Edited version of your written advice

Authorisation Number: 1051471852508

Date of advice: 11 February 2019

Ruling

Subject: Tax treaties

Question 1

With respect to the operation of the vessel, did Entity A have a permanent establishment in Australia under Article 5 of the relevant double tax agreement (the DTA)?

Answer

No.

Question 2

Is Entity A subject to Australian income tax on profits derived from the weekly hire charter rate fees it received under the time charter-party arrangement with Entity B under Article 8 of the DTA?

Answer

Yes.

Question 3

Does the DTA limit the rate of income tax payable by Entity A on profits derived from the weekly hire charter rate fees it received under the time charter-party arrangement with Entity B in Australia?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1. Entity A is incorporated in and is a tax resident of a country with whom Australia has the DTA.

2. Entity A owns and operates a dredging vessel (the vessel).

3. Entity B was successful in tendering for a land reclamation project in Australia.

4. As Entity B did not own or lease any dredging vessels, Entity B subcontracted the offshore activity to Entity A.

5. Entity B entered into a time charter-party arrangement with Entity A for use of the vessel. Under the time charter-party arrangement Entity B agreed to pay Entity A:

a. an initial mobilisation charge for the delivery of the vessel to a specified point outside of Australian waters.

b. a weekly charter hire rate for use of the vessel, and

c. a final demobilisation charge at the conclusion of the time charter-party arrangement at which time the vessel is re-delivered to the specified point outside of Australian waters.

6. Entity A brought the vessel to Australia to perform the subcontract offshore activities for a period of approximately four months.

7. The time charter-party agreement states:

“The entire operation, navigation, and management of the Vessel shall be in the exclusive control and command of the Owners. The Vessel will be operated in Australia and the services will be rendered as requested by the Charterers, subject always to the exclusive right of the Owners or the Master of the Vessel to determine whether operation of the Vessel may be safely undertaken. In the performance of the Charter Party, the Owners are deemed to be an independent contractor, the Charterers being concerned only with the results of the services performed.”

8. As part of the offshore activities, the vessel travelled to a location offshore from Australia within Australian territorial waters, and used its suction dredge to extract undersea sand and spoil.

9. The vessel then travelled to a designated location in Australia and discharged the sand and spoil.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 129

Income Tax Assessment Act 1936 section 317

International Tax Agreements Act 1953 section 4

Income Tax Assessment Act 1997 section 6-5

The DTA Article 3

The DTA Article 5

The DTA Article 8

Reasons for decision

Question 1

With respect to the operation of the vessel, did Entity A have a permanent establishment in Australia under Article 5 of the DTA?

Detailed reasoning

Paragraph 6-5(3)(a) of Income Tax Assessment Act 1997 (ITAA 1997) provides that a non-resident’s assessable income includes ordinary income derived directly or indirectly from all Australian sources during the income year.

The income from the extraction, transport and discharge of the sand and spoil in Australia by Entity A under the time charter-party arrangement with Entity B is ordinary income derived by Entity A from Australian sources for the purposes of subsection 6-5(3) of the ITAA 1997.

However, in determining liability to tax on Australian sourced income received by a non-resident, it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (ITAA 1953).

Section 4 of ITAA 1953 incorporates the ITAA 1953 with the ITAA 1997 so that those Acts are read as one. According to subsection 4(2) of the ITAA 1953 the provisions of the ITAA 1953 override the ITAA 1997 where there are inconsistent provisions across those Acts. The ITAA 1953 contains the DTA. The DTA operates to avoid the double taxation of income received by residents of the Contracting States (Article 1 of the DTA). As a resident of a Contracting State, the DTA therefore applies to Entity A.

Article 7 of the DTA provides that the profits of an enterprise of a resident of a contracting state will be taxable only in the state of residence unless the enterprise carries on business in Australia through a permanent establishment situated in Australia.

Article 5(1) of the DTA relevantly states that for the purpose of the Agreement, the term ‘permanent establishment’ means a fixed place of business in which the business of the enterprise is wholly or partly carried on.

