Edited version of private advice

Authorisation Number: 1052222246719

Date of advice: 13 September 2024

Ruling

Subject: International issues

Question 1

Are the profits derived by non-resident Company A from the service fees received from Company B for services rendered pursuant to the Service Agreement in respect of Project A (Project A Service Fees) "profits from the operations of ships" confined solely to places in Australia pursuant to Article 8 of the double tax agreement with Country X?

Answer

Yes.

Question 2

Are the profits derived by non-resident Company A from the service fees received from Company B for services rendered pursuant to the Service Agreement in respect of Project B (Project B Service Fees) "profits from the operations of ships" confined solely to places in Australia pursuant to Article 8 of the double tax agreement with Country X?

Answer

Yes.

Question 3

If the answer to Question 1 and/or 2 is 'No', does Article 7 of the double tax agreement with Country X allocate taxing rights to Australia in respect of the relevant Service Fees derived by Company A?

Answer

Not necessary to answer.

This ruling applies for the following period:

Year ended 31 December 2021

The scheme commenced on:

1 January 2021

Relevant facts and circumstances

1.         Company A is a resident for tax purposes of Country X, a country with whom Australia has a double tax agreement.

2.         Company A is a wholly owned subsidiary of Group Z.

3.         Group Z is a non-resident for Australian tax purposes. Group Z operates a fleet of specialised vessels. Group Z has subsidiaries in various countries, including Australia.

4.         Company B is an Australian incorporated company and a wholly owned subsidiary of Group Z. Company B functions as the head contractor for Group Z's projects in Australia.

5.         The scope of a project is defined by the third-party client. This scope will then determine which Group Z vessel(s) are appropriate for the projects.

6.         Company B is responsible for the overall execution and delivery of the contractual scope of Group Z's projects in Australia. To complete its contracted scope of work under a project, Company B routinely subcontracts various scopes of work for projects to other Group Z entities.

7.         Company A renders specialised services linked to a specific Group Z vessel, Vessel A.

8.         Company A and Company B entered into a Services Agreement under which Company A is required to render specialised services on a basis as directed by Company B and is responsible for arranging any specialist crew to carry out certain tasks (the Services Agreement). In exchange, Company B paid all of Company A's costs related to the performance of the services, including labour costs of all crew and costs relating to the provision of specialised equipment and production consumables, plus a mark-up (Service Fees).

9.         Under the terms of the Services Agreement, Company B will provide Company A with (free) access to the relevant vessel so that Company A can carry out the services it is required to provide to Company B.

10.       Company A does not employ any of its own crew or operators but instead makes use of crew employed from Group Z's central crewing company.

Vessel A

11.       Vessel A is leased by Company C from another Group Z entity under an existing long-term worldwide bareboat charter agreement.

12.       Vessel A has various features and equipment which make it suitable to be utilised for offshore activities in the relevant industry.

13.       Vessel A also has certain equipment that is modular and removable. This equipment can be swapped between vessels as required for different projects as well as for repairs, maintenance and overhaul purposes.

14.       This equipment is incapable of operating independently and can only operate with the support infrastructure aboard a host vessel. An umbilical cord and tether management system links/tethers the equipment to the host vessel - in this case Vessel A - and provide the power, video and data signals to the equipment.

15.       On average, this specific equipment will remain on a particular Group Z vessel for about 4 years before undertaking repairs and maintenance or overhaul, unless switched to another vessel earlier due to operational desires.

16.       This equipment was dry leased by Company B from another Group Z entity.

Projects

17.       Company B entered into a number of separate contracts with unrelated third parties to complete scopes of work in Australian waters, including Project A and Project B.

18.       Company B entered into a time charter agreement with Company C to utilise Vessel A for these projects. Under this time charter agreement, Company C was responsible for the management and piloting of Vessel A.

Project A

19.       Project A related to a contract between Company B and Third Party A under which Company B was required to complete certain scopes of work to Third Party A.

20.       Group Z deployed two of its vessels for the purposes of completing the Project A scopes of work, including Vessel A.

21.       Pursuant to the time charter agreement between Company B and Company C, the crew of Company C piloted and ran the vessel.

22.       Company B engaged Company A, pursuant to the Services Agreement, to undertake the specialised activities for Project A onboard Vessel A, including providing the specialist crew required to carry out these activities.

23.       There was no cross-over between the activities of the crew of Company C and the crew of Company A as each crew had different specialist functions, qualification, certifications and skillsets and as such were not interchangeable.

