Edited version of private ruling

Authorisation Number: 1011679918978

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Ruling

Subject: Australian taxation implications of proposed lease transaction

Issue 1

Will the Lessor be liable to pay income tax on interest derived under the Finance Lease pursuant to subsection 128B(5) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Issue 2

Will the Lessor be liable to pay income tax on rent derived under the Finance Lease pursuant to subsection 128B(5A) of the ITAA 1936?

Answer

No.

Issue 3

Will the Lessor be liable to pay income tax on the rent derived under the Finance Lease pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following periods:

1 January 2012 to 31 December 2012

1 January 2013 to 31 December 2013

1 January 2014 to 31 December 2014

1 January 2015 to 31 December 2015

1 January 2016 to 31 December 2016

1 January 2017 to 31 December 2017

1 January 2018 to 31 December 2018

1 January 2019 to 31 December 2019

1 January 2020 to 31 December 2020

1 January 2021 to 31 December 2021

1 January 2022 to 31 December 2022

1 January 2023 to 31 December 2023

1 January 2024 to 31 December 2024

The scheme commences on:

1 January 2012

Relevant facts and circumstances

The Leasing Company

The non-resident Leasing Company is in the business of leasing substantial equipment.

The Leasing Company intends to acquire and lease substantial equipment to an Australian Company.

The substantial equipment is currently on order with the manufacturer.

The purchase price of the substantial equipment represents an arm's length market price and will be paid through a combination of:

§ pre-delivery payments, and

§ proceeds from finance arrangements by the Lessor.

On the delivery date, the legal title to the substantial equipment will be assigned to the Lessor.

Delivery of the substantial equipment to the Australian Company will take place outside Australia.

The Lessor

The non-resident Lessor is not a related entity of the Lessee.

Part of the purchase price of the substantial equipment will be funded by the Lessor with external commercial debt, which will be guaranteed by the Guarantor.

The Lessor will enter into a Finance Lease to the Lessee, fully amortising over the life of the loan.

The Finance Lease will be negotiated and executed outside Australia.

The Finance Lease will contain an option for the Lessee to purchase the substantial equipment at the expiry of the Finance Lease for nominal consideration.

The Finance Lease constitutes a hire-purchase agreement as defined in subsection 995-1(1) of the ITAA 1997.

The Lessee

The Lessee is a non-resident company and a wholly-owned subsidiary of the Leasing Company.

Under the Finance Lease, the Lessee will have all the benefits and burdens of ownership. The Lessee intends to exercise its option to purchase the substantial equipment at the expiry of the Finance Lease.

The Lessee will lease the substantial equipment to a Related Entity (which is also a wholly-owned subsidiary of the Leasing Company) under a Head Lease and the Related Entity will in turn sub-lease the substantial equipment under a Sub-Lease to an Australian Company.

All leases will be executed outside Australia. All leases will be effective from the same date, being the delivery date of the substantial equipment and will have a lease term of the same period.

During the term of the leases, full legal ownership of the substantial equipment will remain with the Lessor but the substantial equipment will be in the possession of and under the exclusive control of the Australian Company.

Neither the Related Entity nor the Australian Company will have an option to purchase the substantial equipment during or at the end of the Head Lease or Sub-Lease respectively.

Rental payments payable by the Australian Company to the Related Entity will be paid directly into the Related Entity's bank account outside Australia. The Related Entity will pay rental payments to the Lessee. No other activities other than the receipt of rental payments by the Australian Company to the Related Entity arise in Australia. The Leasing Company, Related Entity and the Lessee will not undertake any repairs or maintenance of the substantial equipment during the lease term.

The Lessee does not have any employees, office or other place of business in Australia.

The rent payable by the Lessee does not constitute income listed in subsection 128B(3) of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 995-1(1)

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Subsection 128AC

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Subsection 128B(2)

Income Tax Assessment Act 1936 Subsection 128B(2B)

Income Tax Assessment Act 1936 Subsection 128B(3)

Income Tax Assessment Act 1936 Subsection 128B(5)

Income Tax Assessment Act 1936 Subsection 128B(5A)

Reasons for decision

Issue 1

Summary

The Lessor will not be liable to income tax under subsection 128B(5) of the ITAA 1936 on the interest component of the rent payable by the Lessee under the Finance Lease as that amount is not an outgoing incurred by the Lessee in carrying on business in Australia at or through a permanent establishment in Australia.

