Income or net capital gains derived by a resident company from a business carried on through a PE outside Australia, including income and gains derived from disposing of the business, is generally exempt under section 23AH of the ITAA 1936, provided certain conditions are met.
To qualify for the exemption, the income must be "foreign income" as determined under the provisions of Australian tax law.
The PE must satisfy an "active income test". The test is generally the same as that for CFCs (see Sec. 13). Where the PE is in a listed country (i.e. Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States), the exemption will not apply if the foreign income is "adjusted tainted income" that is also "eligible designated concession income". For PEs in unlisted countries, the exemption is inapplicable if the income is "adjusted tainted income". As in the case of the "active income test", the "adjusted tainted income" and “eligible designated concession income” concepts used in this context are the same as those used in the context of CFCs (see Sec. 13).
For capital gains derived by the resident company on the disposal of assets used in carrying on the business through a foreign PE of the company, the exemption will not apply if:
- the gain is from the sale of taxable Australian property;
- the asset is a "tainted asset" (i.e. generally an asset producing passive income, such as shares and financial instruments); and
- the PE is in a listed country and the gain is "eligible designated concession income".
The foreign branch income and capital gains exemption also applies where the income or capital gain is derived through one or more interposed partnerships or trusts.
The exemption does not cover income and capital gains derived through a foreign PE that is engaged in the operation of ships or aircraft in international traffic.
The concept of PE applied for the purposes of the exemption is that contained in the domestic law (explained above), as modified by the provisions of any applicable tax treaty.