Client Update

Update on Withholding Tax

On 18 October 2006, the ATO released Taxation Ruling TR 2006/12 on construction withholding tax. This Ruling makes substantial changes to the draft Ruling (TR 2006/D3).

Australian entities should carefully consider the effect of the Ruling before entering into a contract with a foreign entity for “works or related activities”.

Construction withholding tax was the subject of an article in the September 2006 Construction Update. This article can be referred to for background information.

Substantial Changes

Activities performed in Australia

Only works and related activities performed in Australia (including the coastal sea of Australia), and as extended by section 6AA of the ITAA 1936 (see below *), will attract the obligation to pay withholding tax. If related activities are performed in Australia, withholding tax will be payable regardless of whether the corresponding works are also performed in Australia.

For example, if an Australian entity subcontracts design works to a German company and that company inspects and conducts tests at the site in Australia, but performs all other design work in Germany, only the portion of the contract price which relates to those activities performed in Australia will be subject to withholding tax.

* (section 6AA ITAA 1936 basically provides that offshore resource and environment-related activities are subject to Australian income tax laws)

Acquisition of Plant and Equipment

Withholding tax will not generally be payable with respect to the acquisition of plant and equipment, but withholding tax will be payable on payments for the use of plant and equipment in undertaking works or related activities. For example, payment for the use of a bulldozer in undertaking earthworks will be subject to withholding tax. However, payment for the acquisition of a furnace to be installed at a mining site will not attract withholding tax.

Apportionment between works/related activities and other items allowed

Where a payment under a contract is made for both works/related activities and something else, only that portion which is reasonably related to the works/related activities is subject to withholding tax. For example, if an Australian entity purchases a brake press from an Indian firm who assembles it on site, the portion of the contract price that relates to installation and commissioning is subject to withholding tax, while the amount paid to acquire the braking press itself is not subject to withholding tax.

This is a substantial change from the draft Ruling, which did not allow any apportionment.

Date of Effect

With one exception, the Ruling applies to payments made or received on or after 1 July 2004 under a contract entered into after 30 June 2004. The exception is that where the Ruling provides for tax to be withheld, but the draft Ruling did not, the Ruling only applies to payments made after 18 October 2006.

Background

The Ruling provides guidance on the application of regulation 44C of Taxation Administration Regulations 1976. The Regulation requires Australian taxpayers to withhold 5% tax on all payments made to or for a foreign contractor or subcontractor under a contract “for works or related activities” entered into after 30 June 2004, where the works/related activities are performed in Australia.