Practice Statement Law Administration
(General Administration)

PS LA 2008/2 (GA)

SUBJECT:	Non-treaty airlines
PURPOSE:	To advise the Commissioner's approaches to calculating the Australian taxable income of a non-treaty airline

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FOI status: may be released

SCOPE

1. This practice statement applies to non-treaty airlines. In this practice statement, a non-treaty airline means an airline that is a resident of a country that does not have a tax treaty with Australia.^[1]

BACKGROUND

2. There is no statutory source rule under Australian income tax law that deems a source for income derived from air transport. There are also issues around apportioning / allocating allowable deductions to Australian source income from air transport.

3. The Commissioner recognises that owing to the above and to the nature of international air transport, there are practical difficulties in working out the Australian taxable income of a non-treaty airline. Despite these difficulties, the Commissioner needs to ensure that non-treaty airlines calculate their taxable income in accordance with Australian income tax law.

4. The purpose of this Practice Statement is to provide direction and assistance to Tax Office staff on approaches to be taken when applying tax laws to the calculation of the Australian taxable income of a non-treaty airline. In providing these directions, it is recognised that a degree of flexibility is required, particularly in terms of striking a balance between the cost of compliance and the strict application of the law.

STATEMENT

5. This practice statement sets out approaches the Commissioner will accept in practice for ascertaining the Australian taxable income of a non-treaty airline.

6. As a matter of practical compliance and sensible administration, the Commissioner has decided that a non-treaty airline that calculates its Australian taxable income based on either the Maritime Formula or the Calcutta Formula, as described in paragraphs 11 to 17 of this practice statement, will have complied with Australian income tax law. A non-treaty airline can only use one formula to calculate its Australian taxable income in any given income year. Therefore, an airline cannot use both the Maritime Formula and the Calcutta Formula in the same year.

7. In the future, the Commissioner may consider other methodologies to calculate a non-treaty airline's Australian taxable income. Prior to being considered however, a methodology would need to satisfy the criteria given in paragraph 31 of Law Administration Practice Statement PS LA 1998/1.

8. A key element of both the Maritime Formula and the Calcutta Formula is the determination of 'gross Australian revenue'. The Commissioner considers that in most cases, the 'point of uplift' method is the more appropriate method to determine an airline's gross Australian revenue. However, the Commissioner accepts a non-treaty airline may use the 'point of sale' method to determine gross Australian revenue if the airline can demonstrate, if / when requested to do so, the method's appropriateness to its individual facts and circumstances. In any given income year, an airline's gross Australian revenue must be determined using either the point of uplift method or the point of sale method. Hence, both methods cannot be used in the same year. The point of uplift and point of sale methodologies are described in paragraphs 22 to 27 of this practice statement.

9. The approach a non-treaty airline adopts to calculate its Australian taxable income, in respect of the choice of the Maritime Formula or the Calcutta Formula and in the choice of the point of uplift method or the point of sale method, must be used consistently from year to year, unless there are special circumstances warranting a change in approach. Special circumstances could include:

•

an airline wanting to align the approach it uses to calculate Australian taxable income with the approach used to determine taxable position in all other jurisdictions

•

a significant change to an airline's accounting system that enables it to more accurately calculate income and expenses attributable to a particular sector.

An airline should inform the Tax Office in writing if it has changed its approach to calculating taxable income, thoroughly explaining the facts and circumstances that make the change appropriate.

EXPLANATION

10. The Commissioner's approach to calculating the Australian taxable income of a non-treaty airline is by reference to either the Maritime Formula or the Calcutta Formula, as described in an International Air Transport Association study.^[2] This study describes these formulae as 'some of the more usual apportionment formulae' to apportion the global net operating result.

Calculating Australian taxable income using the Maritime Formula

11. The Maritime Formula calculates Australian taxable income by apportioning an airline's global result on the basis of Australian revenue to world revenue. The formula is expressed as:

Australian Taxable Income = [(Gross Australian Revenue / Gross World Revenue) * World Net Income] + Net Australian Non Air Transport Income


12. In this formula:

Gross Australian Revenue means the total revenue from air transport activities having a source in Australia. It does not include 'Non Air Transport Income'.

Gross World Revenue means all revenue from air transport activities, irrespective of the country of source. It does not include Non Air Transport Income.

