McDERMOTT INDUSTRIES (AUST) PTY LTD v FC of TJudges:
Full Federal Court
MEDIA NEUTRAL CITATION:
 FCAFC 67
Hill, Sundberg and Stone JJ
This appeal from the judgment of a judge of this Court concerns the meaning of Article 4 of the Agreement Between the Government of the Commonwealth of Australia and the Government of the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (``the Singapore Agreement''). It concerns also, the relationship between Article 5 of the Singapore Agreement (popularly referred to as the ``business profits article'') and Article 10 of the Singapore Agreement, concerned with the taxation of
ATC 4400royalties. It arises in the context of a Singapore corporation, Chartering Company Singapore Pte Ltd (``CCS''), making available to the appellant, McDermott Industries (Aust) Pty Ltd (``MIA''), an Australian corporation, in the relevant year of income for use in Australian territorial waters for the purposes of the latter's business in Australia as an offshore marine construction and engineering contractor, barges pursuant to bare boat charters.
2. As the long title to the Singapore Agreement makes clear, a purpose of a double tax agreement is the avoidance of double taxation. That purpose is, in part, given effect to by allocating exclusively to one or the other contracting State the power to tax certain classes of income:
FC of T v Lamesa Holdings BV 97 ATC 4752 at 4759; (1997) 77 FCR 597 at 605. A similar statement was made by Gzell J of the Supreme Court of New South Wales in
Unisys Corporation Inc v FC of T 2002 ATC 5146. Such an exclusive allocation of the power to tax is to be found in Article 5 of the Singapore Agreement which, in general terms, provides that business income of an enterprise of one contracting State will be taxable in that State and that State alone, unless the enterprise carries on business in the other State through a permanent establishment there, when it will be taxed in the State where the permanent establishment is.
3. Another theme which will be found in all double tax agreements is that certain forms of income such as dividends, interest and royalties (these expressions being used in a defined sense) will be taxed in the country of source by withholding at a rate which is set by the double tax agreements. Credit for such withholding taxes will then be required to be given in the country of residence or nationality as the case may be, that is to say, the other contracting State. In the case of income by way of ``royalty'' as defined, the rate of withholding tax is capped at 10 per cent of the gross royalty. This contrasts with the ordinary rate of withholding tax payable in Australia (30 per cent) upon royalties where a double tax agreement does not operate to reduce the applicable rate.
4. Perhaps in past times, the capped rates of withholding tax might have been seen as advantageous; a concession granted to certain types of income in respect of which withholding tax was payable. However, in modern times at least, a fixed rate of withholding tax which is payable on gross royalties may well exceed the ordinary tax rate on net income after deductions allowable are taken into account. That is the present case. So it is in the interest here of the appellant taxpayer to argue that income of the non-resident Singapore taxpayer should be taxed in Australia, by force of the operation of Article 5 of the Singapore Agreement, at ordinary Australian tax rates applied to ``taxable income'', that is to say, relevantly upon the gross income by way of royalty (if it is properly to be described as a royalty), after allowing for deductions, inter alia, of ordinary business expenses and not by withholding at the rate of 10 per cent on what the respondent, the Commissioner of Taxation (``the Commissioner''), submits is a gross royalty.
5. In the present case, the appellant taxpayer is not the Singapore resident company CCS, which is the recipient of what the Commissioner says are royalties, but rather, the Australian resident company MIA, which is the payer of the amounts said to be royalties. As will be seen, the impact to MIA of the payment of what the Commissioner says are royalties arises under Australian domestic taxation law because no deduction will be allowable to MIA as an Australian resident in determining its taxable income where the amount it pays to the non-resident is a royalty subject to withholding tax and withholding tax has not been remitted to the Commissioner. It is common ground that if the amounts paid were royalties in the defined sense and did not fall within Article 5 of the Singapore Agreement, withholding tax should have been remitted upon the payments, but was not.
The relevant facts
6. There is no dispute as to the relevant facts. MIA is a resident of Australia and at relevant times carried on business here. Between 1 April 1993 and 31 March 1997, MIA chartered vessels from CCS pursuant to lease agreements. The charters were bare boat charters. The vessels so chartered were barges and not ``ships'' as that expression is used in the Singapore Agreement in Article 7, which allocates the power to tax profits from ships to the place of residence of a taxpayer.
7. MIA paid $43,251,778 to CCS by way of charter fees and claimed these amounts as allowable deductions in its returns of income
ATC 4401for the years of income ended 1994 to 1997 inclusive. MIA did not deduct or remit to the Commissioner withholding tax in respect of the charter fees it paid to CCS.
8. CCS is resident in Singapore. It did not carry on business in Australia. It had no office in Australia and no staff in Australia. It entered into the bare boat charters in Singapore where the charters were signed by it.
9. It is common ground that the barges in question were ``substantial equipment'' as that expression is used in Article 4(3)(b) of the Singapore Agreement. It is also now common ground that the charters were, at least generally, subject to the terms of a master agreement which required that the barges be used only in Australian waters. We say ``generally'', because we were told from the bar table that while this was not necessarily so in every case, the Commissioner now accepted that it was not relevant to the appeal whether there was such a requirement.
