Edited version of your written advice

Authorisation Number: 1012797875877

Ruling

Subject: Royalty withholding tax liability

Question 1

Does Overseas Co have a permanent establishment in Australia under the Permanent Establishment Article of the Double Tax Agreement between the Government of Australia and the Government of Country Y (the DTA)?

Answer

Yes

Question 2

Is Overseas Co liable to royalty withholding tax pursuant to section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) on the lease payments paid by Aus Co in respect of the rent of equipment to be used for the B project in Australia?

Answer

No

Question 3

Is Overseas Co liable to royalty withholding tax pursuant to section 128B of the ITAA 1936 on the lease payments paid by Aus Co in respect of the rent of equipment to be used for the C project in Australia?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2015 to Year ended 30 June 20XX

The scheme commences on:

During the 2015 income year

Relevant facts and circumstances

Background to the X MEC group

1. The X Group is a part of the Global Group, a global conglomerate headquartered in Country Y.

2. The X Group acquired another group some time ago and formed the X multiple entry consolidated tax group (the X MEC group).

3. The X MEC Group has focussed on a particular industry activity in Australia. A subsidiary of the X MEC group, Subsidiary Aus Co currently owns and operates this particular business in Australia.

Overseas Co

4. Overseas Co is a Country Y incorporated and tax resident company operating in Australia through a branch ("Overseas Co Australian Branch").

5. Parent Co (a Country Y resident company that is also part of the Global group) owns more than 99% of Overseas Co and the balance is owned by a Global Group company.

6. Overseas Co previously operated in Australia under another name.

7. The office of Subsidiary Aus Co was previously located at a particular Australian location. Subsidiary Aus Co has since moved office to another Australian location.

8. The premises at the initial location were used by Overseas Co Australian Branch until Subsidiary Aus Co moved to the new location, at which time Overseas Co Australian Branch also moved to the new office in the new location. Overseas Co has no office outside of Australia.

9. Overseas Co Australian Branch will have an Australian bank account.

10. Overseas Co has a number of Country Y directors and one Australian director. The Australian director will also act as the Branch Manager of Overseas Co Australian Branch.

11. Board meetings will be held in the Australian office. It is intended that there will be at least one general meeting per year in Australia.

12. No business activities will be undertaken by Overseas Co in Country Y.

13. The activities of the Branch Manager will be carried out from the Australian office. A Power of Attorney will enable the Branch Manager to legally bind the branch by signing contracts on its behalf.

14. The Power of Attorney will allow the Branch Manager to:

a. Negotiate, execute and sign, on behalf of Overseas Co, the required documents in connection with an internal sale or purchase of equipment from one company controlled or 100% owned by Overseas Co or Parent Co to another company controlled or 100% owned by Overseas Co or Parent Co;

b. Negotiate, execute and sign, on behalf of Overseas Co, documents in connection with any inter-company loan agreements between Overseas Co and its affiliates;

c. Negotiate, execute and sign, on behalf of Overseas Co, the Services Agreement between Subsidiary Aus Co and Overseas Co Australian Branch; and

d. Negotiate, execute and sign any internal equipment lease agreements between Overseas Co and its affiliates.

B Project

15. Subsidiary Aus Co has signed a contract with an independent third party to provide services for a project in Australia ("the B contract").

16. The B contract term is for a number of years with options to extend.

17. The B contract requires Subsidiary Aus Co to supply the project with certain equipment.

18. The B contract contains a clause allowing an affiliate of Subsidiary Aus Co to own the equipment to be used in the project.

C Project

19. Subsidiary Aus Co has also signed a contract with the same independent third party to provide services for another project in Australian ("the C contract").

20. The C contract term is for a number of years with options to extend.

21. The C contract requires Subsidiary Aus Co to supply the project with certain equipment.

Proposed Structure

22. It is proposed that Subsidiary Aus Co will execute a Novation Deed with the independent third party and Aus Co to release Subsidiary Aus Co's rights and obligations with the independent third party in place of Aus Co. This will occur in relation to both the B and C contracts.

23. The independent third party will execute the Novation Deed with respect to the B contract in due course. It is expected that the novation in relation to the C contract will occur in 2015.

24. No changes will arise to the contracts, other than changing the contracting parties.

25. Aus Co is an Australian incorporated entity and is a wholly owned subsidiary member of the X MEC group.

26. Overseas Co Australian Branch has ordered the B contract equipment and will soon take delivery of the equipment. It will own this equipment.

