Edited version of private advice

Authorisation Number: 1012617883893

Ruling

Subject: Permanent Establishment and Withholding of Royalties

Question 1

Do you have, or deemed to have a permanent establishment in Australia under Article 5 of the Overseas Country Double Tax Agreement through which you are, or are deemed to be carrying on a business?

Answer

No

Question 2

Are the payments you receive from the Lessee royalty payments that are subject to Australian withholding tax and is the rate of withholding tax reduced to 10% under Article 12(2) of the Overseas Country Double Tax Agreement?

Answer

Yes.

Question 3

If the payments received are royalties subject to Australian withholding tax, are they not assessable and not exempt under section 128D of the ITAA 1936?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2013,

Year ended 30 June 2014,

Year ended 30 June 2015.

The scheme commences on

1 July 2012.

Relevant facts and circumstances

You were incorporated in the Overseas Country.

You are a tax resident in the Overseas Country.

You are a non-resident of Australia for tax purposes.

You are part of the an overseas company.

You do not have any employees or offices in Australia.

You have a modern business of support and work assets, which you lease out to other companies (in a variety of industries) as part of your business.

Your core business consists of the assets and the rental of other equipment. The equipment could be used for a number of offshore activities and therefore could be hired to and used by customers in a wide variety of other industries.

You hold assets on various bases. At present, you only have limited contracts to customers in Australia, being those contracts that are the subject of this ruling.

You do not have any plans to provide staff to your customers in Australia, whether in the natural resource industry or otherwise.

You do not undertake activities in connection with the business of exploration or exploitation of natural resources in Australia.

You have currently two assets leased to a company which uses those assets in Australia as per the Agreements.

The 2012 Agreement:

You entered into an Agreement ("The 2012 Agreement") with an Australian company.

No staff accompany the leased asset.

The Asset was built in The Overseas Country.

The 2012 Agreement was negotiated and signed in The Overseas Country.

Under the terms of the 2012 Agreement, the place of delivery and the place of redelivery for the Asset are both in The Overseas Country.

Under a Clause of the 2012 Agreement, the period is X months.

Under a Clause of the 2012 Agreement, the trading limit of the Asset is specified.

Under a Clause of the 2012 Agreement, the currency and method of payment is in an overseas currency and payment by bank transfer to your bank account in The Overseas Country.

Under a Clause of the 2012 Agreement, during the period, the asset shall be in full possession and at the absolute disposal for all purposes of the Lessee and under the Lessee's complete control in every aspect.

You have no control over the use of the asset or its application (other than the area in which it must be operated).

The Lessee shall maintain the asset in accordance with good commercial maintenance practice. In this regard, the Lessee is required to insure the asset at its own expense and to pay for uninsured repairs to the asset.

The Lessee has also indemnified you against any loss, damage or expense incurred by you that arises out of or in relation to the operation of the asset by the Lessee.

The 2013 Agreement:

You have also entered into a second agreement with the Lessee ("the 2013 Agreement") for an asset.

The Asset was built in The Overseas Country.

The 2013 Agreement was negotiated in The Overseas Country, which is also where the contract will be signed.

Under the terms of the 2013 Agreement, the place of delivery and the place of redelivery for the Asset are both in Australia.

Under a Clause of the 2013 Agreement, the period is several months.

Under a Clause of the 2013 Agreement, the currency and method of payment is in an overseas currency and payment by bank transfer to your bank account as shown in the invoice.

Under a Clause of the 2013 Agreement, during the period, the asset shall be in full possession and at the absolute disposal for all purposes of the Lessee and under the Lessee's complete control in every aspect.

The Lessee shall maintain the asset in accordance with good commercial maintenance practice. In this regard, the Lessee is required to insure the asset at its own expense and to pay for uninsured repairs to the asset.

The Lessee has also indemnified you against any loss, damage or expense incurred by you that arises out of or in relation to the operation of the asset by the Lessee.

A description of the Lessee's Business

The Lessee is an Australian incorporated company and operates a similar business to you.

The Lessee operates a diverse range of modern, high performance assets, and provides offshore services to Industries.

The offshore services provided by the Lessee include various activities.

The Lessee had a shortage of general purpose asset for supply to its customers in Australia and hence contracted with you to obtain suitable asset which the Lessee can use in its business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(3).

International Tax Agreements Act 1953 Section 4.

Income Tax Assessment Act 1936 Section 128B(2B).

Income Tax Assessment Act 1936 Section 6(1).

Income Tax Assessment Act 1936 Section 128D.

Reasons for decision

Summary

You do not have a Permanent Establishment in Australia as per the Agreement. The payments you receive are royalties as per the Agreement. Withholding tax will be treated as a final tax under section 128D of the ITAA 1936.

Detailed reasoning

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

The income derived from leasing equipment in Australia is ordinary income for the purposes of subsections 6-5(3) of the ITAA 1997.

In determining liability to tax on Australian sourced income, it is necessary to consider not only the income tax laws but also any applicable tax treaties contained in the International Tax Agreements Act 1953 (Agreements Act).

Section 4 of the International Tax Agreements Act 1953 incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The Overseas Country Agreement (the Agreement) is listed in section 5 of the Agreements Act.

The Agreement operates to avoid the double taxation of income received by residents of Australia and The Overseas Country.

Under Article 7 of the Agreement, the business profits of an enterprise of the Overseas Country shall be only taxable in the Overseas Country unless the enterprise carries on business in Australia through a permanent establishment (PE) situated in Australia. If so, so much of the profit of the enterprises profit attributable to the PE in Australia may be taxed in Australia.