The Singapore Agreement
10. A double taxation agreement is an international treaty negotiated by officials of each contracting State. Like all international treaties to which Australia is a party, it forms part of domestic law only because Parliament has enacted legislation providing for the treaty to be incorporated into domestic law. The legislation which so enacts is the International Tax Agreements Act 1953 (Cth) (``the International Agreements Act''). That Act gives the force of law to the various international double tax agreements scheduled to it, including the Singapore Agreement (Sch 5 and Sch 5A). The Singapore Agreement is made up of an initial agreement signed on 11 February 1969 (Sch 5) as amended by the Protocol signed by the parties in 1989 and which entered into force on 5 January 1990.
11. The International Agreements Act, in addition to incorporating the double taxation agreements scheduled to it into domestic law, defines certain expressions used in the scheduled agreements. Subsection 4(2) provides, subject to exceptions not presently relevant, that it and thus the double taxation agreements scheduled to it both prevail over provisions of the Income Tax Assessment Act 1936 (Cth) (``the Assessment Act'') and indeed, the Income Tax Assessment Act 1997 (Cth). The definition section, s 3(2), provides that a reference in a double taxation agreement to ``profits of an activity or business'' is to be read, for the purposes of Australian tax, as a reference to taxable income derived from that activity or business. Further, expressions undefined in the agreement will have, relevantly for present purposes, the meaning they have under the law of Australia relating to income tax.
12. Section 17A of the International Agreements Act makes it clear that the provisions of s 128B of the Assessment Act, which operate domestically to impose withholding tax on royalties, are to have no operation if a provision in a double tax agreement operates to exclude a payment that is otherwise a royalty from the royalty provisions of the treaty.
The relevant provisions of the Assessment Act
13. Under the Assessment Act as in force at the relevant time, there was allowable to a taxpayer generally, a deduction for ordinary business expenditure: s 51(1). It is unnecessary to set out here the provisions of that well known subsection.
14. A liability to deduct withholding tax was imposed upon a resident payer of a ``royalty'' who paid that royalty to a non-resident by virtue of s 128B of the Assessment Act, but subject to s 128B(3), not presently relevant. Section 128B(2B) of the Assessment Act imposes the liability for withholding tax by reference to a royalty derived by the non-resident payee that:
- (i) is paid to the non-resident by a person to whom [the] section applies and is not an outgoing wholly incurred by that person in carrying on business in a foreign country at or through a permanent establishment of that person in that country; or
- (ii) is paid to the non-resident by a person who, or by persons each of whom, is not a resident and is, or is in part, an outgoing incurred by that person or those persons in carrying on business in Australia at or through a permanent establishment of that person or those persons in Australia.''
It is common ground that neither of the exceptions in (i) or (ii) apply. In particular, the payee in the present case does not have a ``permanent establishment'' as defined in the Assessment Act.
15. The expression ``royalty'' is defined in the Assessment Act, inter alia, to include any amount paid or credited, however described or computed and whether or not paid periodically, to the extent to which is it paid or credited, as the case may be, as consideration, inter alia, for ``the use of, or the right to use, any industrial, commercial or scientific equipment''. It is common ground that the payment made by the taxpayer to the Singapore company was, relevantly, for the use of, or the right to use, equipment falling within the words ``industrial, commercial or scientific equipment''.
16. The requirement for a deduction of withholding tax is, however, subject to s 221YL(3) of the Assessment Act which provides that no deduction will be required if withholding tax is not payable on the royalty. Indeed, any deduction required is limited to the amount of the withholding tax required to be paid in respect of the particular royalty. Section 221YRA(1A) then provides that if a person has not made the required deduction for withholding tax in accordance with s 221YL and not paid the withholding tax due, that person will not be entitled to an allowable deduction in the year of income in respect of the royalty paid. It is common ground that withholding tax would not be required to be paid in the present case if the non-payment is mandated by the provisions of the Singapore Agreement.
The relevant provisions of the Singapore Agreement
17. Article 4 of the Singapore Agreement defines, for the purpose of that agreement, what a ``permanent establishment'' is. The definition, which differs substantially from that in the Assessment Act, is as follows:
``(1) For the purposes of this Agreement, the term `permanent establishment', in relation to an enterprise, means a fixed place of business through which the business of the enterprise is wholly or partly carried on.
(2) The term `permanent establishment' includes but is not limited to-
- (a) a place of management;
- (b) a branch;
- (c) an office;
- (d) a store or other sales outlet;
- (e) a factory;
- (f) a workshop;
- (g) a warehouse except where it is used solely for any of the purposes mentioned in paragraph (4);
- (h) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; and
- (i) a building site, or a construction, installation or assembly project, but only where such site or project or any combination of them continues for a period aggregating more than 6 months within any 12-month period.
(3) An enterprise of a Contracting State shall be deemed to have a permanent establishment and to carry on trade or business through that permanent establishment in the other Contracting State if-
- (b) substantial equipment is being used in that other State by, for or under contract with the enterprise.