World Net Income means the amount of profit from air transport activities, before income tax, appearing in an airline's annual profit and loss statement, adjusted to take into account the general principles under which taxable income is ascertained under Australian income tax law. All material adjustments must be made to the profit and loss amount. At a minimum, adjustments must be made for:

•

reserves

•

provisions, and

•

depreciation to reflect the decline in value rates under the Uniform Capital Allowances regime.

World Net Income does not include Non Air Transport Income.

Net Australian Non Air Transport Income ^[3] means Non Air Transport Income to the extent that it has an Australian source under the ordinary provisions of income tax law, with applicable allowable tax deductions subtracted.

Non Air Transport Income means income of the non-treaty airline that is not related to air transport activities, such as income from interest, rent, duty free shops, restaurants and hotels.

13. Determining whether gross revenue has a source in Australia is crucial to calculating gross Australian revenue. This aspect is discussed further at paragraphs 18 to 33 of this practice statement under the heading 'Calculating gross Australian revenue'.

Calculating Australian taxable income using the Calcutta Formula

14. Under the Calcutta Formula, Australian taxable income is calculated by deducting from gross Australian revenue, all expenditure incurred in gaining that revenue. It is expressed as:

Australian Taxable Income = Gross Australian Revenue - [Direct Expenditure in Australia + Apportioned Other Expenditure] + Net Australian Non Air Transport Income


15. In this formula:

Gross Australian Revenue and Net Australian Non Air Transport Income have the same meanings as under the Maritime Formula (see paragraph 12 of this practice statement).

Direct Expenditure in Australia means the costs incurred in Australia as part of the Australian air transport activities of the non-treaty airline. It typically includes Australian station and ground costs (such as the salary, wages and costs of employees working in Australia, commissions relating to sales made by agents in Australia, office, rent and other utility costs, and depreciation on assets located in Australia to the extent that tax depreciation for those assets is available in Australia) and other local selling and administrative costs. It does not include the direct costs of flight operations - these are included in Apportioned Other Expenditure (see below).

Apportioned Other Expenditure means 'Other Expenditure' apportioned according to the extent that it reasonably relates to the production of gross Australian revenue. Other Expenditure refers to all costs incurred in deriving air transport income, with the exception of direct expenditure in Australia or equivalently direct expenditure in a foreign country. Other Expenditure typically includes costs directly attributable to flights that are referrable to gross Australian revenue (for example, fuel, in-flight catering and crew salary, wages, and allowances) as well as expenditure related to air transport income that is not directly related to a particular airline route (for example, head office expenses, aircraft depreciation, aircraft lease payments and aircraft maintenance).

16. A reasonable basis for the apportionment of Other Expenditure is the ratio of gross Australian revenue to gross world revenue. The Commissioner will also accept another basis of apportionment provided it:

•

gives a reasonable reflection of the proportion of expenditure relating to the non-treaty airline's gross Australian revenue

•

is not arbitrary

•

is suitable for the type of expenditure, and

•

gives a correct reflection of the expenditure incurred.

17. Expenditure, in the definitions in paragraph 15 of this practice statement, excludes costs that are not deductible under Australian law.

Calculating gross Australian revenue

18. The assessable income of a non-treaty airline is determined based on the same principles as for any other foreign resident. Specifically, subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a foreign resident's assessable income includes ordinary income derived directly or indirectly from all Australian sources during an income year. Similarly, subsection 6-10(5) of the ITAA 1997 provides that a foreign resident's assessable income includes statutory income from all Australian sources.

19. There is no statutory rule that deems a source for income derived from air transport. Accordingly, the precise determination of a non-treaty airline's assessable income is based on the common law principles for determining the source of income.

20. Income in a transport business, such as an international airline operation, is produced from the provision of transport services. Determination of the source of income is, in all cases, 'a practical, hard matter of fact'.^[4] However, it is clear from case law that a number of factors are important in determining source of income from performing services, including the place where the contract for services is entered into, the place where the services are performed, and the place where payment for the services is made.^[5]

21. It is neither possible, nor appropriate, for the Commissioner to be prescriptive about which factors should be dominant in the case of air transport income derived by non-treaty airlines, or how the interplay of those factors will apply to all non-treaty airlines in all circumstances.

22. Historically, there are two methods that the Tax Office has accepted to determine the source of air transport income derived by airlines, namely:

•

the point of uplift method, which broadly approximates to the common law principle which allocates the source of income based on the place where services are performed, and

•

the point of sale method, which broadly approximates to the place where a contract for services is entered into.

