Edited version of private advice

Authorisation Number: 1052014695397

Date of advice: 18 August 2022

Ruling

Subject: Tax treaties

Question 1

Are the profits derived by Company A from the service fees under the relevant Agreement from the project (Service Fees) included in its assessable income under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) by virtue of Article 8 of the Agreement between Australia and Country B for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (Double Tax Agreement (DTA))?

Answer

Yes

Question 2

If the answer to Question 1 is 'No', does Article 7 of the DTA apply to Company A's Service Fees?

Answer

Not necessary to answer.

This ruling applies for the following period:

Year ended 31 December 20XX

The scheme commences on:

11 January 20XX

Relevant facts and circumstances

Company A is a resident for tax purposes of a country with whom Australia has a DTA (Country B).

Company A is a wholly owned subsidiary of Group Z.

Group Z is a non-resident for Australian tax purposes. Group Z operates a fleet of specialised vessels.

Group Z was awarded a tender to undertake a specialised project in Australian waters.

Company B is an Australian incorporated company and a wholly owned subsidiary of Group Z.

Company B was responsible for the completion of the specialised project. Company B routinely subcontracts various scopes of work to other Group Z entities.

Company A undertakes specialised work in Australian waters. It is linked to a specialised vessel ('vessel') which is chartered in respect of any work that is required to be undertaken by Company A.

Company C owns the vessel and is responsible for its management and piloting. Company C provided the marine crew for the vessel and Company A provided the specialist crew that completed the relevant specialised activity required under the project.

Company B entered into a service agreement with Company A for the provision of specialised services under which Company B paid Company A all costs plus a mark-up. The service agreement provided for Company A to have access to the vessel free of charge.

Company B entered into a time charter party arrangement over the vessel with Company C.

Specialised equipment is fixed to, and forms part of, the vessel.

The crew of Company C piloted and ran the vessel. The crew of Company A undertook the relevant specialised activities onboard the vessel. There was no cross-over as, by necessity, each crew had different specialist functions, qualifications/certifications and skillsets and - as such - were not interchangeable. The only exception was that the specialist crew (and anyone else onboard) were subject to the authority of the captain of the ship (who was part of the marine crew) in accordance with usual maritime law conventions.

Relevant legislative provisions

International Tax Agreements Act 1953 section 4

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1997 subsection 6-5(3)

DTA Article 8

Reasons for decision

1 Subsection 6-5(3) of the ITAA 1997 and interaction with tax treaties

Subsection 6-5(3) of the 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.

Subsection 4(1) of the International Tax Agreements Act 1953 (Agreements Act) incorporates the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that those Acts are read as one with the Agreements Act. Subsection 4(2) of the Agreements Act operates to effectively override any provisions in the ITAA 1936 and the ITAA 1997 that are inconsistent with the Agreements Act.

A provision of an "agreement" has the force of law on and after its date of entry into force if it is listed in subsection 5(1) of the Agreements Act. The DTA is listed in that subsection. The Agreements Act also provides that the DTA has the force of law.

2 Article 8 of the DTA

Article 8 of the DTA governs the taxation of income relating to Shipping and Air Transport and provides for the allocation of taxing rights to the Contracting States.

•           Paragraph 1 of Article 8 provides an exclusive residence country taxing right over profits from the operations of ships or aircraft.

•           Paragraph 2 of Article 8 provides a source country taxing right over profits from the operation of ships or aircraft to the extent that the profits are derived from operations that are confined solely to places in that other State.

As such, profits of a resident of Country B derived from "the operation of ships" may be taxed in Australia where the profits are from "operations of ships" that are "confined solely to places" in Australia.

3 Taxation Ruling TR 2008/8

The Commissioner's view of the operation of Article 8 of the DTA is set out in Taxation Ruling TR 2008/8 Income tax: the taxation treatment for ships and aircraft leasing profits under the ships and aircraft articles of Australia's tax treaties (TR 2008/8). The Ruling also describes "how the ships and aircraft article applies more generally in non-leasing situations."

Paragraph 9 of TR 2008/8 stipulates that Australia's position is to preserve source taxation rights over profits from internal

ship and aircraft operations, which include not just transport activities but also non-transport activities. Furthermore, paragraph 10 draws attention to Australia's intention to depart from the OECD model by way of reservation, stating that:

Australia reserves the right to tax profits from the carriage of passengers or cargo taken on board at one place in Australia for discharge in Australia. Australia also reserves the right to tax profits from other coastal and continental shelf activities (emphasis added).

4 Application to Company A

Company A is a resident of Country B for tax purposes and hence is a resident of Country B for the purposes of the DTA. The relevant activities conducted by Company A (in respect of which the Service Fees were rendered) were confined to Australian waters and hence had an Australian source. Australia can, therefore, assert taxing rights over the relevant profits derived by Company A if the requirements of Article 8(2) of the DTA are satisfied.

There were, in effect, two 'crews' on the vessel and the functions of each can be succinctly described as follows:

•                    Company B entered into a subcontract agreement with Company A for the performance of offshore specialised work. The specialist crew of Company A performed the specialised services onboard the vessel.

•                    Company B also time chartered the vessel from Company C (with full marine crew required to operate the vessel). The marine crew were employed by Company C and their role solely related to the navigation and running of the vessel - they were not engaged in performing the specialised activity. There was no cross-over as, by necessity, the specialist crew and marine crew had different specialised functions and skillsets and, as such, were not interchangeable. The only exception was that the specialist crew (and anyone else onboard) were subject to the authority of the captain of the ship (who was part of the marine crew) in accordance with usual maritime law conventions (e.g. the captain employed by Company C could order the specialist crew to do certain things in an emergency). However, the captain of the ship was not involved directly with the specialised activities.