18. Article 3(5) of the Singapore Agreement defines ``enterprise of a Contracting State'' to be a Singapore enterprise or an Australian enterprise as the case may be. These expressions are defined in the same article as ``an industrial or commercial enterprise (including a mining, agricultural, pastoral, forestry or plantation enterprise)'' carried on by an Australian or Singapore resident as the case may be. It is not in dispute that CCS is a Singapore enterprise.
19. Article 5(1) and Article 5(6) of the Singapore Agreement then provide:
``(1) Profits of an Australian enterprise shall not be subject to Singapore tax unless the enterprise carries on trade or business in Singapore through a permanent establish- ment in Singapore. If it carries on trade or business as aforesaid, Singapore tax may be imposed on those profits but only on so much of them as is attributable to that permanent establishment.
(6) Profits shall not be attributed to a permanent establishment by reason of the mere purchase or mere purchase and transportation by that permanent establishment of goods or merchandise for the enterprise.''
20. Article 7, to which reference is made above, deals with the taxation of profits from the operation of ships and, it is agreed, is irrelevant to the present question.
21. Article 10 of the Singapore Agreement is concerned with the taxation of royalties. Sub- articles (1) to (4) of that article provide:
``(1) The Australian tax on royalties derived by a Singapore resident who is beneficially entitled to the royalties shall not exceed 10 per centum of the gross amount of the royalties.
(2) The Singapore tax on royalties derived by an Australian resident who is beneficially entitled to the royalties shall not exceed 10 per centum of the gross amount of the royalties.
(3) In this Article royalties means payments of any kind to the extent to which they are received as consideration for-
- (a) the use of, or the right to use, any-
- (i) copyright (other than a literary, dramatic, musical or artistic copyright), patent, design or model, plan, secret formula or process, trademark, or other like property or right; or
- (ii) industrial, commercial or scientific equipment; or
- (b) the supply of information concerning industrial, commercial or scientific experience,
but does not include royalties or other payments in respect of the operation of mines or quarries or of the exploitation of natural resources or payments to the extent to which they are received as consideration for the use of, or the right to use, motion picture films, tapes for use in connection with radio broadcasting or films or video tapes for use in connection with television.
(4) Paragraphs 1 and 2 of this Article shall not apply if the resident of one of the Contracting States who is beneficially entitled to the royalties has in the other Contracting State a permanent establishment and the information, right or property giving rise to the royalties is effectively connected with a trade or business carried on through that permanent establishment.''
22. It is common ground that the payments made by MIA to CCS for the bare boat charters fall within the definition of ``royalty'' in Article 10(3)(a)(ii) as payments received as ``consideration for the use of, or the right to use... industrial, commercial or scientific equipment''.
The judgment appealed from
23. The learned primary judge first considered and correctly applied the principles governing the interpretation of double tax agreements. They will be set out later in the present reasons. His Honour correctly concluded that it was necessary to have regard to the context of the Singapore Agreement while giving effect to the language of it.
24. His Honour then addressed a submission advanced by the Commissioner that the Singapore Agreement, considered by reference to its context, object and purpose, operated to divide income into two broad categories, namely active and passive income; the former category being applicable to the business profits article, Article 5 and the latter to the provisions of the Singapore Agreement dealing with royalties, Article 10. Hence, it was submitted before his Honour that the word ``used'' as it appears in Article 4(3)(b) did not extend to passive use. Mere receipt of income for the ``use'' of substantial equipment did not, it was submitted, fall within that sub-article.
25. The learned primary judge rejected the submission that there was any contextual implication to be found in the Singapore Agreement that income was divided into the two broad categories of active and passive income. That argument was not repeated before us and requires no further discussion.
26. His Honour then considered the specific terms of Article 4(3)(b) and concluded that the broad meaning of ``use'' as extending to passive use, for example use by granting a lease, illustrated by cases applicable to Australian domestic law such as
Ryde Municipal Council v Macquarie University (1978) 139 CLR 633 and
Attorney-General (ACT) v Commonwealth of Australia (1990) 26 FCR 82, should not be adopted as applicable to Article 4(3)(b). His Honour expressed the following view as to the interpretation of the sub-article:
``(1) Where substantial equipment is being used in the other State (here Australia) `by... the enterprise' of the Contracting State, that enterprise will necessarily be active in
ATC 4404the other State unless the word `used' refers to the passive sense identified in a case such as Ryde. No such identification is apt, however, for two reasons. The first is the fact that it is a permanent establishment which is being deemed and, understood in the context of art 4(2), it is unlikely passive usage would be intended unless made clear by the terms of the deeming provision. The second is the effect of the words `for or under contract with the enterprise'. There is no necessity for the implication of a passive interpretation where the text specifically provides for these two forms of engagement other than by the enterprise of the Contracting State itself.
(2) Where substantial equipment is being used in the other State `for... the enterprise' there is necessarily an involvement on behalf of the enterprise of the Contracting State. No reliance is placed on the word `for' by MIA.