23. The Commissioner considers that in most cases the place of performance, being where the actual provision of transportation services takes place, will be the vital factor leading to the derivation of income. However, given the cross border nature of air transportation, practical and legal issues may arise with respect to working out the source of income generated by the performance of such activity. For instance, do you attribute the source of income proportionately to the respective parts of national and international airspace that comprise an airline's journey? To overcome these difficulties, the Commissioner considers that the place where carriage commences - otherwise known as the point of uplift - is a reasonable approximation of the place of performance source rule.

24. The point of uplift method allocates an Australian source to sales income for flights where the carriage commences in Australia. The income attributable to carriage from point to point is allocated to Australia where the first point is Australia, and the second point is the final destination of the passenger. Where a ticket itinerary for a flight commencing in Australia includes a transit stop - such as a stop to refuel or to allow passengers to change carriage to another aircraft of the airline - between Australia and the final destination, the Commissioner regards gross revenue derived from the entire journey as having an Australian source under the uplift method. On the other hand, where a flight commencing in Australia includes a stopover - that is, a significant break in the journey, such as an overnight stay in a hotel - the stopover destination is treated, under the point of uplift method, as the final destination.

25. The point of sale method allocates an Australian source to all gross income derived by an airline from tickets sold in Australia, provided the carriage is undertaken by that airline. It is irrelevant whether or not the carriage is to and from Australia. The Commissioner may accept the point of sale method as the determinant of gross Australian revenue where the circumstances of a non-treaty airline demonstrate that this is a more appropriate source rule.

26. Examples of the types of circumstances, which would make the point of sale method more appropriate than the point of uplift method, might include where:

•

a non-treaty airline carries on significant operations in Australia, as evidenced by the existence of operational and sales offices, or

•

a non-treaty airline engages in specific and strategic marketing and advertising in Australia.

It may also be appropriate to examine the way in which the gross revenue of the non-treaty airline is determined in other tax jurisdictions, although this will not necessarily decide the most appropriate method of determining gross Australian revenue.

27. Generally, the point of sale will align with the place where the contract is entered into. However, in the case of internet and other forms of electronic sales, the point of sale may not always accord with the place where the contract is entered into based on contract law principles.^[6] Nonetheless, the Commissioner accepts that the point of sale method is a reasonable approximation of the 'place of contract' source rule taken as a whole under prevailing selling processes.

Calculating gross Australian revenue for code-share and similar arrangements

28. The Commissioner considers that income derived under code-share, or arrangements similar to code-share, is income from air transport activities. Ascertaining whether such income has a source in Australia will involve applying the point of sale method or point of uplift method.

29. Code-share type arrangements vary between airlines. Generally, under code-share and similar arrangements, travellers purchasing one airline's tickets may find themselves travelling on another airline's plane.

30. A code-share type arrangement may involve an 'operating carrier', which operates the aircraft used for a flight, along with a 'marketing carrier', which purchases seats from the operating carrier for on-sale to the public. If a non-treaty airline is the marketing carrier, the amount included in gross Australian revenue under the point of sale method is the 'net' amount derived from tickets sold in Australia by the non-treaty airline, that is, the full fare the marketing carrier charges the passenger less the amount it pays to the operating carrier to acquire seats. Furthermore, the amount included in gross Australian revenue under the point of uplift method is the 'net' amount derived from tickets sold anywhere in the world by the non-treaty airline, but only in relation to flights departing Australia (see Example 2a of this practice statement).^[7]

31. If a non-treaty airline is the operating carrier, the amount included in gross Australian revenue under the point of sale method is the fee received from the marketing carrier from tickets sold in Australia. Additionally, under the point of uplift method, only the portion of the fee received relating to flights leaving Australia is included in gross Australian revenue (see Example 2b of this practice statement).

32. A code-share type arrangement may involve a 'seat swap' arrangement, such that neither airline pays the other a fee, but instead agrees that the exchange of seats represents full consideration. In such an arrangement, each airline keeps the entire revenue generated from its sale of tickets, irrespective of which airline performs the flight. Under the point of sale method, the non-treaty airline needs to include in gross Australian revenue the total revenue from tickets it sold in Australia, whether or not the tickets are for flights operated by the non-treaty airline or another airline. Under the point of uplift method, the amount derived from tickets sold by the non-treaty airline anywhere in the world needs to be included in gross Australian revenue, irrespective of whether it performed the flight, but only the portion relevant to flights leaving Australia.