27. Subsidiary Aus Co has entered into contracts for the equipment in relation to the C contracts. Subsidiary Aus Co will take delivery of this equipment and then sell the equipment to Overseas Co Australian Branch for market value consideration at that time, such that this branch will then retain ownership of the equipment.

28. Overseas Co Australian Branch will enter into Agreements to lease the equipment to Aus Co. These Agreements will initially be for a number of years with an option to extend for an additional number of years at the discretion of Aus Co. The Agreements will be based on industry standard terms used by Parent Co.

29. The lease payments Aus Co will pay to Overseas Co Australian Branch will be a day rate, in Australian dollars, to be calculated using Parent Co's internal rate of return for investments in equipment. Lease payments will be invoiced and paid in in Australian dollars.

30. The leases will take effect from the date the equipment is used to provide services to the independent third party.

31. Overseas Co Australian Branch will also enter into an agreement to provide equipment management services to Aus Co. These management activities will be carried out at other locations in Australia. Invoices for these services are to be issued by Overseas Co Australian Branch in Australian dollars and charged at cost plus x%.

32. Aus Co will use the equipment to provide services to the independent third party and other clients in relation to the B Project and C Project. It will employ staff and be responsible for operating expenses.

33. Subsidiary Aus Co will provide support services (including office, branch manager and back office functions) under a service level agreement with Overseas Co Australian Branch. Invoices are to be issued to Overseas Co Australian Branch in Australian dollars and charged at cost plus x%.

34. Aus Co will operate the equipment and hire the onshore staff (with the exception of managers - to be employed by Overseas Co Australian Branch).

Relevant legislative provisions

International Tax Agreements Act 1953 subsection 17A(4)

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 128B

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

Income Tax Assessment Act 1936 subparagraph 128B(2B)(b)(i)

Reasons for decision

Question 1

Under the relevant Permanent Establishment (PE) Article of the DTA a 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

The PE Article of the DTA states that this term includes especially an office. 'Office' is not a defined term in the DTA and Australian domestic law.

Paragraph 102 of Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements (TR 2001/13) refers to Thiel v. FC of T (1990) 90 ATC 4717, where it was accepted that the OECD Model Taxation Convention's official Commentaries may be relevant to the interpretation of double tax agreements based on the OECD Model Tax Convention on Income and on Capital (the OECD Model). As the PE Article of the DTA is based on the OECD Model, the OECD Model Tax Commentary (OECD Commentary) is relevant for the purposes of interpreting the PE Article.

Paragraph 12 of the OECD Commentary on Article 5 of the OECD Model states that it is assumed that the term 'office' is interpreted in such a way that such places of business constitute permanent establishments only if they meet the requirements of the general definition of 'permanent establishment'.

Paragraph 2 of the OECD Commentary on Article 5 of the OECD Model states that the OECD Model's general definition of 'permanent establishment' contains the following conditions:

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

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

• 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.

Paragraph 4 of the OECD Commentary on Article 5 of the OECD Model states that the term 'place of business' covers:

any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose.

And further:

a place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise.

The office of Overseas Co Australian Branch was previously located at a particular Australian location and recently moved to office premises at another Australian location. The office spaces currently occupied and previously occupied by Subsidiary Aus Co will be made available to be used by Overseas Co Australian Branch. Overseas Co will have no office outside of Australia. This space made available to and used by Overseas Co Australian Branch will thus constitute a place of business.

According to paragraph 6 of the OECD Commentary on Article 5 of the OECD Model, the term 'fixed' includes the concept of geographic and temporal permanence, with temporal permanence being the carrying on of the business for a period of greater than six months.

It is considered that the office to be used by Overseas Co Australian Branch is a fixed place of business. It is located at a permanent geographical location, being the premises at the current Australian location, and previously at another Australian location. Further, the use of premises by Overseas Co Australian Branch in Australia will be for a period of greater than 6 months. The duration of the leases will be for a number of years, and further the B contract for which equipment will be provided will be for a number of years.

Paragraph 4.6 of the OECD Commentary on Article 5 of the OECD Model states:

that the words 'through which' must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose.

Paragraph 7 of the OECD Commentary on Article 5 of the OECD Model further explains that:

For a place of business to constitute a permanent establishment the enterprise using it must carry on its business wholly or partly through it. …the activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis.

