Mr. Russell was an individual taxpayer having residence in Australia. Mr. Russel was the sole shareholder of a company “Ancath” (hereinafter – Ancath) located in New Zealand. Formally Mr. Russell was also employed by Ancath to provide accountancy services to Ancath clients.
One of the main clients of Ancath was Tradecorp International Pty Ltd (hereinafter –
Tradecorp) located in Australia. According to Mr. Russell’s words, there were also clients in Vanuatu.
Furthermore, Mr. and Mrs. Russell (Mr. Russell’s wife) were 100% owners of the partnership
“A W Russell & Co” located in New Zealand. During the existence of the partnership, Mr.
and Mrs. Russell were the only partners. The only income which the partnership received was contributions from Ancath to the partnership. It is possible to say that this income provided by Ancath was some kind of fee for services provided by the partnership.
6.2. Issue and applicable law
The question which arose before the Court was focused on the point of whether New Zealand – Australia Double Tax Treaty can preclude the application of Australian domestic legislation and taxation of the income in hands of the individual. Analyzing the Double Tax Agreement between New Zealand and Australia (hereinafter – DTA) it is possible to say that it generally follows the OECD approach. One of the key aims of such an agreement is to prevent double taxation. The question which arose before the Court was focused on the point of whether the New Zealand – Australia Double Tax Treaty can preclude the application of Australian domestic legislation and taxation of the income in hands of the individual.
Australian personal services income rules which were applicable in the case at hand are anti-abuse norms that express the “look-through” regime which allows determining when the activity of the company is a part of services provided by the individual and when it’s an independent company’s activity.
6.3. Commissioner’s assessment and lower court
The Commissioner of Taxation (hereinafter – tax authority) noted that Mr. Russel paid tax only on 50% of the income paid by Ancath to the partnership. The tax authority started the tax assessment of Mr. Russel during which he checked the income paid to Ancath from 2001 to 2004. Commissioner based his decision on domestic Australian legislation since Mr. Russell was an Australian tax resident.
During the assessment, the tax authority highlighted that the income earned by Mr. Russell constituted personal services income attributed to him even though the actual recipient of the income was the company and the income should be taxed respectively according to Australian legislation (personal services income rules). Since Mr. Russell performed accountancy
services based on his education, probable previous working experience, and knowledge which was achieved by him making efforts, it is possible to say that the income which was received because of Mr. Russell providing accountancy services was a reward for personal efforts and skills, thus, an income for personal services. The question was if Ancath complied with the requirements of the personal services business.
Mr. Russell appealed against the Commissioner’s decision to the Federal Court of Australia, however, the Court took the side of the tax authority. After the examination of evidence (invoices provided by Mr. Russell), the Court stated that the 80/20 requirement was failed
which means that general personal services income rules are applicable and the income was attributable to the individual, particularly Mr. Russell.
6.4. High court
Mr. Russell tried to appeal the Federal Court’s decision in the higher instance but the High Court upheld the decision of the Federal Court.
In Mr. Russell’s appeal, he insisted that domestic Australian legislation was not applicable because the Double tax treaty between New Zealand and Australia had precedence in the case.
Mr. Russell stated that the application of domestic Australian legislation raised economic double taxation because the income received by Ancath was treated as income received by a company in New Zealand and as income received by Mr. Russell in Australia. This was possible to see from the following chain of transactions expressed in point 113 of the primary decision:
- Ancath’s income from Tradecorp forms part of its assessable income in New Zealand;
- where Ancath itself was taxed in Australia on this income, it would receive a foreign tax credit against its New Zealand tax for any Australian tax paid;
- the personal services income regime in Pt 2-42 of the [1997 Act] deems Ancath’s income to be part of [Mr. Russell’s] assessable income;
- Ancath receives no credit in New Zealand for any Australian tax it pays on income so included by deeming; and
- the outcome is double taxation and hence it is in breach of the double taxation agreement36.
Mr. Russell also invoked that the application of the domestic Australian legislation will be inconsistent with the scope of Article 7 of the New-Zealand – Australia Double Tax Treaty.
Under the treaty, the Australian tax authority had no right to tax the income which was derived by Ancath because the latter was a New Zealand company without a permanent establishment in Australia. In meantime, the Commissioner insisted that Article 7 aims to prevent juridical double taxation, not economic.
Therefore, there was a clash between the ITAA 1997 and the Australia – New Zealand double
36 Australia: Federal Court of Australia, 30 Oct. 2009, No B20 of 2011, Anthony Whitworth Russell v.
Commissioner of Taxation of Commonwealth of Australia, paragraph 113, Case Law IBFD
tax convention: according to the domestic legislation of Australia, the income of Ancath was attributable to Mr. Russell, whereas according to the convention, due to the fact that Ancath was a tax resident of New Zealand, Australia did not have right to tax such income.
The Federal Court upheld the approach of the lower Court that Australian domestic legislation is applicable in this case. Both instances based the idea on other case law37 mentioned in the lower Court decision which highlighted the significance of Australian rules of statutory interpretation in construing legislation because it gives effect to international obligations, including treaties. The lower Court also explained the interaction between the ITAA 1997 and New Zealand – Australia Double Tax Treaty: “The Convention does not provide any of the framework for the operation of the Act. The contrary is the case. That does not mean that the Convention in and to the extent of its application to Australia should be narrowly construed. It simply means that Australian law is determinative, and it is that which should be clearly ascertained before attention is turned to the Convention.”38
Analyzing the connection between Mr. Russell and the income received by Ancath and the economic double taxation that existed in the case, the Federal Court came to the same conclusion as the lower Court did. Under s 86-30 of the ITAA 1997, Mr. Russell’s personal income should be excluded from the income of Ancath because this part of the income is not included in the profit of the company. Mr. Russell’s income taxation should be separated from Ancath profits for the taxation in Australia. In this case, Article 7 of New Zealand – Australia Double Tax Treaty was applicable. The profits of Ancath which were effectively attributable to the company were taxed in the State where they were received. The income received by Ancath but attributable to Mr. Russell was taxed in accordance with Australian law. As it was already mentioned Part 2-42 of ITAA 1997 is an anti-avoidance rule. The income received by Ancath was effectively attributable to Mr. Russell because of the service provision.
Application of ITAA 1997 or New Zealand – Australia double tax treaty does not allow to enjoy the abusive scheme, directing the flow of income through a personal service company.
Assessing Mr. Russell’s argument about economic double taxation, the Court again agreed with the lower court and the discussion that Australian legislation treats Mr. Russell as a subject to tax but not Ancath. The Court also upheld the lower Courts’ reasoning that
“profits” mentioned in Article 7 of the Double Tax Treaty should be discussed as profits of a
37 Thiel v Federal Commissioner of Taxation (1990), McDermott Industries (Aust) Pty Ltd v Commissioner of Taxation (2005), Minister for Immigration and Multicultural and Indigenous Affairs v QAAH (2006)
38 Australia: Federal Court of Australia, 30 Oct. 2009, No B20 of 2011, Anthony Whitworth Russell v.
Commissioner of Taxation of Commonwealth of Australia, paragraph 69, Case Law IBFD
particular enterprise but not profits in the abstract sense.
Subsequently, the lower Court came to the conclusion that the word “enterprise” should not be treated in a restrictive interpretation. The frameworks of this term can be expanded or narrowed.
7. Appendix 2. Aznavour case