Detailed reasoning

Section 128AC of the ITAA 1936 deems a component of rentals and other payments made to a non-resident under a relevant agreement to notionally constitute interest income.

A 'relevant agreement' is defined in subsection 128AC(1) of the ITAA 1936 to include a hire-purchase agreement.

The Finance Lease from the Lessor to the Lessee constitutes a hire-purchase agreement as defined in subsection 995-1(1) of the ITAA 1997. Accordingly, the rent payments made by the Lessee to the Lessor under the Finance Lease will be deemed to contain an implicit interest component.

Section 128B of the ITAA 1936 sets out the circumstances in which there is liability to withholding tax in respect of certain income derived by a non-resident.

Under subsection 128B(5) of the ITAA 1936, a person who derives income to which section 128B of the ITAA 1936 applies that consists of interest is, subject to subsections 128B(6) and (7), liable to pay income tax upon that income.

Pursuant to subparagraph 128B(2)(b)(ii) of the ITAA 1936, interest income derived by a non-resident is subject to withholding tax where the interest is paid by another non-resident and that non-resident payer:

§ has a permanent establishment in Australia; and

§ makes the payment to the non-resident as an outgoing incurred by it in carrying on business in Australia at or through a permanent establishment in Australia.

Permanent establishment is defined in subsection 6(1) of the ITAA 1936 to mean a place at or through which the person carries on business and includes, without limiting the generality of the foregoing …

(b) a place where the person has, is using or is installing substantial equipment or substantial machinery …

Taxation Ruling TR 2007/11 Income tax: withholding tax and related implications for a non-resident head lessor or hire-purchase provider of substantial equipment where the equipment is obtained by another non-resident entity that subleases, subprovides or leases it for use in Australia provides guidance on the meaning of '…has, is using…' for the purposes of the definition of 'permanent establishment' in subsection 6(1) of the ITAA 1936.

The Lessee holds the substantial equipment for its business purposes of leasing it to other entities and which is ultimately used in Australia. Accordingly, the Lessee has a permanent establishment in Australia for the purposes of subsection 6(1) of the ITAA 1936.

In determining a non-resident's liability to withholding tax under section 128B of the ITAA 1936 on interest income it derives, it is necessary that the interest is an outgoing incurred by the payer in carrying on business in Australia at or through a permanent establishment in Australia.

Whether or not a non-resident is carrying on business is a question for fact and degree to be determined on balance according to the facts and circumstances of each particular case. A non-resident which leases substantial equipment will almost always be found to be carrying on business by virtue of its leasing activities.

In determining whether the non-resident is carrying on business at or through the permanent establishment in Australia requires an examination of the business activities of the enterprise that relate to the permanent establishment to determine whether they have been undertaken in Australia through that permanent establishment. For a non-resident in the business of leasing and sub-leasing, the activities of the business will usually involve entering into leasing contracts and other activities concerning the equipment.

On the facts, the Lessee does not carry on business at or through its deemed permanent establishment in Australia. All of the business activities of the Lessee arise outside Australia as the leases were executed outside Australia and lease revenues are received from the non-resident Related Entity. The mere presence of the leased equipment in Australia does not constitute carrying on business at or through the deemed permanent establishment in Australia.

Accordingly, the implicit interest component of the rent payable by the Lessee to the Lessor will not be subject to withholding tax under section 128B of the ITAA 1936 and the Lessor will not be liable to withholding tax under subsection 128B(5) of the ITAA 1936.

Issue 2

Summary

The Lessor will not be subject to royalty withholding tax under subsection 128B(5A) of the ITAA 1936 as the rent payable by the Lessee pursuant to the Finance Lease does not constitute a royalty in accordance with subparagraph 128B(2B)(b)(ii) of the ITAA 1936.

Detailed reasoning

Section 128B of the ITAA 1936 sets out the circumstances in which there is a liability to withholding tax in respect of certain income derived by a non-resident.

Under subsection 128B(5A) of the ITAA 1936, a person who derives income to which section 128B of the ITAA 1936 applies that consists of a royalty is liable to pay income tax upon that income.

Pursuant to subparagraph 128B(2B)(b)(ii) of the ITAA 1936, royalty income is subject to withholding tax where it is paid by a person who is not a resident to another non-resident and it is an outgoing incurred by the person in carrying on business in Australia at or through a permanent establishment of that person in Australia.

Subsection 6(1) of the ITAA 1936 defines a 'royalty' to include an amount paid as consideration for the use of, or right to use any industrial, commercial or scientific equipment.