It is considered that the premises at the current and previous Australian locations, constitute the particular location through which the business activities of Overseas Co Australian Branch will be carried on. It is noted that Overseas Co Australian Branch will partly carry out business activities at other locations in Australia including conducting management activities, but that no business activities will be undertaken in Country Y.

The business activities of Overseas Co Australian Branch that will be carried out at these premises in Australia include:

• Board meetings conducted by the Country Y directors and one Australian director, including at least one general meeting per year.

• The Australian director acting as the Branch Manager of Overseas Co and under a Power of Attorney will negotiate, execute and sign, on behalf of Overseas Co:

• the required documents in connection with an internal sale or purchase of equipment from one company controlled or 100% owned by Overseas Co or Parent Co, to another company controlled or 100% owned by Overseas Co or Parent Co

• documents in connection with any inter-company loan agreements between Overseas Co and its affiliates

• the Services Agreement between Subsidiary Aus Co and Overseas Co Australian Branch; and

• any internal equipment lease agreements between Overseas Co and its affiliates.

n Invoices will be raised by Overseas Co Australian Branch in Australia and in Australian dollars.

Consequently, the office at the Australian location (and previous Australian location) is a fixed place of business through which the activities of Overseas Co Australian Branch will be carried on. As such, Overseas Co has a permanent establishment in Australia under the PE Article of the DTA.

Question 2

Withholding tax liability under Australian income tax legislation is determined under section 128B of the ITAA 1936. Relevantly, subparagraph 128B(2B)(b)(i) of the ITAA 1936 provides that section 128B of the ITAA 1936 applies where income consisting of a royalty is paid to a non-resident by a resident of Australia and is not an outgoing wholly incurred by the resident carrying on a business in a foreign country through a permanent establishment of the resident in that country.

Subsection 128B(5A) of the ITAA 1936 provides that a person who derives income to which this section applies that consists of a royalty is liable to pay withholding tax.

Subsection 6(1) of the ITAA 1936 defines the term 'royalty' to include:

any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for:

…

(b) the use of, or the right to use, any industrial, commercial or scientific equipment;

…

Taxation Ruling IT 2660 Income Tax: Definition of Royalties at paragraph 18, states that in the context of the subsection 6(1) definition of royalties, the word 'equipment' does not have a narrow meaning and includes such things as machinery and apparatus.

The lease payments received by Overseas Co Australian Branch from Aus Co under the lease Agreements will be for the use of or the right to use the equipment owned by Overseas Co Australian Branch. This equipment is industrial or commercial equipment. These payments would thus constitute royalties and is income to which section 128B of the ITAA 1936 applies. Consequently, Overseas Co is liable to royalty withholding tax pursuant to subsection 128B(5A) of the ITAA 1936.

It is then to be determined whether any Article of the DTA operates to preclude or limit the ITAA 1936 and thereby as a consequence affect the liability of Overseas Co under section 128B.

The Royalties Article of the DTA states:

(1) Royalties arising in one of the Contracting States, being royalties to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State.

(2) Such royalties may be taxed in the Contracting State in which they arise, and according to the law of that State, but the tax so charged shall not exceed X per cent of the gross amount of the royalties.

(3) The term "royalties" in this Article means payments or credits, whether periodical or not, and however described or computed, to the extent to which they are made as consideration for-

…

(b) the use of, or the right to use, any industrial, commercial or scientific equipment;

…

Royalties are relevantly defined in the Royalties Article of the DTA in terms identical to subsection 6(1) of the ITAA 1936. The lease payments to be made by Aus Co were determined above to constitute royalties under subsection 6(1) of the ITAA 1936. For the reasons given above, the lease payments received by Overseas Co Australian Branch are also considered royalties for the purposes of the DTA.

Paragraph 4 of the Royalties Article of the DTA operates to expressly exclude particular royalties from the scope of the basic royalty provision of the DTA. It provides that:

The provisions of paragraphs 1 and 2 shall not apply if the person beneficially entitled to the royalties, being a resident of one of the Contracting States, carries on business in the other Contracting State, in which the royalties arise, through a permanent establishment situated therein...and the...property in respect of which the royalties are paid or credited is effectively connected with such permanent establishment....In such a case, the provisions of Article 7 (Business Profits Article) or Article 14 (Independent Personal Services Article) as the case may be shall apply.

