15 September 2004
Key Points:
The principal under the contract will be required to withhold 5 percent from each payment under the contract and forward the amount withheld to the Australian Taxation Office.
A new form of withholding tax has been introduced for payments to foreign contractors. The new rules will apply to payments under contracts entered into from 1 July 2004. The principal under the contract will be required to withhold 5 percent from each payment under the contract and forward the amount withheld to the Australian Taxation Office (ATO).
The new form of withholding has been introduced because of a concern that foreign contractors are not always reporting their Australian income to the ATO. The withholding is not a final tax. Foreign contractors still need to lodge an Australian income tax return if they derive taxable income in Australia and pay income tax at the appropriate rate. They can claim a credit for the amount withheld in their Australian income tax return.
Relevant law
Some time ago, an amendment was made to the Taxation Administration Act 1953 to allow regulations to be made that require withholding on payments to non-residents. Earlier this year, the Taxation Administration Amendment Regulations 2004 (No 1) were introduced to provide for withholding in relation to a number of categories of payments made to non-residents. Apart from withholding in the case of payments to foreign contractors, withholding is now also required in relation to entertainers and to sport professionals and in relation to gambling events. This article covers only the withholding required in relation to payments to foreign contractors.
"Works" and "related activities"
Withholding is required in relation to payments for "works" or "related activities". Works are defined to include the construction, installation and upgrading of buildings, plant and fixtures. Examples are given in the regulations of dams, electricity links, mine site development, natural gas field development, natural resource infrastructure, oil field development, pipeline, power generation infrastructure, railway or road development, residential building, resort development, retail or commercial development, upgrading airports, upgrading telecommunications equipment, and water treatment plant.
Given that the definition of works includes installation, payments to a foreign contractor for the installation of plant and equipment would also be covered. For instance, if a supplier of computer equipment agrees to install the equipment in Australia, payments for the installation work would be covered by the regulations.
Also included are payments for upgrading of facilities. The regulations probably would not cover the installation of computer software. Even though this may come within the notion of "upgrading" of the relevant computer equipment, the regulations are designed to cover only physical work on equipment. However, clarification of this point would be helpful.
Payments for "related activities" are also covered by the regulations. "Related activities" are activities associated with the construction, installation and upgrading of buildings, plant and fixtures. The regulations give examples of "related activities" of administration, assembly, decommissioning plant, design, commissioning and operation of facilities, costing, engineering, erection, fabrication, hook up, installation, project management, site management, supervision and provision of personnel, supply of plant and equipment, and warranty repairs. Thus, payments need not be under the main contract for "works". They could be under a sub-contract for some component of the work. The principal under the sub-contract would have the withholding obligation if the sub-contractor is foreign.
The reference to "commissioning and operation" of facilities is curious. It seems to suggest that ongoing payments to a foreign contractor to operate a facility would be covered. However, the operation of the facility would not be "related activities" because it would not be associated with the construction, installation or upgrading. Clarification on this point would be helpful.
Contractors covered
Withholding is required on payments to contractors who are not residents for Australian tax purposes. The question of whether an individual or entity is a resident for tax purposes can be complex. Even companies that have a fixed place of business in Australia may not be resident. Residence in the case of companies is dependent on place of incorporation and management and control. In the case of an individual, residence depends mainly on place of permanent residence but can be more complex than this. Principals may need to verify the residence status of their contractors if they unsure.
Obviously, payments to employees are covered by existing withholding arrangements, but payments to independent contractors would be covered by the new regulations. This would include architects, engineers and other consultants.
There is no limitation in the regulations to construction work undertaken in Australia. Therefore the regulations could potentially apply to Australian principals who make payments to foreign contractors in relation to construction work occurring outside Australia. This would be an absurd result as the foreign contractor would have no liability to Australian income tax. It may be that the regulations will be clarified in this respect so as to exclude such a payment.
As in the case of other withholding regimes, Government bodies are required to withhold in the same manner as the private sector.
Timing
The new rules apply to contracts entered into after 30 June 2004. Thus, any payments made under a contract entered into on or before 30 June 2004 will not be affected.
If a contract is entered into on or before 30 June 2004 but is later amended, the principal under the contract should still be free of any obligation to withhold. However, it would need to be clear that the change to the contract is in fact an amendment and the underlying contract continues rather than being replaced by a new contract.
Exemption or variation
Foreign contractors are able to obtain an exemption from the ATO from any withholding on payments to them. For the ATO to grant the exemption, it must be satisfied that the foreign contractor has an established history of compliance with its obligations under Australian taxation laws and is likely to continue to comply in the future.
This form of exemption is not designed to cover situations where the foreign contractor will have no liability to Australian income tax. It is focused only on the compliance history of the foreign contractors. If a foreign contractor wishes to avoid withholding on the basis that it will have no liability to Australian income tax on the relevant payments, it will need to seek a variation in the rate of withholding from ATO. This feature is designed to give the ATO an opportunity to examine the contractor's case for exemption from Australian tax, rather than letting the contractor self-assess its liability to Australian tax.
The ATO can vary the rate of withholding, even to zero, to accommodate the circumstances of a particular foreign contractor or a class of foreign contractor. An obvious example of where a variation to zero should be made is in relation to a payment for construction that occurs wholly outside Australia. Other examples are payments that are not taxable to the foreign contractor because the contractor has tax losses or is protected from Australian tax under a tax treaty.
Action
Contracts need to be reviewed to determine whether the principal would be in breach of contract by making the necessary withholding. The contract does not need to give the principal specific authority to make the withholding but it is advisable to include provisions allowing the withholding to put the matter beyond dispute.
Where the principal is unsure whether the contractor is resident or non-resident, it would be advisable to seek evidence of the residence status of the contractor. A warranty from the contractor as to residence may also be advisable when the contractor claims to be resident but the principal is in some doubt about whether this is correct.