(3) Where the substantial equipment is being used in the other State `under contract with the enterprise' it is necessary not only that the usage takes pace in the other State but, in accordance with the paragraph, the substantial equipment `is being used in that other State... under contract with the enterprise'. Reference to the relevant contracts here, the lease agreements, shows that they do not contain any contractual requirement for the usage to take place in the other State (Australia) (cf Explanatory Memorandum to the Income Tax International Agreements Bill 1953 (Cth) at p 54 relating to the provision in its former wording). There is therefore no establishment of a nexus with the other State and no foundation at all akin to the foundation needed to consistently satisfy the concept of permanent establishment. The position may arguably be different if the lease agreements had required the usage to be in Australia, but that is not the position here.''
27. As already noted, the Commissioner no longer relies upon the third of the paragraphs quoted above which, it might be thought, was an essential part of the reasoning adopted by the learned primary judge. It is accepted by the Commissioner that no difference would arise in the present case, whether the lease agreements required the barges to be used in Australia (which indeed they generally did by incorporation of the terms of the master agreement) or whether there was no such requirement in the lease agreements. However, it is submitted before us that the same result follows in that the payments by MIA to CCS of the charter fees were not within Article 4(3)(b), but rather, fell within Article 10 of the Singapore Agreement as royalties to be taxed by withholding.
The submissions of the Commissioner on the appeal
28. Queen's counsel for the Commissioner submitted that Article 4 required on its proper construction that a permanent establishment would not be found to exist unless the relevant enterprise had a ``significant presence'' in the relevant State. There was, it was submitted, no permanent establishment to be found merely as a consequence of ownership of property giving rise to passive income such as rent, interest, dividends and royalties. Article 4(3)(b), like other sub-articles of Article 4, should be construed having regard to the general principle enunciated in Article 4(1) of the Singapore Agreement, namely that a permanent establishment was a fixed place of business through which the business of the enterprise was carried on. The object of the several sub- articles of Article 4 was, it was submitted, to elaborate and elucidate (but not ``vastly'' to expand) the concept of substantial business presence enunciated in Article 4(1).
29. Income from property such as royalty income was, under the Singapore Agreement, it was submitted, to be taxed in the country of residence. It was said to be improbable that the operation of Article 10 dealing with royalties was intended to be limited by the terms of Article 4(3)(b) so that royalties from the use of substantial equipment fell outside Article 10 and the obligation to withhold tax upon royalties for the use of equipment which was insubstantial was to be treated as falling within Article 10.
30. It was submitted that the expression ``used... by, for or under contract with'' in Article 4(3)(b) did not stipulate three different and alternative occasions of usage. Rather it expressed a single complex idea (said to be a ``hendiadys''), namely use in furtherance of the enterprise whether directly by the non-resident or indirectly, by others for the non-resident or under contract (to operate or use the equipment
ATC 4405in the conduct of the enterprise) with the non- resident.
31. It was also submitted that recourse to the historical provenance of Article 4(3)(b) confirmed this interpretation. Reference was made to the fact that Article 4(3)(b) first made its appearance in double tax agreements to which Australia was a party in the double tax agreement entered into between Australia and the United States in 1953 (the Convention Between the Government of the United States of America and the Government of the Commonwealth of Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, signed at Washington on 14 May 1953). It was submitted that the decision of the Board of Review No 3 in Case H106 (1958) 8 TBRD 484, dealing with the United States double taxation agreement, supported the interpretation contended for by the Commissioner.
32. Finally it was submitted that acceptance of what was said to be an alternative argument of the taxpayer that use under a contract with the enterprise was sufficient, although actual use was by another entity and not by the enterprise, gave rise to what were said to be ``curious'' and ``improbable results'' where what was said to be mere adventitious use in Australia would result in there being a permanent establishment here. Some examples were given which were said to demonstrate this.
The submissions of the appellant
33. Queen's counsel for the appellant submitted that in the present case the barges were ``used'' by CCS in that they were being employed by CCS to generate income by leasing them out and alternatively, the barges were used in Australia by MIA under contract (the bare boat charters) with CCS, pursuant to which CCS supplied the vessels for use by MIA in its offshore marine construction business. The first of these meanings of ``use'' involved both passive and active use. Reference was made to cases such as Ryde (at 638) as showing that a person may be said to ``use'' property where that property is leased or licensed to someone else.
34. The learned primary judge erred, it was submitted, in holding that the word ``use'' in Article 4(3) was constrained by the provisions of Article 4(2) as requiring significant presence and thus as not contemplating what his Honour referred to as ``passive use''. Rather, it was submitted that Article 4(3) was a deeming provision operating to fix an enterprise of a State with a permanent establishment where its operations fell outside Article 4(2). Thus Article 4(3) operated to expand the notion of permanent establishment and should not be read down by reference to Article 4(2).
35. The submission of the appellant involved no improbable consequences as submitted by the Commissioner. To the contrary, it was submitted on behalf of the appellant that the Singapore Agreement revealed an intention to treat equipment leasing of substantial equipment as excluded from the royalty provisions involving tax withholding.
36. It was submitted also that the construction contended for by the appellant was supported by the decision of the Board of Review in Case H106, also relied upon by the Commissioner. Although the case was distinguished by the learned primary judge, it was, so it was submitted, decided on language not relevantly different from that in the Singapore Agreement.
