year. This was prima facie taxable under sec. 25A and 26AAA. It was found that this speculation was not part of the taxpayer's overall business. The term ``enterprise'' was not restricted to an identifiable business and (at p. 4036):

``may consist of an activity or activities and be comprised of one or more transactions provided they were entered into for business or commercial purposes.''

But Art. 7(1) of the Swiss treaty referred to ``an enterprise carried on'', a composite phrase

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involving the habitual pursuit of conduct. This was not satisfied and the taxpayer failed to get relief under the treaty.

17. Whether it was Mr Straw or one of his unincorporated businesses which carried on the enterprise in this case is immaterial. Those ``entities'' were not separate legal persons. Whilst the trust vehicle may seem, on its face, to make the term ``enterprise'' inappropriate, on closer examination the term aptly describes Straw's activity. Like the taxpayer in Thiel, Straw invested capital in an Australian investment and generated a return. True, the return here was continuing income rather than a lump sum from trading in his rights to the underlying business. If anything, this factor makes this a stronger case than Thiel for arguing there was an ``enterprise''.

18. An example of the ordinary operation of the commercial profits provision is found in the decision of Mr Roach in Case U162,
87 ATC 942 at pp. 946-947. A United States resident company contracted with a golfer to supply, exclusively, golf services in Australia. Because there was no permanent establishment in Australia, the company's Australian income was exempt from Australian tax.

19. The taxpayer's argument was that the operation of the treaty as a whole made it clear that it could operate on enterprises carried on solely in the United States. Reference to the definition Art. 2(1)(k) was cited in support of this proposition and so was Art. 4. While it is clear that these provisions create the threshold conditions for the operation of the treaty on taxpayers who are solely United States residents, they cannot foreclose the construction of Art. 3(2) itself.

20. The taxpayer contrasted the provision in the 1953 United States treaty with Art. 5 of the Australian/United Kingdom double tax treaty and Art. 2(1)(j) of the New Zealand treaty, which make it clear that the analogous terms of the treaty apply only where the foreign enterprise itself carries on business in Australia. But to assert that one treaty between sovereign nations lays down a requirement expressly is not a very strong basis for inferring that another treaty, which leaves such matters silent, means to exclude them. Treaties are negotiated by the revenue authorities at arm's length and we can assume a high degree of consciousness about what they say and what they do not. Silence is very often a deliberate decision which does not admit an inference about what was left out.

21. Once the threshold conditions have been established, the decision on the critical third problem comes back to construction of the terms of Art. 3(2). As I have indicated, neither the express terms of that provision nor anything in its context or policy would persuade me to read in the tax relief which the taxpayer claims in this case.

22. Assuming that I am wrong and that Art. 3 of the treaty does exempt profits from an Australian enterprise, we get to the fifth problem, do the trust distributions to Mr Straw retain their character as ``industrial or commercial profits'' as they flow through the trust? Recent Australian authority has supported this proposition, and I am bound by that authority. If I had to consider the question de novo, I would look at the answers supplied by that authority with some scepticism. The taxpayer cited
Syme v. Commr of Taxes (Vic.) (1914) A.C. 1013 for the proposition and he could also have cited
Charles v. F.C. of T. (1954) 10 A.T.D. 328; (1953-1954) 6 A.I.T.R. 85. He also cited
Baker v. Archer-Shee (1927) A.C. 844. But against this are fundamental concepts of trust law, which regard the legal rights of the trustee and the rights of beneficiaries to an account from the trust as very different creatures (see the hostile reception to Baker and its subsequent reversal on a different point in
Archer-Shee v. Garland (1931) A.C. 212 and opposing House of Lords authority in
Williamson v. Ough (1934) 20 T.C. 1940. The trustee is not mere agent and conduit of trust income for the beneficiary. The trustee is legal owner of trust property and accountable to the beneficiary for surplus after accounts have been taken.

23. For the reasons given above the decision under review is affirmed.