33. Airlines may sell tickets in the capacity of an agent. Such situations must be distinguished from code-share type arrangements. Where an airline makes a sale in an agency capacity, it does not have responsibility for the carriage of the actual passenger aboard the airline performing the flight. The commission received by the airline making the sale is not income from air transport activities. Consequently, when calculating taxable income under the Maritime Formula or Calcutta Formula, the income must be treated as Non Air Transport Income.

34. Examples 2 and 3 of this practice statement apply the principles to arrangements which involve a code-share.

Other matters

Converting amounts of foreign currency

35. The Commissioner will accept an approach for converting foreign currency amounts into Australian currency where it is consistent with the rules contained in subdivision 960-C or subdivision 960-D of the ITAA 1997, as modified by the Income Tax Assessment Regulations 1997.

Foreign Income Tax Offsets

36. Under Division 770 of the ITAA 1997, a taxpayer may be entitled to a non-refundable tax offset for foreign income tax paid on an amount included in assessable income.^[8] This offset effectively reduces the potential Australian tax that would be payable on double-taxed amounts.^[9] Division 770 will apply from income years, statutory accounting periods and notional accounting periods starting on or after 1 July 2008.

Non arm's length dealings between different parts of the same entity

37. Where a non-treaty airline operates in Australia through a branch (permanent establishment), consideration should be given to the application of Division 13 of Part III of the Income Tax Assessment Act 1936, which allows for the arm's length allocation of the appropriate part of the income, profits and expenses between the Australian and foreign operations.

Examples on calculating gross Australian revenue

Example 1 (Basic Example)

38. One hundred people purchased Sydney to London return airline tickets, stopping in country A. The stop did not significantly break the passengers' journey (refer to paragraph 24 of this practice statement). The return fare was $2,700. The flight was performed entirely by the non-treaty airline.

(a)

Assume all one hundred return tickets were sold through the non-treaty airline's office in Sydney.

Using the point of uplift method

The Sydney to London portion of the fares, namely half of the total, or $135,000 ($2,700 multiplied by 100 tickets divided by 2), is included as gross Australian revenue. Australian revenue is calculated in this manner because the point of uplift for the Sydney to London leg of the journey occurs in Australia.

Using the point of sale method

The total of the fares of $270,000 ($2,700 multiplied by 100 tickets) is included as gross Australian revenue. As the tickets were sold in Australia, the whole amount of the fares is Australian revenue, irrespective of the point of uplift.

(b)

Assume all one hundred return tickets were sold overseas.

Using the point of uplift method

The Sydney to London portion of the fares, namely half of the total, or $135,000 ($2,700 multiplied by 100 tickets divided by 2), is included as gross Australian revenue given that uplift for that leg of the journey occurs in Australia.

Using the point of sale method

No amount is included as Australian revenue, given that the tickets were not sold in Australia.

Example 2 (Code-share - aircraft of only one airline used for flights)

39. One hundred people purchased Sydney to London return airline tickets, stopping in Country A. The stop did not significantly break the passengers' journey. The flights were operated under a code-share arrangement by two airlines, 'Operating Carrier' and 'Marketing Carrier'. Operating Carrier operated the aircraft used for the flights, while Marketing Carrier marketed and sold tickets on the flights. The return fare was $2,700. Under the code-share arrangement between the two airlines, Marketing Carrier pays Operating Carrier 90% of the ticket sale price, retaining a 10% margin. All one hundred return tickets were sold by Marketing Carrier through its Sydney sales office.

(a)

Assume that Marketing Carrier is a non-treaty airline.

Using the point of uplift method

Marketing Carrier receives total ticket revenue of $135,000 ($1,350 multiplied by 100 tickets) for the Sydney to London portion of the fares. Marketing Carrier pays Operating Carrier $121,500 in respect of the tickets sold (90% multiplied by $1,350 multiplied by 100 tickets). Marketing carrier's net revenue of $13,500 has an Australian source and is included as gross Australian revenue.

Using the point of sale method

Marketing Carrier receives total ticket revenue of $270,000 ($2,700 multiplied by 100 tickets) for the tickets sold in its Sydney sales office. Marketing Carrier pays Operating Carrier $243,000 in respect of the tickets sold (90% multiplied by $2,700 multiplied by 100 tickets). Marketing carrier's net revenue of $27,000 has an Australian source and is included as gross Australian revenue.

(b)

Assume that Operating Carrier is a non-treaty airline.