24.       Company A provided approximately 140 crew on average per day onboard Vessel A during Project A. This crew comprised of both Group Z employed crew as well as personnel hired via third party agencies.

25.       The crew provided by Company A operated various equipment onboard or tethered to Vessel A to complete the Project A scopes of work.

26.       Company B paid Company A the relevant Service Fees pursuant to the Services Agreement for carrying out this work in respect of Project A (Project A Service Fees).

Project B

27.       Project B related to a charter party agreement between Company B and Third Party B for Third Party B to utilise Vessel A to undertake certain scopes of work for Third Party B's own client.

28.       Pursuant to the charter party agreement between Company B and Third Party B, Company B was required to provide Vessel A complete with all associated crewing and equipment capable of performing the activities to complete the scopes of work for Third Party B's client. Company B was responsible for providing specialist crew members, which consisted of certain senior specialist crew and specific equipment operators, in addition to the marine crew.

29.       Company B did not take responsibility for the successful execution of Third Party B's contracted scope of work to its client.

30.       To fulfil its obligation to provide the crew specified under the charter party agreement with Third Party B, Company B engaged Company A's services pursuant to the Services Agreement. The specialist crew provided by Company A to Company B for Project B consisted of a combination of Group Z employees as well as personnel hired via third party agencies.

31.       The crew provided by Company A operated the specific equipment onboard or tethered to Vessel A under the guidance and direction of the relevant Third Party B crew onboard the vessel.

32.       Company B paid Company A the relevant Service Fees pursuant to the Services Agreement for providing the relevant services in respect of Project B (Project B Service Fees).

Relevant legislative provisions

International Tax Agreements Act 1953 section 4

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

Double Tax Agreement between Australia and Country X Article 8

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not 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.

Reasons for decision

Question 1

Summary

The Project A Service Fees derived by Company A are profits from 'operations' of a ship confined solely to places in Australia and, as such, Australia has a taxing right to those profits pursuant to Article 8(2) of the double tax agreement with Country X.

Detailed reasoning

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 provides that the Agreements Act should be read as one with the ITAA 1936 and the ITAA 1997, with it prevailing to the extent of any inconsistency (other than Part IVA and Subdivision 165-C (corporate collective investment vehicles)).

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 double tax agreement with Country X (DTA) is listed in that subsection. Section 11C of the Agreements Act also provides that the DTA has the force of law.

For completeness, the operation of the DTA is modified by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (Multilateral Instrument) as both Australia and Country X are signatories to and have ratified the Multilateral Instrument. The Multilateral Instrument was given the force of law in Australia by the Treasury Laws Amendment (OECD Multilateral Instrument) Act 2018 which amended the Agreements Act so that the MLI was added to the list of current agreements under section 3AAA of the Agreements Act and given the force of law under section 5 of that Act. References to the DTA in this document incorporate any relevant modifications made by the application of the MLI. However, we note that Article 8 of the DTA has not been modified by the MLI.

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 of the DTA provides a residence country taxing right over profits from the operations of ships or aircraft.

Paragraph 2 of Article 8 of the DTA 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 of ships confined solely to places in that other State.

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

3 Taxation Ruling TR 2008/8

In addition to clarifying Australia's view of profits from the leasing of ships within the relevant treaty articles, 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 also considers 'how the ships and aircraft article applies more generally in non-leasing situations' (paragraph 7).

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 (paragraph 9). Further, paragraph 10 notes 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).

Further consideration of TR 2008/8 is discussed below in applying it to Company A.

4 Application to Company A

The relevant activities conducted by Company A in respect of which the Project A Service Fees were paid were confined to Australian waters and hence had an Australian source. Company A is a foreign resident for Australian tax purposes. On this basis, and pursuant to subsection 6-5(3) of the ITAA 1997, the Project A Service Fees should be included in the assessable income of Company A.

However, the application of the DTA must be considered to determine the allocation of taxing rights between Australia and Country X.

The DTA applies to persons who are residents of one or both of the Contracting States. Company A is a resident of Country X for tax purposes, so is within scope of the DTA. Paragraph 1 of Article 8 of the DTA provides a residence country taxing right over profits from the operations of ships or aircraft. However, this is not an exclusive residence country taxing right as Paragraph 2 of Article 8 of the DTA provides that a source country taxing right over profits from the operations of ships or aircraft to the extent that the profits are derived from 'operations of ships... confined solely to places in' that other State.

The relevant question, therefore, is whether the activities of Company A constituted operations of ships that were confined solely to places in Australia.