Article 5(2) of the DTA lists a number of specific situations that are permanent establishments. These include a place of management, a branch, an office, a factory, a workshop, a mine, quarry or other place of extraction of natural resources, an agricultural, pastoral or forestry property, or a building site or construction, installation or assembly project which exists for more than 12 months.

Article 5(4) of the DTA provides other situations where an enterprise shall be deemed to have a permanent establishment in a Contracting State, including carrying on either supervisory activities in relation to a construction, installation or assembly project, or using substantial equipment for the exploration or exploitation of natural resources for at least 12 months.

Given that Entity A’s activities in Australia were being conducted by a vessel that moved regularly throughout Australian territorial waters, there was no specific fixed place of business for Entity A. Entity A’s physical presence in Australia was limited to its vessel in connection with the dredging services it performed as a subcontractor to Entity B for a period of approximately four months. These services performed by Entity A may constitute working on a construction, installation or assembly project under Article 5(4) of the DTA.

When interpreting a treaty, consideration may be had to the OECD Model Convention and the Commentaries on the Articles of the OECD Model (the OECD Commentaries) (Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338; [1990] HCA 37; 64 ALJR 516; 21 ATR 531; 94 ALR 647; 90 ATC 4717). The Court also suggested that the relevant commentaries were the commentaries at the time the treaty was entered into.

The OECD Commentaries, however, promote an evolving interpretation. Paragraph 33 of the Introduction to the OECD Commentaries states:

‘At that time [of drafting the 1977 Model Convention] the Committee considered that existing conventions should, as far as possible, be interpreted in the spirit of the revised Commentaries, even though the provisions of these conventions did not yet include the more precise wording of the 1977 Model Convention… The Committee believes that changes to the Articles of the Model Convention and the Commentaries that have been made since 1977 should be similarly interpreted.’

The Commissioner’s view, as stated in Taxation Ruling TR 2001/13 Income tax: Interpreting Australia’s Double tax Agreements is that in accordance with the OECD Commentary, the most recent commentary should be used as long as it is relevant to the words of the treaty to be interpreted.

The OECD Commentaries in both the 1977 and 2017 OECD Models are similar as to the description of what would constitute a construction, installation or assembly project.

The 1977 OECD Commentary:

16. 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 laying of pipe-lines and excavating and dredging…

19. The very nature of a construction or installation project may be such that the contractor's activity has to be relocated continuously or at least from time to time, as the project progresses. This would be the case for instance where roads or canals were being constructed, waterways dredged, or pipe-lines laid. In such a case, the fact that the work force is not present for twelve months in one particular place is immaterial. The activities performed at each particular spot are part of a single project, and that project must be regarded as a permanent establishment if, as a whole, it lasts more than twelve months.

Similarly, in the 2017 OECD commentary at paragraph 50:

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 pipe-lines and excavating and dredging.

And at paragraph 57:

The very nature of a construction or installation project may be such that the contractor’s activity has to be relocated continuously or at least from time to time, as the project progresses. This would be the case for instances where roads or canals were being constructed, waterways dredged, or pipelines laid. Similarly where parts of a substantial structure such as an offshore platform are assembled at various locations within a country and moved to another location within the country for final assembly, this is part of a single project. In such a case, the fact that the work force is not present for twelve months in one particular place is immaterial. The activities performed at each particular spot are part of a single project, and that project must be regarded as a permanent establishment if, as a whole, it lasts more than twelve months.

The OECD Commentaries are consistent from 1977 to 2017 in relation to the fact that dredging can be considered an activity that forms part of a building site or construction project. However, even though Entity A’s dredging activities constituted activity on a building site or construction site, Entity A was not at the site for a period of 12 months, as their role was limited to a period of approximately four months.

Similarly, the use of substantial equipment in Australia may be deemed to be a permanent establishment if the use of the equipment is for longer than a 12 month period. Although the use of the vessel by Entity A may constitute use of ‘substantial equipment’ in Australia, it was not used for a period of 12 months or more.

As such, Entity A will not be found to have had a permanent establishment in Australia by virtue of the presence of the vessel in Australian territory while it conducted the dredging activities it performed as part of the Project.