The principles applicable to interpretation of double tax agreements
37. Double tax treaties are bilateral treaties entered into between two states. As such they are to be interpreted in accordance with the requirements of the Vienna Convention on the Law of Treaties (23 May 1969, entered into force on 22 January 1974) (``the Convention'') and in particular Article 31 of the Convention.
38. The application of the Convention has been discussed by McHugh J in
Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225 and in
Thiel v FC of T 90 ATC 4717; (1990) 171 CLR 338, the latter case being concerned with the interpretation of the double taxation agreement between Australia and Switzerland. The leading authority in this Court on interpretation of double taxation agreements is Lamesa. It is unnecessary here, to set out again what is there said. The following principles can be said to be applicable:
- • Regard should be had to the ``four corners of the actual text''. The text must be given primacy in the interpretation process. The ordinary meaning of the words used are presumed to be ``the authentic representation of the parties' intentions'': Applicant A at 252-3.
- • The courts must, however, in addition to having regard to the text, have regard as well to the context, object and purpose of the treaty provisions. The approach to interpretation involves a holistic approach.
- • International agreements should be interpreted ``liberally''.
- • Treaties often fail to demonstrate the precision of domestic legislation and should thus not be applied with ``taut logical precision''.
The textual language
39. There is nothing particularly difficult about the language used in Article 4(3) of the Singapore Agreement. On its face it operates to deem there to be a permanent establishment in Australia if the Singapore enterprise (in the present case CCS), inter alia, owns ``substantial equipment'' (here a barge) which is used in Australia, inter alia, under contract with the Singapore enterprise. The relevant use might, but need not be, use by an Australian enterprise. All that is required is that there be a use of the equipment in Australia and that the use be ``under contract''. On the face of it there is no difficulty in concluding that a bare boat charter entered into between CCS and MIA of barges, used only in Australian waters in the relevant period, falls within Article 4(3).
40. If the natural meaning of Article 4(3) is to give way to some other construction this must be as a result of something to be found in the context, object or purpose of the treaty. We will accordingly start with a consideration of ``context'', using that expression in its broadest sense as including the historical background to Australia's double taxation agreements and particularly the Singapore Agreement.
The historical background
41. An examination of the historical background to the relevant articles of the Singapore Agreement assists in understanding the policy issues which those articles reveal.
42. A useful starting point is the commentary to the draft OECD Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital, presented in 1963 (``OECD Model Convention''), which has served as a model for many although not all of Australia's double tax agreements. Certainly the commentary has been used to assist in the interpretation of double tax agreements based upon it, although there may be a theoretical difficulty in using commentary published after the adoption of a double taxation agreement as relevant to the construction of that agreement. Hence, the High Court of Australia in Thiel had regard to the commentary to the 1977 OECD Model Convention in construing the business profits article in the Swiss-Australian double taxation agreement. Whether there may be a different result in taking into account commentary published after ratification of an agreement is not a matter that need concern us here, cf: John F. Avery Jones et al, ``The Interpretation of Tax Treaties with Particular Reference to Article 3(2) of the OECD Model (Pt 2)'' (1984) British Tax Review 90, fn 27, where reference is made to examples from the Netherlands where a particular interpretation of an article was justified by a subsequent commentary.
43. Reference to the 1997 OECD Model Convention commentary makes it clear that there had, for some time, been debate as to the proper treatment of royalties paid for the use of or the right to use industrial, commercial or scientific equipment. Both the 1963 draft convention and the 1997 OECD Model Convention had defined royalties in a way such as to include payments for the use or the right to use industrial, commercial or scientific equipment. The definition of ``royalties'' was subsequently changed so that the 1997 OECD Model Convention excluded such payments from the definition. There was clear disagreement among states using the OECD model as to whether such payments should be treated as royalties and so subject to withholding, or treated as within the business profits article. Australia, it is noted, reserved the right to tax income derived from the leasing of equipment as royalties where such income had an Australian source. Other countries took a different view.
44. The different views are dealt with in a report on the taxation of income derived from the leasing of industrial, commercial or scientific equipment, published by the OECD in November 1997. It is noted that equipment leasing had developed world wide in the preceding 20 years and that there were problems in the relationship between double tax agreement articles dealing with royalties on equipment and the business profits articles to be found in those agreements. That report concluded (contrary to the apparent position of
ATC 4407Australia) that income from the leasing of industrial, commercial or scientific equipment should be excluded from the definition of ``royalty'' altogether, and so not be the subject of withholding tax.
45. However, while amendment to the definition of ``royalty'' could be said to solve the problem in part, it is noted by Associate Professor Evans of Dalhousie University in Halifax, writing in the Canadian Tax Journal, Vol 50 in 2002, that, absent special provision, the question whether presence in a state of leased equipment would of itself constitute a permanent establishment was unclear in both the OECD Model Convention and the UN Model Tax Convention on income and capital (``UN Model Convention'') (see at p 491).