The royalties arise in Australia

The Royalties Article of the DTA provides that where the payer is a person who is a resident of that country for tax purposes, the royalties are deemed to arise in that country.

The DTA states that for the purposes of the DTA, a person is a resident of Australia, "… if the person is a resident of Australia for the purposes of Australian tax".

For Australian tax purposes, resident is defined under subsection 6(1) of the ITAA 1936 to mean a company incorporated in Australia. The payer, Aus Co is a company incorporated in Australia. It is a resident of Australia for tax purposes. Therefore, the lease payments made by Aus Co are deemed to arise in Australia.

Permanent establishment

The Commissioner has ruled above at Question 1 that Overseas Co has a permanent establishment in Australia under the PE Article of the DTA with respect to an office and a fixed place of business through which the business of Overseas Co Australian Branch is carried on.

Equipment is effectively connected to the permanent establishment

The property giving rise to the royalties paid to Overseas Co Australian Branch under the Agreements is the equipment to be provided for the use of Aus Co to meet its obligations under the B contract.

The term 'effectively connected' used in the DTA is not defined under the General Definitions Article of the DTA and Australian domestic law.

The OECD Commentary on paragraph 3 of the Royalties Article provides at paragraph 21.1:

A right or property in respect of which royalties are paid will be effectively connected with a permanent establishment, and will therefore form part of its business assets, if the "economic" ownership of that right or property is allocated to that permanent establishment... [T]he "economic" ownership of a right or property means the equivalent of ownership for income tax purposes by a separate enterprise, with the attendant benefits and burdens (e.g. the right to the royalties attributable to the ownership of the right or property, the right to any available depreciation and the potential exposure to gains or losses from the appreciation or depreciation of that right or property).

Under the B contract, Overseas Co Australian Branch ordered the equipment which will be provided to Aus Co under the lease Agreements. The equipment will be owned by Overseas Co. The right to the royalties (the lease payments) attributable to this equipment is allocated to the permanent establishment, that being the office of Overseas Co Australian Branch. This is the place where part of Overseas Co Australian Branch's business is conducted. The equipment which gives rise to the royalties is thus effectively connected to the permanent establishment in Australia and form part of Overseas Co Australian Branch's business assets.

The lease payments received by Overseas Co Australian Branch, will thus meet the requirements of paragraph 4 of the Royalties Article of the DTA to expressly exclude these royalties from the scope of the basic royalty provisions of the DTA. Instead, the Business Profits Article of the DTA will apply to these lease payments.

Subsection 17A(4) of the International Tax Agreements Act 1953 ('Agreements Act') ensures that excluded royalties paid to a non-resident of a treaty country are not subject to withholding tax. Subsection 17A(4) of the Agreements Act provides that:

If:

(a) a provision ('basic royalty provision') of an agreement is covered by either of the following paragraphs:

i. paragraph 1 or 2 of Article 12 of the Chinese agreement;

ii. a corresponding provision in another agreement; and

(b) another provision of the agreement expressly excludes particular royalties ('excluded royalties') from the scope of the basic royalty provision;

section 128B of the ITAA 1936 (which deals with liability for withholding tax) does not apply to the excluded royalties.

The basic royalty provisions of the DTA correspond to paragraphs (1) and (2) of Article 12 of the Chinese Agreement referred to in subparagraph 17A(4)(a)(i) of the Agreements Act.

As discussed above, paragraph 4 of the Royalties Article of the DTA operates to expressly exclude royalties from the scope of the basic royalty provision in instances where particular conditions are satisfied. The lease payments received by Overseas Co Australian Branch are 'excluded royalties' as they are attributed to a permanent establishment and satisfy the requirements of paragraph 4 of the Royalties Article of the DTA.

As the requirements pursuant to subsection 17A(4) of the Agreements Act are satisfied section 128B of the ITAA 1936 will not apply to the lease payments received by Overseas Co Australian Branch. Consequently, Overseas Co is not liable to royalty withholding tax pursuant to section 128B of the ITAA 1936 on the lease payments paid by Aus Co in respect of the rent of equipment to be used for the B project in Australia.

Question 3

For the reasons stated above in response to Question 2, Overseas Co is not liable to royalty withholding tax pursuant to section 128B of the ITAA 1936 on the lease payments paid by Aus Co in respect of the rent of equipment to be used for the C project in Australia.