Question 2

Is Entity A subject to Australian income tax on profits derived from the weekly hire charter rate fees it received under the time charter-party arrangement with Entity B under Article 8 of the DTA?

Detailed reasoning

Under subsection 4(2) of the ITAA 1953, where a bilateral double tax treaty has been entered into between Australia and another jurisdiction, the terms of that double tax treaty take precedence over Australia’s domestic tax legislation to the extent of any inconsistencies.

Under Article 3(3) of the DTA, to the extent there is a term not defined under the treaty, its meaning takes the meaning under the laws of the relevant country looking to assert its right to tax.

Article 8 of the DTA allocates taxing rights to Contracting States on profits from the operation of ships or aircraft.

Article 8(1) of the DTA states that profits made by a resident of one of the Contracting States from the operation of ships is taxable only in the State of residence.

Article 8(2) of the DTA however provides an exception to Article 8(1) of the DTA such that notwithstanding Article 8(1), profits of a resident of a Contracting State derived from the operation of ships may be taxed in Australia where they are profits from operations of ships confined solely to places in Australia.

Article 8(4) of the DTA clarifies that profits derived from the carriage of passengers, livestock, mail, goods or merchandise shipping in Australia for discharge at another place in Australia shall be treated as profits from the operation of ships confined solely to places in Australia.

As the term ‘ship’ is not defined in the DTA, its meaning takes the meaning under the Australian income tax law.

Section 317 of the ITAA 1936 defines a ‘ship’ to mean:

A vessel, or boat of any description and includes an air cushion vehicle and any floating structure.

Entity A’s dredging vessel is a ship under Australia’s income tax law.

Taxation Ruling TR 2008/8 Income tax: the taxation treatment for ships and aircraft leasing profits under the ships and aircraft articles of Australia’s tax treaties (TR 2008/8) outlines Australia’s position with respect to ‘profits from the operation of ships and aircraft’. TR 2008/8 states in paragraphs 8 and 9 that its position is to preserve source taxation rights over profits from internal ship and aircraft operations, which include not just transport activities but also non-transport activities. Paragraph 10 of TR 2008/8 notes Australia’s intention to depart from the OECD model by way of reservation, stating that:

Australia reserves the right to tax profits from the carriage of passengers or cargo taken on board at one place in Australia for discharge in Australia. Australia also reserves the right to tax profits from other coastal and continental shelf activities.

TR 2008/8 states that paragraph 8(2) of Australia’s taxation treaties applies to both transport and non-transport profits derived by a tax treaty resident. It states that determining profits that are derived from non-transport activities confined solely to places in the other State requires an examination of the shipping activities undertaken by the enterprise in that other State and determining whether those particular activities constitute operations which are confined to places in that State. Whether activities undertaken constitute an ‘operation’ of the ship will depend on the type of activity and nature and extent of the particular activities being undertaken. Provided the activities consist of an active process, activity, performance and discharge of function in their own right, they would constitute an operation. The explanation includes, as non-transport profits, profits from ship operations such as fishing, dredging, crop dusting, salvage operations and surveying.

Taxation Ruling TR 2003/2 Income tax: the royalty withholding tax implications of ship chartering arrangements states that payments made under a standard time charter-party are not royalties as the essence of such arrangements is the rendering of services by the ship owner to the charterer. TR 2008/8 states that such hire payments can therefore be considered to be amounts received ‘for the operation of ships.’

Paragraph 127 of TR 2008/8 provides the ATO view that a dredging vessel contracted to dredge a harbour in an Australian port, the dredging and associated activities conducted in that Australian port area would be treated as conducting an operation of a ship confined solely to places in Australia. The travel necessary for the contractor to bring the dredge to Australia, and on completion travel to another location for the next contract would not form part of the operation.

The activities that Entity A was required to perform under the time charter-party arrangement with Entity B to obtain the weekly charter hire rate were the dredging of sand, and subsequent discharge of the extracted materials for pumping inland. These activities took place entirely within Australian territories and were an ‘operation’ in their own right in accordance with paragraph 127 of TR 2008/8. The travel of the ship from elsewhere to Australian waters prior to these activities and away from Australia subsequent to the activities do not exclude the operation from being considered to take place solely in Australia.