46. Article 4(3)(b) with its reference to ``substantial equipment'' does not derive from the OECD Model Convention, or for that matter from the UN Model Convention. So far as Australia is concerned it would seem to have entered into Australia's agreements for the first time with the negotiation of the double taxation agreement with the United States in 1953. That agreement defined ``permanent establishment'' in Article II as follows:
``[T]he term `permanent establishment' means a branch, agency, management or fixed place of business and includes a factory, workshop, mine, oil-well, office or agricultural or pastoral property, or the use or installation of substantial equipment or machinery by, for, or under contract with, an enterprise of one of the Contracting States.''
47. The explanatory memorandum accompanying the amendments to the International Agreements Act which incorporated the US-Australia double taxation agreement into Australian domestic law notes that it was desirable to give a wide meaning to the term ``permanent establishment''. Otherwise, the comments in that memorandum assist little.
48. It may be accepted that generally there is, underlying the ordinary definition of ``permanent establishment'', the notion of a fixed place of business (see the Singapore Agreement, Article 4(1)) having some degree of permanence (see per Gzell J in Unisys, who held that merely temporary rented premises were not a permanent establishment in the sense used in s 128B of the Assessment Act).
49. The 1953 agreement between the United States and Australia excluded from the definition of ``industrial or commercial profits'', subject to the business profits provision, income in the form of royalties. However, it did not define ``royalties'' in a way which included equipment leases. Rather, the royalty provisions were restricted to works in which copyright existed, or royalties in respect of the exploitation of mines, quarries or other natural resources. The definition did not extend to payments for the use of, or right to use, industrial, commercial or scientific property. In other words, the definition of ``permanent establishment'' as including use or installation of substantial equipment ``by, for, or under contract with'' an enterprise of the other State raised no conflict between the business profits article and the article dealing with royalties.
50. The Board of Review No 3 decided Case H 106 in 1957. That case concerned an American company which licensed an English company to manufacture a product as the sole independent contractor for the American company and to use trade names of the American company relating to the product. The American company also lent to the English company the necessary equipment to manufacture the product. It was held that the American company had a permanent establishment in Australia. While it would seem that the American company in any event carried on business in Australia, the case appears to have been decided on the basis that there was a permanent establishment by virtue of the American company making available the necessary equipment which was found to be ``substantial''. The Chairman, Mr Fletcher said at 486:
``In my opinion, the fact that all the machinery used belonged to the American company is sufficient to find that the American company was a `United States enterprise' engaged in trade or business in Australia through a permanent establishment in Australia.''
51. Both Mr McCaffrey and Mr Antcliffe, members of the Board of Review, appear to have taken a similar view.
52. Of course, decisions of Boards of Review are not binding upon this Court. They, like decisions of the successor to the Boards, the Administrative Appeals Tribunal, are decisions of an administrative tribunal. Nevertheless, they
ATC 4408are decisions of an expert tribunal learned in taxation law and entitled to at least the same respect as would today be given to decisions of the Administrative Appeals Tribunal as well as commentaries of learned text book writers.
53. It may also be realised here that there was significance given, particularly in double taxation agreements to which the United States later became a party, to the setting of a time limit on when construction sites or building projects were to be considered as a permanent establishment. Article 5(2)(i) of the 1983 agreement between the United States and Australia (the Double Taxation Taxes on Income Convention Between the United States of America and Australia, signed at Sydney on 6 August 1982, entered into force 31 October 1983) is an example where the time limit imposed was nine months. Article 5(3) of the 1977 OECD Model Convention adopts a period in excess of 12 months. Article 5(3) of the 1979 UN Model Convention adopted a period of six months within any 12 month period. The Singapore Agreement adopts now in Article 2(i) a similar period to the UN Model Convention and, see too, Article 4(3)(a) of the Singapore Agreement. These time limits may be taken, where they are applicable, to signify the degree of permanence required for there to be found a permanent establishment or, conversely, a relaxation, to the extent allowed, of the concept of permanence. By contrast, the deeming provision of Article 4(3)(b) operates without a time limit. However, like Article 4(3)(a), sub- article (3)(b) will operate to deem there to be a permanent establishment, notwithstanding that otherwise the provisions of Article 4(1) will not permit there to be found a permanent establishment. We shall return to that matter later.
Policy - Substantial equipment as a permanent establishment
54. One obvious explanation for treating the presence (under contract) of leased substantial equipment as a permanent establishment relates to the very nature of the equipment itself. It is obvious from the text itself that the equipment must be ``substantial''. Just how substantial is not stated and need not be considered here, for it is conceded by the Commissioner that the barges represented equipment that was substantial. Whether the concession was correctly made is not a matter with which we are presently concerned.
55. However, it is clear that the article is concerned with equipment that is not, either in a relative, or in an absolute sense, insubstantial. Floating oil rigs are a good example of equipment which would properly be treated as substantial. It does not seem surprising that the owner of such a rig which had granted rights of use under a bailment agreement for reward should be treated as having a permanent establishment in the place where the rig is and where it is used, and thus be liable to be assessed for tax on the basis of the income derived from the rig in the jurisdiction where the rig is and where it is used and not the place of residence of the owner. Construction cranes employed in large construction projects would likewise be properly characterised as ``substantial equipment'' and suggest another example where payment of the right to use, under a bailment agreement, might readily be seen as properly taxed in the place where the equipment is used and not the place of residence of the owner.
