Edited version of private ruling

Authorisation Number: 1011765672843

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Ruling

Subject: Equipment royalty

Question 1

Are equipment lease payments made by the Australian Company, to the taxpayer, a foreign resident company, subject to royalty withholding tax in accordance with section 128B of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No, equipment lease payments made by the Australian Company to the taxpayer are not subject to royalty withholding tax under section 128B of the ITAA 1936.

Question 2

Does Australia have a right to tax the taxpayer under Article X of Schedule X of the International Agreements Act 1953 (Agreements Act) where the taxpayer leases equipment to the Australian Company, who subleases the equipment to third parties in Australia?

Answer

No, Australia does not have a right to tax the taxpayer where the taxpayer leases equipment to the Australian Company who subleases the equipment to third parties in Australia.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Relevant facts and circumstances

The taxpayer is a resident of an overseas country for the purposes of the Double Tax Convention between Australia and that overseas country (the Convention).

The taxpayer leases substantial equipment to the Australian Company who subleases the equipment to third parties. The third parties operate the equipment within Australia for more than 12 months.

The taxpayer receives lease payments from the Australian Company in accordance with a lease agreement.

The lease agreement is not a hire-purchase agreement for the purposes of the Convention.

The taxpayer entered into the present lease agreement with the Australian Company outside Australia. However, the equipment that is the subject of the lease was previously leased by the taxpayer to the Australian Company under an earlier lease agreement

The negotiations for the lease agreement were carried out predominantly outside Australia. Up until the commencement of the new lease, the equipment remained in the possession of the Australian Company and was located in Australia during this time.

There is no requirement in the lease for the equipment to be physically located or used in Australia by the Australian Company.

At the end of the lease period, the lease agreement requires that the Australian Company return the equipment to the taxpayer at an overseas address.

The taxpayer does not lease the equipment through an office, dependent agent or any other fixed place of business in Australia.

The taxpayer does not undertake any maintenance or inspection activities for the equipment while it is used in Australia, as this is the responsibility of the Australian Company under the lease agreement.

Relevant legislative provisions

International Tax Agreements Act 1953 SchX.

Income Tax Assessment Act 1936 Subsection 6(1).

Income Tax Assessment Act 1936 Section 128B.

Income Tax Assessment Act 1997 Section 995-1.

International Tax Agreements Act 1953 Section 17A.

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

The equipment lease payments are not subject to royalty withholding tax under section 128B of the ITAA 1936.

Detailed reasoning

Under subsection 6(1) of the ITAA 1936, the definition of 'royalty' or 'royalties' includes payments for 'the use of, or right to use, any industrial, commercial or scientific equipment'. The definition of royalty in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) takes its meaning from the definition in the ITAA 1936. The payments made by the Australian Company to the taxpayer pursuant to the lease agreement would generally be regarded as 'royalties' for the purposes of the ITAA 1936 and ITAA 1997 because they are payments made by the Australian Company for the right to use industrial equipment.

The definition of 'royalties' in the Royalties Article of the Convention does not include 'payments for the use of or the right to use industrial, commercial or scientific equipment'. Accordingly, the equipment lease payments are not 'royalties' for the purposes of the Convention.

Subparagraph 17A(5)(b) of the International Tax Agreements Act 1953 (the Agreements Act) provides that section 128B of the ITAA 1936 (which deals with liability to withholding tax) does not apply to payments that are royalties for the purposes of the Assessment Act (i.e. the ITAA 1936 and the ITAA 1997) where a tax treaty does not treat the payments as royalties.

Therefore, as the equipment lease payments made by the Australian Company to the taxpayer are not royalties for the purposes of the Convention, the Convention does not treat those payments as royalties for the purposes of paragraph 17A(5)(b) of the Agreements Act. Accordingly, subsection 17A(5) of the Agreements Act applies and payments for the lease of industrial equipment are not subject to royalty withholding tax.

Question 2

Summary

Australia does not have a right to tax the taxpayer under the business profits article of the Convention where the taxpayer leases equipment to an Australian company who subleases the equipment to third parties in Australia.

Detailed reasoning

The Convention allocates Australia a right to tax profits of an enterprise of the overseas country where that enterprise carries on business in Australia through a permanent establishment in Australia.

Permanent establishment

The Convention deems an enterprise to have a permanent establishment in Australia where it maintains substantial equipment for rental purposes for a period of more than 12 months.

A lessor enterprise will be considered to maintain substantial equipment within Australia where the lessor directs or otherwise requires that the equipment be used by the lessee within Australia, or, already has equipment located within Australia which is available for lease in Australia, and the equipment is used within Australia.

The actions of the taxpayer are considered to be directed towards keeping the equipment in Australia because:

· the equipment was already located in Australia before the new lease was entered into,

· the equipment was made available by the taxpayer for lease in Australia, and

· the equipment is actually used by the Australian Company in Australia for a period of more than 12 months.

Therefore, the taxpayer is considered to be maintaining substantial equipment for rental purposes within Australia for a period of more than 12 months. Accordingly, the taxpayer is deemed to have a permanent establishment in Australia under the Convention in relation to this equipment leasing activity.

Carrying on business at permanent establishment

However, Australia will only have a taxing right under business profits article of the Convention over the leasing profits attributable to this deemed permanent establishment where the taxpayer is considered to be carrying on its leasing business in Australia through its deemed permanent establishment.

Maintaining leased equipment in Australia that gives rise to a deemed permanent establishment does not necessarily mean, of itself, that the lessor enterprise is carrying on its business in Australia through that permanent establishment.

Where the lease contracts are entered into outside Australia and no other activities of the lessor, apart from the receipt of lease rentals are carried out in Australia, this mere leasing of equipment by the lessor enterprise in Australia will not, of itself, constitute the carrying on of business in Australia through the deemed permanent establishment. For business to be carried on in Australia through the deemed permanent establishment, a lessor enterprise would need to be undertaking more of the activities constituting its leasing business within Australia, for example, undertaking inspection or maintenance checks on the equipment in Australia, or, conducting lease negotiations in Australia.

The taxpayer does not carry on any of its leasing business activities through its deemed permanent establishment in Australia other than the activity of maintaining the equipment within Australia for rental purposes. Accordingly, the taxpayer is not considered to be carrying on business through its deemed permanent establishment in Australia. Therefore, Australia does not have a taxing right over the taxpayer's leasing profits under the Convention.