The Commissioner's view of what constitutes the operation of a ship, for the purposes of Article 8 of the DTA, encompasses activities undertaken that involve the ship in question. It is not limited by, or to, the contractual rights and obligations that a particular entity has in respect of the ship.

TR 2008/8 relevantly provides:

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.

(emphasis added)

Therefore, what is required in this instance is an examination of the activities conducted by Company A to derive profits, to determine whether those activities amounted to operations of Vessel A.

Company A received the Project A Service Fees for rendering the services stipulated in the Services Agreement to Company B. The Service Fees received by Company A for rendering the services pursuant to the Services Agreement consisted of Company A's costs that related to the performance of the services increased by a mark-up. This included the labour costs of all crew and costs relating to the provision of specialised equipment and production consumables provided by Company A.

Company A was contracted by Company B under the Services Agreement to provide various services. In accordance with the terms of the Services Agreement, Company B provided to Company A (free) access to Vessel A and its marine crew. Company A undertook the following in providing these services to Company B under Project A:

•         It supplied certain equipment that was tethered to Vessel A (which Company A dry-leased from another Group Z entity) and provided a crew with the requisite expertise to operate this equipment.

•         It provided a specialist crew that - when present on Vessel A - physically operated certain equipment onboard Vessel A.

Vessel A is not a generic vessel. It is a multipurpose vessel that has specific features that make it suitable to provide the services required in the relevant industry and for Project A.

While certain equipment may not be permanently fixed to Vessel A, this equipment was dependent on, and connected to, Vessel A during the relevant periods (being the project periods) and, functionally, formed part of Vessel A during these periods. The equipment was required, collectively, to deliver the relevant services during these periods. This special equipment could not travel to the required locations independently and had to be transported to the relevant locations by Vessel A. This equipment was operated and controlled by the specialist crew provided by Company A using other equipment that was onboard Vessel A. This equipment was connected to Vessel A whilst in operation through an umbilical cord which provided power to the equipment and transmitted data from the equipment back to the crew onboard Vessel A. Importantly, this equipment required the support of a vessel with specialised features and could not have been launched or operated from a generic vessel.

The Commissioner considers that the operation of the equipment described above by the specialist crew provided by Company A amounted to 'operations' of a ship - being Vessel A - for the purposes of Article 8 of the DTA and the activities carried out constituted an operation of that ship.

The services were delivered by Company A, using the particular combination of resources operating together. The Project A Service Fees were derived by Company A for providing services which constituted 'operations' of a ship that were confined solely to places in Australia during Project A. Australia therefore has taxing rights over the profits from the Project A Service Fees pursuant to Article 8(2) of the DTA. As such, the Project A Service Fees are included in Company A's assessable income pursuant to subsection 6-5(3) of the ITAA 1997.

Question 2

Summary

The Project B Service Fees derived by Company A are profits from 'operations' of a ship confined solely to places in Australia and, as such, Australia has a taxing right to those profits pursuant to Article 8(2) of the DTA.

Detailed reasoning

The relevant activities conducted by Company A, in respect of the Project B Service Fees that were paid, were confined to Australian waters and hence had an Australian source. As per the application of Article 8(2) of the DTA to the Project A Service Fees, Australia can, therefore, assert taxing rights over the relevant profits derived by Company A if the profits from the Project B Service Fees are from 'operations of ships'.

In relation to Project B, Company A provided services under the Services Agreement so that Company B could fulfil its contractual obligations to Third Party B under the charter party agreement between Company B and Third Party B.

Company A was supplying specialised services to Company B that were provided for under an agreement that pre-dated the charter party agreement between Company B and Third Party B i.e., the Services Agreement.

Company A undertook the following in providing these services to Company B for the Project B:

• It supplied certain equipment that was tethered to Vessel A and provided a crew with the requisite expertise to operate that equipment.
• It provided a specialist crew that - when present on Vessel A - physically operated certain equipment onboard Vessel A.

Whilst the operation of this equipment by the specialist crew provided by Company A was, in practice, to assist Third Party B complete its scope of work to its own third-party client, the legal agreements underlying this (such as the charter party agreement between Company B and Third Party B) did not reflect that practical direct connection.

For the same reasons as set out above in the Detailed Reasoning for Question 1, it is considered that the operation of the equipment described above by the specialist crew provided by Company A in respect of Project B amounted to 'operations' of a ship - being Vessel A- for the purposes of Article 8(2) of the DTA. Therefore, the profits from the Project B Service Fees received by Company A are included in Company A's assessable income under subsection 6-5(3) of the ITAA 1997.

Question 3

Summary

Not necessary to answer.