Context - The structure of Article 4
56. At the heart of the argument for the Commissioner is the proposition that Article 4(1) operates to govern or constrain the interpretation of each of the sub-articles which follow it.
57. It may be accepted that Article 4(1) sets out the general definition of ``permanent establishment'' by reference to the fixed place of business through which the business of the enterprise is wholly or partly carried on. It may well be that Article 4(1) requires, therefore, a significant presence in the relevant contracting state for it to be applicable, so long as the words ``significant presence'' are not taken to be a substitute for the language of Article 4(1).
58. Article 4(2) operates, at least generally, to give examples of cases that would fall within Article 4(1). We say ``generally'', because this may well not be true of Article 4(2)(i) relating to building sites or other construction projects where a time limit of six months is stipulated. It may reasonably be argued that a building or a construction, installation or assembly project continuing for periods in aggregation totalling only six months, or more than six months but less than a year, would not necessarily have the permanence required by Article 4(1) and thus not constitute a permanent establishment within that article.
59. However, Article 4(3) stands in a different position. It is a deeming provision and as such probably operates to deem something to be that which otherwise it might not be. That deeming goes beyond there being a deeming of a permanent establishment. It operates as well to deem the enterprise to be carrying on trade or business through the deemed permanent establishment. If it be the case, as appears to be suggested by the Commissioner, that Article 4(3)(b) is governed by Article 4(1) then, presumably, Article 4(3)(b) would add nothing to Article 4(1). However, the Commissioner's submissions appear to accept that Article 4(3)(b) might add something to Article 4(1). The acceptance, however, is qualified by a submission that the extension to Article 4(1) should not be ``vast''. Once it is accepted that Article 4(3)(b) might add something to Article 4(1), how significant the extension of Article 4(1) will be is a matter to be determined by the language of Article 4(3). It will not assist in determining the extension of the meaning of Article 4(1) to use an adjective such as ``vast''.
60. Article 4(4) operates in reverse of Article 4(3) by deeming there not to be a permanent establishment as a result of certain features there set out. It neither assists nor hinders the Commissioner's argument based upon Article 4(1). The same can be said of the agency provisions of Article 4(6).
61. As a matter of interpretation we can see no reason why Article 4(3) should be read down by reference to Article 4(1) as the Commissioner submits. One difficulty in doing so is that it then becomes necessary to read words into Article 4(3) to effect the limitation. What words would be read into Article 4(3) is far from clear. Further, once it is conceded, as we think it was, that Article 4(3) may in fact operate to expand the operation of Article 4(1) then no reading down of Article 4(3) by reference to Article 4(1) will be possible.
The words ``by, for or under contract''
62. As already noted, it was submitted by Queen's counsel for the Commissioner that the words ``used... by, for or under contract with'' as used in Article 4(3)(b) did not stipulate three different and alternative occasions of usage but rather, the words stipulated a single complex idea. It is said that the one idea here is ``use'' in furtherance of the enterprise, whether that use is direct by the non-resident or indirect, by others, for the non-resident or under contract (to operate or use the equipment in the conduct of the enterprise of the non-resident) with the non- resident. So, in written submissions it was said that if the equipment is operated (``used'') by an employee, its use falls within the ``by'' part of the expression; if by another under supervision, its use falls within the ``for'' part of the expression and if by a subcontractor in furtherance of the enterprise, the use falls within the ``under contract with'' part of the expression.
63. With respect, it is difficult to accept this submission. First, use by an employee is use by the employer, so it is hard to imagine that the ``by'' part of the expression was intended to cover use by an employee. Second, it is difficult to conclude that the ``for'' part of the expression was intended to be limited to cover use under supervision, whether or not such use might be comprehended within it. The most obvious set of facts falling within the second alternative would be where the other person referred to uses the equipment for the benefit of the enterprise. The person using the equipment could, although need not, be a subcontractor. It is only the third class of cases to which the words ``under contract'' apply. No doubt the third factual situation covered might include a subcontractor. There is no reason to believe that the three categories are necessarily mutually exclusive. If, however, a subcontractor did fall within the third category, there is no reason to limit the third category to subcontractors.
64. Rather, with respect to the argument, the normal meaning of Article 4(3) is that it extends to three alternative classes of case. The first of the three separate or alternative cases referred to will be use of the substantial equipment by the enterprise itself. The second class of case will be use of the substantial equipment ``for'' the enterprise. The third class of case will be use of the substantial equipment under a contract with the enterprise.
65. It is then submitted that the approach contended for by the Commissioner is confirmed by the ``provenance'' of the article. Reference is made to the 1953 treaty between Australia and the United States to which reference has already been made and the explanatory memorandum issued by the then Treasurer at the time amendments were made to the International Agreements Act which gave the force of domestic law to that double tax agreement. The Treasurer wrote:
``It may be practicable for an enterprise of one country to fulfil contracts which render it necessary to use or install equipment or machinery in the country, but which do not require the setting up of a branch, or other place of business which constitutes permanent establishment in that country. To cover this position , the definition explicitly includes as a permanent establishment the use or installation of substantial equipment or machinery in the other country. The same result will follow where substantial equipment or machinery is used or installed in one country for, or under contract with, an enterprise of the other country.''
