Australian “permanent establishment” tax issues related to ongoing disruption of construction projects from COVID-19
By Amber Agustin, Peter Feros and Cameron Forbes, Clayton Utz
The COVID-19 pandemic has caused and continues to cause significant interruption and disruption to building sites and construction or installation projects (Construction Projects) around the world, and Australia has been no exception. For example, many Construction Projects in Australia and abroad have been operating with various restrictions and procedures in place which have caused material delays to the overarching project.
Foreign residents with Construction Projects in Australia should carefully consider whether such disruptions may unintentionally be creating Australian permanent establishment (PE) issues (including determining the Australian attributable income of the PE and complying with obligations to lodge income tax returns in Australia and other Australia taxation law requirements) and vice versa for Australian entities with offshore Construction Projects.
Even if a foreign resident does not have an Australian PE in respect of a Construction Project, certain payments made to the foreign resident in respect of construction and related activities in respect of the Construction Project may be subject to Australian withholding tax.
PEs and Construction Projects
Relevantly, Art 5 of the Model Tax Convention on Income and on Capital (OECD Model Tax Convention) prepared by the Organisation for Economic Co-operation and Development (OECD) provides that a building site or construction or installation project can constitute a PE only if it lasts more than 12 months.
Generally speaking, Art 5 of the double tax agreements (DTA) entered into between Australia and other countries is based on and similar to that provided in the OECD Model Tax Convention. However, this deeming period can differ in particular DTAs (for example the DTA between Australia and the United States specifies a 9-month period).
The OECD publishes extensive commentaries accompanying the OECD Model Tax Convention which set out the consensus views of members, including Australia, on its interpretation (OECD Commentaries) and relevantly states that:
- the term “building site or construction or installation project” includes not only the construction of buildings but also the construction of roads, bridges or canals, the renovation of buildings, roads, bridges or canals, the laying of pipelines and excavating and dredging
- an “installation project” is not restricted to an installation related to a construction project and also includes an installation of new equipment such as a complex machine in an existing building or outdoors
- a Construction Project exists from the date on which the contractor begins their work and continues until the work is completed or permanently abandoned, and
- a Construction Project should not be regarded as ceasing to exist when work is temporarily discontinued (ie temporary interruptions should be included in determining the life of a Construction Project) – with a shortage of material or labour difficulties listed as examples of temporary interruptions.
The OECD has released some general guidance on this issue in the context of where a DTA is in place (OECD Guidance), which in broad terms states that:
- many activities on construction sites are being temporarily interrupted by the COVID-19 pandemic
- a construction site would not be regarded as ceasing to exist when work is temporarily interrupted, and
- the duration of such an interruption of activities should however be included in determining the life of a site and therefore will affect the determination whether a “construction site” constitutes a PE.
Interestingly, the OECD Guidance characterises the disruptions caused by the COVID-19 pandemic for Construction Projects in the same manner as other “temporary” interruptions listed in the OECD Commentaries, such as a shortage of material or labour difficulties. In other words, it is the OECD’s position that the COVID-19 pandemic will not give rise to any concessional treatment when determining whether a Construction Project gives rise to a PE.
This seems a curious position – particularly when on its face there would appear to be a clear distinction to the interruption and disruption to Construction Projects caused by the unique and unprecedented COVID-19 pandemic and the aforementioned examples of “temporary” interruptions referred to in the OECD Commentaries.
However, it is important to note that the OECD Guidance was issued by the OECD on 3 April 2020. As that was at a relatively early stage of the COVID-19 pandemic, the full implications of COVID-19 would not have been predicted at that point in time and it may have been the case that the OECD’s position was predicated on the working assumption that any disruptions caused to construction sites by COVID-19 would be “temporary” in nature. However, this is speculation and there has been no subsequent or updated position released by the OECD in respect of this issue.
Further, the ATO has not released any guidance on this issue in the context of the COVID-19 pandemic. However, if the ATO (or other foreign revenue authorities) were to adopt the same position as set out in the OECD Guidance, then it could potentially lead to scenarios (particularly where a DTA is applicable) where:
- a foreign resident will be deemed to have a PE in Australia, or
- an Australian resident will be deemed to have a PE outside Australia,
in respect of a Construction Project in circumstances where but for the temporary disruption of COVID-19, the Construction Project would not have exceeded the relevant deeming period in the relevant DTA.
Australian PE considerations related to COVID-19 disruptions to Construction Projects
In the context of Australia, it is relevant to note that there have been various border lockdowns and restrictions of international travel into and out of Australia. In particular, certain significant restrictions were placed on building and construction sites in Victoria in August 2020 for an initial six-week period due to COVID-19. Similar restrictions have been put in place in various countries around the world.
It is conceivable that such restrictions would have impacted certain Construction Projects carried on by non-resident entities in Australia. For illustrative purposes, take the hypothetical example of specialised personnel of non-resident entities who had intended to temporarily be in Australia throughout the duration of a Construction Project and who have left Australia at the early stages of COVID-19 with the intention of returning to Australia to recommence work on the Construction Project as soon as circumstances allowed. It is possible that the travel restrictions impacted their return to Australia and hence the progress and completion timeframes of the Construction Project.
From an Australian perspective, such interruptions and delays are likely to be of concern for:
- foreign residents with Construction Projects in Australia; and
- Australian residents with Construction Projects outside Australia,
particularly in circumstances where the Construction Project was, prior to COVID-19, anticipated to exist for less than the relevant aforementioned “deeming” period in any applicable DTA.
Moreover, given the lack of ATO guidance on this issue, if a foreign resident who has a Construction Project in Australia has any uncertainty about whether the disruptions caused by COVID-19 could trigger Australian PE issues then they should consider approaching the ATO for guidance. Practically, earlier engagement with the ATO may be a more prudent approach than engaging later in time when the ATO may have developed a firmer approach than currently outlined in the ATO guidance.
Disclaimer: Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.
Source: This article was originally published on the Clayton Utz website, 1 October 2020, and has been reproduced with permission.