Article 5(1) of the Agreement contains the general definition of a PE which is as follows:

  "for the purposes of this agreement, the term "permanent establishment" means a fixed place of business in which the business of an enterprise is wholly or partly carried on."

Taxation Ruling TR 2001/13 at paragraphs 101 to 105 explains the Commissioner's view that the OECD Model Tax Convention and Commentaries are relevant to interpreting Australia's tax treaties. Paragraph 1 of the OECD Commentary on Article 5 of the OECD Model Tax Convention explains that the general definition of a PE contains the following conditions:

1. the existence of a 'place of business', i.e. a facility such as premises or in certain instances, machinery or equipment;

2. this place of business must be 'fixed', i.e. must be established at a distinct place with a certain degree of permanence;

3. the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.

The Commentaries explain that a 'place of business' covers any premises, facilities or installations used for carrying on the business. It is also immaterial if a business is actually carried on in the premises and whether the premises is owned or rented. The important consideration is that the space must be at the disposal of the entity.

Article 5(2) of the Agreement further illustrates the general definition by providing listed facilities that are included in the definition:

"(a) a place of management;

(b) a branch;

(c) an office;

(d) a factory;

(e) a workshop;

(f) a mine, quarry or any other place of extraction of natural resources;

(g) an agricultural, pastoral or forestry property;

(h) a building site or construction, installation or assembly project which lasts for more than twelve months."

The Commentaries at paragraph 2 note that the list is not exhaustive and should only be considered in light of paragraph 1.

In your case, you are in the business of leasing equipment to various businesses around the world. You have described your business activities in Australia as a lease assets. You do not have a fixed place of business in Australia as per Article 5(1) and Article 5(2).

Article 5(4) of the Agreement states that an entity will have a PE if substantial equipment is being used for more than 12 months by, for, or under contract with the entity in exploration for, or the exploitation of, natural resources, or in activities connected with such exploration or exploitation.

The Commentaries contain "Reservation on the Article" which at Paragraph 1 states that Australia reserves the right to treat an entity as having a PE if it carries on activities relating to natural resources or operates substantial equipment with a certain degree of continuity.

Substantial equipment

Substantial equipment is not defined in the Agreement or Commentaries. Taxation Ruling TR 2007/10 deals with the treatment of shipping and aircraft leasing profits of US and UK enterprises and explains that by reason of their size alone, ships or aircraft would be expected to constitute substantial equipment.

TR 2007/10 followed the Full Federal Court decision in McDermott Industries (Aust) P/L v FC of T 2005 ATC 4398. It was found that a permanent establishment existed from the Singaporean company chartering barges for use in Australian waters, even though the entity did not have a significant presence in Australia.

However the Singapore Agreement materially differs from the Overseas Country Agreement, which contains additional requirements that the substantial equipment is connected to the exploration of natural resources.

Exploration and or Exploitation of Natural resources

ATO Interpretive Decision ATO ID 2006/306 discusses the Swiss Agreement which at Article 5(4) is consistent with the Overseas Country Agreement. It also discusses the McDermott decision, stating that the taxpayer will have a deemed PE if the substantial equipment is being used in Australia to process natural resources by:

• the taxpayer itself,

• the Australian company, 'for' the taxpayer; or

• the Australian company, 'under contract with' the taxpayer.

In your case;

• Part of your business is asset rental,

• You have leased assets to Australian resident company,

• You do not undertake activities in connection with the business of exploration or exploitation of natural resources,

• You have no place of business, office or employees in Australia, and

• You have no direct or indirect contractual relationship with any participant in the natural resource industry in Australia in respect of the leased asset.

Your substantial equipment i.e. asset on lease to an Australian company will not be a deemed PE as they are not being used in Australia to process natural resources by you, the Lessee for you or the Lessee under contract with you. Therefore, you do not have a Permanent Establishment in Australia under Article 5 of The Overseas Country Agreement.

Withholding tax

Under section 128B(2B) of the ITAA 1936, there is a requirement to withhold tax from income that is derived by a non-resident and is paid to the non-resident by a person to whom this 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.

Under section 6(1) of the ITAA 1936, a royalty includes:

"any amount credited... as consideration for ... the use of, or right to use, any industrial, commercial or scientific equipment; [and] the supply of any assistance that is ancillary to and subsidiary to, and is furnished as a means of enabling the application or enjoyment of ... any such equipment."

Article 12(3) of the Agreement states that royalties include payments for the use of or right to use commercial equipment.

Article 12(4) of the Agreement restricts the application of Article 12, in this case, to a resident of the Overseas Country who does not have a PE in Australia, being the country where the royalties arise. Alternatively, if there was a PE in Australia, Article 7 "Business Profits" would apply instead.

Taxation Ruling TR 2003/2 confirms that where the arrangement between the asset owner and lessee is a contract for the use of, or right to use a ship the payments will be royalties as defined for tax purposes.

Article 12(2) of the Agreement states that royalties may be taxed in the country in which they arise but the tax cannot exceed 10% of the gross amount.

In your case, you are a non-resident of Australia for taxation purposes and will be deriving income in Australia from the lease of asset to Australian company. This income is considered to be royalties as it is an amount for the use of or right to use commercial equipment. As per the Agreement these amounts may be taxed at 10% of the gross amount.

Subject to section 128(2B) of the ITAA 1936, section 128D of the ITAA 1936 applies to make the applicable income not assessable and not exempt. Therefore, any withholding tax paid is a final tax on the applicable income.