(emphasis supplied in the submission)
66. With respect to the submission, it is difficult to see support for the submission in this extract, even if it is appropriate to use the views of the Treasurer of one of the contracting States to support the interpretation of a bilateral treaty where the other contracting State may have had a different view. As already noted, the Australia-United States double taxation agreement definition of ``permanent establishment'' was quite different from the definition in the Singapore Agreement in both language and structure. The royalty provisions did not extend to payments for the use of industrial, commercial or scientific property. However, to the extent that the language was, in part similar, the Board of Review No 3 appears to have interpreted it as covering the grant of a right to use equipment whether or not the enterprise was actually fulfilling contracts requiring the use or installation of the substantial equipment. In other words, the Board of Review did not seem accepting of the policy said to be reflected in the explanatory memorandum, if indeed, the memorandum intended to espouse a policy.
The absurdity argument
67. It was submitted that it was improbable that those responsible for drafting the Singapore Agreement intended to limit the field of operation of Article 10 by the operation of Articles 4(3)(b) and 10(4) so as to exclude from the scheme of the Singapore Agreement dealing with royalties (where tax is to be imposed by withholding and by reference to the place of residence of the property owner), substantial equipment. A construction of Article 4(3)(b) which avoids that improbability should, it was submitted, be preferred.
68. It is far from clear to us that the result is, as submitted, improbable. First, as we have already suggested, there is a good case for differentiating leases of ``substantial'' equipment from the ordinary equipment leases which fall within Article 10, particularly when there was international disagreement as to the way rental from equipment leases should be taxed. There is nothing improbable about taxing rental from the oil rigs or large cranes, given as examples earlier, under the business profits provision rather than treating the rental as royalties to be taxed under Article 10. More importantly however, it is clear that Article 10, through sub-article (4), itself contemplated that Article 10 did not cover the field by imposing tax on rental from all equipment leases as royalties. Article 10(4) makes it clear that sub- articles (1) and (2) are not to apply to a case falling within the business profits provision (ie Article 5) where the property giving rise to what otherwise would be taxed as a royalty is effectively connected with trade or business carried on through that permanent establishment. It is conceded by the Commissioner that the effective connection required by Article 10(4) is to be found here. In other words, in such a case, Article 5 takes priority over Article 10.
69. Absurdity or, at least, results said to be ``curious'' and ``improbable'' are said to arise because any party to a contract which provided for the use of ``substantial equipment'' would be deemed to have a permanent establishment even where the equipment was ``adventitiously'' used in Australia. By way of example, it was suggested that if the barges here had been owned by a Canadian company and leased under a finance lease to a Singapore company which chartered them to a New Zealand company which, for the purpose of the charter, towed them through Australian waters, the mere presence of the vessels in Australian waters would have the result that each of the Canadian, Singapore and New Zealand parties would be deemed to have a permanent establishment in Australia.
70. There is a danger in approaching questions of construction by reference to examples said to be curious, albeit that it is no doubt correct that the Court would prefer a construction which furthered the purpose of a provision rather than one which created anomalies. There is a danger in courts
ATC 4411answering hypothetical situations where the facts are, to say the least, sparse. With respect however, the suggested consequence would not seem to follow on the proper construction of the Singapore Agreement. The mere towing of a vessel through Australian waters en route to New Zealand (the ``adventitious use'') would not, in our opinion, amount to a relevant use of the vessel within Australia. Article 4(3) would not, in such a circumstance, operate to deem the barges to be used by the Canadian financier. Within the Singapore Agreement, the contemplated use must be a real use of the asset in Australia to gain income. Mere adventitious presence would not amount to a relevant use. The so called ``curious'' or ``improbable'' results do not, in our view, follow.
71. In our view CCS had, in the relevant years of income, a permanent establishment in Australia within Article 4 of the Singapore Agreement as a result of the operation of sub- article 4(3). The permanent establishment is deemed to arise because the barges in question, being admittedly substantial equipment, were being used in Australia by either CCS itself, or by MIA under contract with CCS. Because the provisions of Article 10(4) apply, the consequence is that the charter fees were not to be taxed by withholding as royalties but rather, by the application of the ordinary provisions of the Assessment Act, namely the imposition of tax on the taxable income of CCS, calculated by reference to any allowable deductions available to it under, inter alia, s 51(1) of the Act. It follows that the amounts paid by MIA to CCS were allowable deductions to MIA in calculating its income in the relevant years of income.
72. The appeal should, accordingly, be allowed. The orders made by the learned primary judge should be set aside and, in lieu thereof, it should be ordered that the objection decisions the subject of the appeal be set aside and the objections of MIA should be allowed. The matter should be remitted to the Commissioner to be reassessed in accordance with law.
THE COURT ORDERS THAT:
1. The appeal be allowed and the orders of the learned primary judge be set aside and in lieu thereof, it be ordered that the objection decisions that form the subject of the appeal be set aside and the objections of the appellant be allowed.
2. The assessments the subject of the objections be remitted to the respondent to be reassessed in accordance with law.
3. The respondent pay the appellant's costs of the appeal.