Reconstruction of Australian-source Income of Non-residents

17.78. A non-resident subject to tax by assessment may be able to control the amount of his income liable to Australian tax by incurring inflated costs that will limit his net income from Australian sources. His costs may involve payments to an associated person, who is a non-resident, for goods or services, for money borrowed or for the supply of information. As at present interpreted, the general deduction section (section 51) requires the Commissioner to allow deduction of the actual costs.

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17.79. A non-resident with a branch in Australia, where he manufactures or assembles goods, may sell those goods to an associated person in a foreign country at a price calculated to ensure that no profit arises from the branch operations. Section 42, referred to later in paragraph 17.A5 of Appendix A, enables the Commissioner to apportion the profit between the manufacturing operations in Australia and the selling of the goods. But he can apportion only the actual profit. Section 36, which deems a disposition of trading stock made otherwise than in the ordinary course of business to be a disposition at market value, may be helpful: there is some authority that a sale to an associated person may in some circumstances be regarded as a sale outside the ordinary course of business. However, the assistance it can give to the Commissioner is much less than required.

17.80. The Commissioner should, in the Committee's view, have adequate general power to reconstruct the Australian-source income of a non-resident so as to bring to tax an amount of income that would have been derived had the non-resident's costs been incurred in arm's length transactions and had his receipts been such as might have been expected in arm's length transactions.

17.81. Section 136 of the Act is intended to give the Commissioner such power. It provides:

‘Where any business carried on in Australia—

  • (a) is controlled principally by non-residents;
  • (b) is carried on by a company a majority of the shares in which is held by or on behalf of non-residents; or
  • (c) is carried on by a company which holds or on behalf of which other persons hold a majority of the shares in a non-resident company,

and it appears to the Commissioner that the business produces either no taxable income or less than the amount of taxable income which might be expected to arise from that business, the person carrying on the business in Australia shall, notwithstanding any other provisions of this Act, be liable to pay income tax on a taxable income of such amount of the total receipts (whether cash or credit) of the business as the Commissioner determines.’

In the Committee's view, however, the section does not give the Commissioner adequate power.

17.82. The operation of section 136 in the situations of the kind described in paragraph 17.78, involving inflated costs incurred by the non-resident, is limited by the condition that there must be a business carried on in Australia. The section does not enable the Commissioner to increase the amount of net royalties derived by a tax-haven company. The tax-haven company may have paid, to an associated tax-haven company, an amount in royalties for the information in turn supplied to an Australian resident such as to ensure that the net royalties from an Australian source are zero.

17.83. The operation of the section in situations of the kind described in paragraph 17.79, involving deflated receipts by the non-resident, is probably limited by the condition that the Commissioner must tax an ‘amount of the total receipts … of the business’, which would appear to deny him power to substitute for the actual receipts those receipts that would have been derived in an arm's length transaction.