The relevant question is whether the Company A specialist crew were operating the vesselfor the purposes of Article 8 of the DTA.

The basis of what constitutes the operation of a ship for the purposes of Article 8 of the DTA - in the view of the Commissioner - subsists in activities undertaken that involve the ship in question and is not limited by the contractual rights and obligations that a particular entity has in respect of the ship. The vessel is a specialised vessel and, importantly, the specialised equipment is part of the ship itself. Accordingly, the use of that equipment by Company A equated to a physical operation of the vessel. The exclusive contractual relationship between Company B and Company C concerning the chartering of the vessel (which involved another physical operation of the vessel by Company C) does not change this outcome.

The following paragraphs from TR 2008/8 are particularly relevant in this regard (emphasis added):

114. Paragraph 2 deals with an enterprise of a Contracting State that is deriving profits from the operation of ships or aircraft, and applies to provide a taxing right to the other State over any parts of those profits that are derived from operations confined solely to places in that other State. Therefore, this provision involves an examination of the ship or aircraft activities undertaken by the enterprise in that other Contracting State and determining whether those particular activities constitute operations that are confined solely to places in that State.

115. The predominant activities to be considered are those that involve the physical operation of the ship or aircraft, as opposed to the activities involved in the administration of an enterprise's overall shipping or aircraft business (for example, contract negotiation or ongoing management of ownership, lease or finance obligations relating to the ship or aircraft).

116. In considering whether or how particular activities constitute 'operations of ships or aircraft' guidance can be obtained from the ordinary meaning of the term 'operation' which includes the action or process of operating. Therefore, when considering the plural, 'operations', provided the activities consist of actions or processes of operating in their own right, they would constitute an 'operation'.

117. However, this does not mean that any ship or aircraft activity, or group of activities will constitute a ship or aircraft operation in their own right. The activity or activities undertaken in the other Contracting State must be sufficient to constitute a distinct ship or aircraft operation that is identifiable separately from other ship or aircraft operations of the enterprise.

118. This approach can be distinguished from that taken in respect of the definition of 'international traffic'. That definition only has regard, in relation to the breadth of its internal traffic exclusion, to whether the ship or aircraft itself is operated solely between places in the other State. The reference to 'operated' is linked to the use made of 'the ship or aircraft' and in the context of transport activities this is considered to be the particular voyage undertaken by the particular ship or aircraft. For paragraph 2, however, the focus is on 'operations' with the more general reference to 'ship or aircraft' being of a descriptive nature (that is to distinguish ship or aircraft operations from other operations). Therefore, it involves examining the activities of an enterprise relating to ships or aircraft that take place in the other State, to determine whether they constituted an 'operation' or 'operations' confined solely to that State, rather than merely examining the particular voyage of a ship or aircraft. This difference is consistent with the fact that unlike the definition of 'international traffic', paragraph 2 also deals with non-transport activities, which by their nature involve a wider range of activities than the mere voyage itself (for example fishing, dredging, surveying).

That the specialised activities that were conducted are a type of non-transport activity is supported by an examination of the types of activities that are considered by the Commissioner to be non-transport activities. As previously noted, Article 8 extends to profits from both transport and non-transport activities. In determining the scope of profits from non-transport activities paragraph 112 of TR 2008/8 provides, by way of example, a listing of non-transport activities including "operations such as fishing, dredging, crop dusting, salvage operations and surveying."

We understand that under international maritime law principles there may only be a single operator of a ship. However, even if that is the case, maritime law principles are not relevant to the scope of "operations" in paragraph 2 of Article 8. The question raised by that paragraph is whether there are relevant activities that are sufficient to constitute a distinct operation that itself gives rise to profits. This is clearly reflected in paragraphs 116 and 117 of TR 2008/8 (reproduced above). In this instance, the activities conducted by Company A on the vessel clearly constituted an operation of that ship in its own right that gave rise to profits based on the Service Fees received, and hence paragraph 2 of Article 8 should apply to allocate taxing rights over those profits.

It is acknowledged that the Commentary on Article 8 of the OECD Model and the meaning of "operation of ships" does not explicitly contemplate that more than one entity could potentially derive profits from separate and distinct operations of the same ship at the same time. It also appears to proceed on the basis that the enterprise operating the ship would generally own or lease the ship or otherwise have the ship at its disposal (paragraph 4). However, the OECD Commentary on Article 8 is of limited assistance in this instance because Australian treaty practice, as reflected in the DTA, is not aligned with the current OECD approach. The OECD Model only deals with "operation of ships... in international traffic" and that, by definition, only includes transport activities (other than where the ship is operated solely between places in a Contracting State) and confers taxing rights exclusively on the residence country.

Based on the Commissioner's view as outlined above, paragraph 2 of Article 8 of the DTA applies to allocate exclusive taxing rights to Australia in relation to the profits derived from the specialised activities conducted by Company A on the vessel, as those profits were derived from "operations of ships" confined solely to Australian waters.

Therefore, those profits are included in Company A's assessable income under subsection 6-5(3) of the ITAA 1997 by virtue of Article 8 of the DTA.

Question

2

Summary

Not necessary to answer