The terms 'industrial, commercial or scientific equipment' are not defined in the ITAA 1936 or ITAA 1997.

Taxation Ruling TR 98/21 Income tax: withholding tax implications of cross border leasing arrangements explains the meaning of the terms 'industrial, commercial or scientific equipment' in the context of the definition of 'royalty' in subsection 6(1) of the ITAA 1936.

On the facts, the rent payable by the Lessee constitutes a royalty for the purposes of subsection 6(1) of the ITAA 1936.

For the rent payable by the Lessee to the Lessor to constitute a royalty for the purposes of subsection 6(1) of the ITAA 1936, the amount paid must be paid as consideration for the use or right to use the equipment.

Where it is clear from the outset that the purchase of the equipment is paramount, payments made under a cross border leasing transaction are not subject to royalty withholding tax under subsection 128B(5A) of the ITAA 1936. The paramount purpose of a transaction is to be decided by having regard to all the surrounding circumstances and commercial consequences of the transaction.

On the facts, the paramount purpose of the Finance Lease is the purchase of the substantial equipment by the Lessee.

Accordingly, the rent payable by the Lessee are not royalties for the purposes of subsection 6(1) of the ITAA 1936 and therefore, does not constitute royalty income for the purposes of subparagraph 128B(2B)(b)(ii) of the ITAA 1936. As such, the Lessor will not be liable to royalty withholding tax under subsection 128B(5A) of the ITAA 1936 on rent received from the Lessee.

Issue 3

Summary

Rent income derived by the Lessor will not be assessable under subsection 6-5(3) of the ITAA 1997 as the rent income is not derived from Australian sources.

Detailed reasoning

Under subsection 6-5(3) of the ITAA 1997, if you are a foreign resident your assessable income includes:

a) the ordinary income you derived directly or indirectly from all Australian sources during the income year; and

b) other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australia source.

Pursuant to subsection 995-1(1) of the ITAA 1997 ordinary income or statutory income has an Australian source if and only if it is derived from a source in Australia for the purposes of the ITAA 1936.

Section 6C of the ITAA 1936 prescribes rules for determining when royalties paid or credited to a non-resident are to be treated as being derived from sources in Australia.

Subsection 6(1) of the ITAA 1936 defines a 'royalty' to include an amount paid as consideration for the use of, or right to use any industrial, commercial or scientific equipment.

As identified in Issue 2 above, the rent payable by the Lessee constitutes a royalty as defined in subsection 6(1) of the ITAA 1936.

Subsection 6C(2) of the ITAA 1936 states that for the purposes of sections 6-5 and 6-10 of the ITAA 1997, royalty income derived by a non-resident shall be deemed to have been derived from a source in Australia.

Pursuant to paragraph 6C(1)(b) of the ITAA 1936, the rules in section 6C apply to income that is derived by a non-resident and consists of royalty that is paid or credited to the non-resident by a person who is a non-resident and is, or is in part, an outgoing incurred by that person in carrying on business in Australia at or through a permanent establishment of that person in Australia.

Permanent establishment is defined in subsection 6(1) of the ITAA 1936 to mean a place at or through which the person carries on any business and includes, without limiting the generality of the foregoing …

(b) a place where the person has, is using or installing substantial equipment or substantial machinery.

TR 2007/11 provides guidance on the meaning of permanent establishment for the purposes of subsection 6(1) of the ITAA 1936.

If a non-resident meets paragraph (b) of the above definition of permanent establishment, they will be considered to have a permanent establishment without needing to also meet the requirement of carrying on a business through the permanent establishment.

Pursuant to TR 2007/11, a hire-purchase agreement of substantial equipment should be treated as, in effect, an initial sale of the equipment together with a loan arrangement for the purposes of paragraph (b) of the definition of permanent establishment in subsection 6(1) of the ITAA 1936.

The Finance Lease is a hire-purchase agreement. The mere presence of the leased equipment in Australia does not constitute carrying on business at or through the permanent establishment in Australia if no other activities of the Lessee arise in Australia. Accordingly, the rent payable is not an outgoing incurred by the Lessee in carrying on business in Australia at or through a permanent establishment in Australia.

For the foregoing reasons, the rent income derived by the Lessor pursuant to the Finance Lease will not be deemed to have a source in Australia and will not be assessable pursuant to subsection 6-5(3) of the ITAA 1997.