Entity A’s performance of the services under the time charter-party arrangement with Entity B therefore come within the parameters of Article 8(2) of the DTA. Australia is allocated a taxing right over the profits to the extent that they relate to the dredging operation confined to places in Australia. The amounts received for the delivery of the dredging ship from a previous location to the specified point outside of Australian waters would not constitute profits from the operation of a ship solely in Australia, and therefore would be outside the scope of Article 8(2) of the DTA. For similar reasons, the amounts received for redelivery of the dredging ship from Australia to a specified point outside of Australian waters would not constitute profits from a shipping operation confined solely to Australia.

As such, Entity A will be subject to Australian income tax on the profits derived from the services it provided under the time charter-party arrangement with Entity B in respect of the weekly charter hire rates received as the DTA allocates Australia taxing rights over profits made by Entity A from its Australian shipping operations confined solely to Australia under Article 8(2) of the DTA.

Question 3

Does the DTA limit the rate of income tax payable by Entity A on profits derived from the weekly hire charter rate fees it received under the time charter-party arrangement with Entity B in Australia?

Detailed Reasoning

Article 8(5) of the DTA restricts the tax chargeable on profits from operations of ships that are taxed under Article 8(2) of the DTA to a maximum of 5% of the amount paid or payable in respect of carriage in such operations. Article 8(6) of the DTA clarifies that where profits are taxable under Article 8(2) of the DTA, the 5% limit on taxation does not apply to profits derived from the operation of ships if those profits are derived otherwise than from the carriage of passengers, livestock, mail, goods or merchandise. As such, for the amount of tax to be limited to 5% of the amounts paid or payable to Entity A in relation to the profits derived from the time charter-party arrangement with Entity B must be in respect of ‘carriage.’

This limitation is also implemented in the Australian domestic law by way of section 129 of the ITAA 1936.

Example 8 in TR 2008/8 provides an example of where the limitation in the DTA under Article 8(5) does not apply by virtue of Article 8(6). The example states that a Belgian resident making profits from a bareboat lease would not be profits in respect of carriage as the fees are received regardless of the number of passengers, amount of goods etc. carried on the ship during the lease. Australia in such a circumstance is not restricted by this rate limit when exercising its source country taxing right under Article 8(2) of the DTA.

Entity A’s vessel, the vessel, did not carry passengers, livestock or mail. As such, it must be considered whether the vessel carried goods or merchandise.

‘Carriage of goods’ is not a defined term under the DTA or in Australian taxation legislation. As such, for the purposes of interpreting the DTA, the words are given their ordinary meaning. The Commissioner considers the carriage of goods for the purposes of the domestic tax law in Taxation Ruling TR 2006/1 Income tax: the scope of and nature of payments falling within section 129 of the Income Tax Assessment Act 1936. The carriage of goods is seen as the shipping of goods for a purchaser from one place to another, and includes amounts such as freight under a bill of lading. It may include payments made for a time charter-party where the activities performed by the ship are the transportation of either goods/cargo or people. The key is that the payment must be made for the actual transport or carriage of the goods, rather than for non-transport services provided by the ship or for its carrying capacity.

The activities performed by the vessel were not within the ordinary meaning of ‘carriage.’ The dredging of sand and soil, and subsequent discharge of the extracted materials via a pumping mechanism inland is not the ‘carriage of goods or merchandise’ as it is ordinarily understood. They were non-transport services. The time charter-party is for the boat and its services; the ability to dredge, store and pump the material recovered from the dredging exercise to undertake the land reclamation project. Entity A did not transport purchased goods, merchandise to sell, or carry general cargo. No freight or amounts similar to freight were paid to Entity A. The time charter-party fees were received for the non-transport services, and were chargeable on a time hire basis regardless of what was carried, and what amounts were carried on the ship. As such, Article 8(5) of the DTA does not apply to impose a rate limitation on the taxing of profits made by Entity A in relation to the time charter-party arrangement between Entity B and Entity A.

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