Withholding tax is applicable to all payments made by an Australian entity to a foreign contractor or subcontractor under a contract “for works or related activities” entered into after 30 June 2004.

A Draft Taxation Ruling issued by the ATO in March 2006 and a new Practice Statement released on 4 September 2006 provide guidance on how this withholding tax works. Australian businesses should carefully consider the impact of this Ruling and Practice Statement when entering into any contract with a foreign contractor or subcontractor, including a supplier of goods.

The New Practice Statement

The ATO has the power to vary the rate of withholding to nil or to an appropriate rate under section 15-15 of Schedule 1 to the Taxation Administration Act 1953.

Practice Statement Law Administration PS LA 2006/10 (the “Practice Statement”) indicates how ATO staff are likely to approach applications for a variation.

An application for variation can be made by lodging the PAYG Foreign Resident Withholding Variation Application form for the tax year in which the payment will be received (note that this form changes each year).

The Practice Statement says that the Commissioner’s general policy is that:

• a variation to nil will be issued where it can be established that the foreign resident will have no tax liability on the payment (eg due to the application of a double tax agreement), and
• in other cases, a variation of the withholding rate below 5% will be granted if it can be shown that the lower rate would more closely match the amount of tax that will be payable when the foreign resident lodges its Australian income tax return for the relevant year.

In practice, the ATO will be likely to approve a variation application if the foreign resident:

• has either lodged required tax returns, or notified the ATO in writing if they have not been required to lodge tax returns in earlier years
• did not receive a debit assessment on their last tax assessment if they had an approved variation application for that year
• does not have any outstanding tax unpaid after its due date and/or does not have any outstanding debts under any other Acts administered by the Commissioner
• supplies all the information requested by the Commissioner, and
• has demonstrated sufficient reasons to justify the variation.

If the foreign resident’s application contains either income that is understated, or deductions that are overstated or not allowable under Australian tax laws, the ATO will either make adjustments to this information (which in turn adjusts the requested withholding rate), or not grant a variation.

The foreign resident’s actual tax liability will be determined following lodgment of its tax return.

Background

The Regulation

Regulation 44C of the Taxation Administration Regulations 1976 imposes withholding tax on all payments made to a foreign contractor by an Australian entity under a contract entered into after 30 June 2004 “for works or related activities”. The rate of withholding is 5%. The amount withheld must be remitted by the payer to the Commissioner of Taxation, for credit against the foreign resident’s tax liability for the relevant year of income.

In September 2004, Mallesons published an article detailing the practical effect of this new withholding tax on the construction industry. Click here to view this article.

The Draft ATO Ruling

On 15 March 2006, the ATO issued Draft Taxation Ruling TR 2006/D3 which provides guidance on what constitutes a “payment under a contract for works or related activities”. “Works” and “related activities” are defined very broadly, as follows:

• “Works” means works within the ordinary meaning of that term as understood in the building, construction, infrastructure and resources sector.
• “Related activities” include all activities associated with works, which enable the works to be undertaken. Examples include assembly, erection, installation, fabrication, administration, project or site management, supervision, commissioning, operating, decommissioning, provision of personnel and warranty repairs.

The “supply of plant and equipment” will not be a “related activity” where the contract (including any associated contracts) is purely for the acquisition of plant and equipment and does not involve any works or only involves incidental works (see examples 3 and 4 in the Ruling).

Importantly, you can not avoid paying withholding tax by entering into separate contracts - one for works or related activities and the other for the supply of plant and equipment. Withholding tax will be payable on all payments made under both contracts.

Further information

Please contact John King (02 9269 2216 or john.king@mallesons.com) in our Sydney office if you require further information on the foreign resident withholding provisions.