Using the point of uplift method

The Sydney to London portion of the fare income derived by Operating Carrier, attributable to the sales by Marketing Carrier, is included as gross Australian revenue. Accordingly, Operating Carrier's gross Australian revenue is $121,500 (90% multiplied by $2,700 multiplied by 100 tickets divided by 2).

Using the point of sale method

The total fare income derived by Operating Carrier, attributable to the sales by Marketing Carrier in its Sydney office, is included as gross Australian revenue. Operating Carrier's gross Australian revenue is therefore, $243,000 (90% multiplied by $2,700 multiplied by 100 tickets).

Note that if Operating Carrier had also sold tickets to customers itself, it would have further gross Australian revenue under the point of uplift method. Additionally, Operating Carrier would have further gross Australian revenue using the point of sale method, to the extent that the sales occurred in Australia.

Example 3 (Code-share - aircraft of more than one airline used for flights)

40. One hundred people purchased Sydney to London return airline tickets, stopping in Country A. The flights were operated under a code-share arrangement by two airlines, Airline 1 and Airline 2. Both airlines marketed and sold the flights. The return fare was $2,700. Under the code-share arrangement between the airlines, the airline that actually performed the flight derived 90% of the fare sold by the other airline. All one hundred return tickets were sold in Australia. Specifically, Airline 1 sold 40 tickets, while Airline 2 sold 60 tickets.

41. The table below provides details of the route flown by each airline, the number of passengers transported and the value of performing each leg of the flight:

(a)

Assume that Airline 1 is a non treaty airline.

Using the point of uplift method

Fares sold by Airline 1 on the journey departing from Australia
($1,350 multiplied by 40 tickets)	$54,000
less fee paid to Airline 2 for seats on the Country A to London leg
(90% multiplied by $1,000 multiplied by 40 tickets)	- $36,000
plus 90% of fares sold by Airline 2 on Sydney to Country A leg
(90% multiplied by $350 multiplied by 60 tickets)	+ $18,900
Gross Australian revenue of Airline 1:	$ 36,900

Using the point of sale method

Fares sold by Airline 1 in its Sydney sales office
($2,700 multiplied by 40 tickets)	$108,000
less fee paid to Airline 2 for seats on Airline 2 operated flights
(90% multiplied by $2,000 multiplied by 40 tickets)	- $72,000
plus 90% of fares sold by Airline 2 in its Sydney sales office
(90% multiplied by $700 multiplied by 60 tickets)	+ $37,800
Gross Australian revenue of Airline 1:	$ 73,800

(b)

Assume that Airline 2 is a non treaty airline.

Using the point of uplift method

Fares sold by Airline 2 on the journey departing from Australia
($1,350 multiplied by 60 tickets)	$81,000
less fee paid to Airline 1 for seats on the Sydney to Country A leg
(90% multiplied by $350 multiplied by 60 tickets)	- $18,900
plus 90% of fares sold by Airline 1 on Country A to London leg
(90% multiplied by $1000 multiplied by 40 tickets)	+ $36,000
Gross Australian revenue of Airline 2:	$ 98,100

Using the point of sale method

Fares sold by Airline 2 in its Sydney sales office
($2,700 multiplied by 60 tickets)	$162,000
less fee paid to Airline 1 for seats on Airline 1 operated flights
(90% multiplied by $700 multiplied by 60 tickets)	- $37,800
plus 90% of fares sold by Airline 1 in its Sydney sales office
(90% multiplied by $2000 multiplied by 40 tickets)	+ $72,000
Gross Australian revenue of Airline 2:	$ 196,200

© AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA

You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).

Date of Issue: 17 April 2008

Date of Effect: This Practice Statement applies to income years commencing after its date of issue

File 07/17966

Related Practice Statements:
PS LA 1998/1

Other References: A study by the International Air Transport Association dated September 1975 and titled "Taxation of International Air Transport Net Income Basis - An Alternative to Reciprocal Exemption"
Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No.4) Bill 2007

Legislative References:
ITAA 1936 Pt III Div 13
ITAA 1997 6-5(3)
ITAA 1997 6-10(5)
ITAA 1997 770-1
ITAA 1997 Div 770
ITAA 1997 Subdiv 960-C
ITAA 1997 Subdiv 960-D
Electronic Transactions Act 1999
Income Tax Assessment Regulations 1997

Case References:

C of T (NSW) v. Cam & Sons Ltd
(1936) 36 SR (NSW) 544

Nathan v. FCT
(1918) 25 CLR 183

Authorised by:
Michael D'Ascenzo

Business Line:  PGI

ISSN: 2651-9526