Issue
Is the income derived by a New Zealand resident from leasing a ship fully crewed and supplied to an Australian resident, who charters the vessel from New Zealand and uses it for fishing activities in Australian waters, assessable under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. The income derived by a New Zealand resident from leasing a ship fully crewed and supplied to an Australian resident who charters the vessel from New Zealand and uses it for fishing activities in Australian waters is not assessable under subsection 6-5(3) of the ITAA 1997.
Facts
The taxpayer is a non-resident for Australian income tax purposes and is resident of New Zealand for tax treaty purposes.
The taxpayer is a shipowner who enters into a charter agreement with an Australian resident, under which it provides a fully crewed and supplied fishing vessel for a specified period of time.
The Australian resident uses the fishing vessel for fishing in Australian waters.
The taxpayer derives leasing profits from chartering out its fishing vessel.
The fishing vessel is a 'ship' for tax treaty purposes.
The charter of the vessel commences and ends at a port in New Zealand.
The charter fee derived by the taxpayer comprises: • the charter fee for the vessel; • recovery of crew costs, and • recovery of other vessel costs such as fuel, packaging, repair and maintenance.
The charter fee is not a royalty for the purposes of Article 12 of the tax treaty between Australia and New Zealand Agreement (the New Zealand Agreement).
Reasons for Decision
Subsection 6-5(3) of the ITAA 1997 provides that the assessable income of a non-resident taxpayer includes ordinary income derived directly and indirectly from all Australian sources during the income year.
In determining a non-resident taxpayer's liability to Australian tax, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act).
Section 4 of the Agreements Act incorporates the ITAA 1936 and ITAA 1997 so that those Acts are read as one with the Agreements Act. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in specified situations).
Schedule 4 of the Agreements Act contains the New Zealand Agreement which operates to avoid the double taxation of income received by Australian and New Zealand residents.
In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 21 ATR 531; 90 ATC 4717 (Thiel), the High Court accepted that the OECD Model Tax Convention on Income and on Capital (the OECD Model) and the Commentaries on the Articles of the OECD Model (the OECD Commentary) may be relevant to the interpretation of tax treaties based on the OECD Model. The High Court approved recourse to the OECD Model and the OECD Commentary under Article 32 of the Vienna Convention (see paragraph 102 of Taxation Ruling TR 2001/13). Unless specified otherwise, references to the OECD Model and Commentary are to the version published on 15 July 2005.
Article 8.1 of the New Zealand Agreement allocates the sole taxing right over 'profits from ship or aircraft operations' to New Zealand, as the taxpayer's country of residence.
Unlike Article 8 of the OECD Model, Article 8 of the New Zealand Agreement is not restricted to transport activities and extends to non-transport activities such as fishing, dredging and haulage. The scope of Article 8 of the New Zealand Agreement is extended by not referring to 'transport' in the title of the Article and by not restricting Article 8.1 to the 'operation of ships ... in international traffic '.
The possibility of countries bilaterally agreeing to extend the scope of Article 8 to non-transport activities is provided for at paragraph 17.1 of the OECD Model Commentary on Article 8. Australia's intention to depart from the OECD Model in this respect is reflected in Australia's reservation at paragraph 38 of the OECD Model Commentary on Article 8 which states, 'Australia also reserves the right to tax profits from other coastal and continental shelf activities'.
The words 'profits from ship operations' refers to those profits an enterprise directly derives from the transportation of passengers or cargo by ship, or from using the ship for other activities such as fishing, dredging and haulage.
It is arguable that the leasing profits derived by the taxpayer fall within the meaning of the term 'profits from ship operations'. This is based on an argument that the activity undertaken by the taxpayer that gives rise to its profits, that is, the provision of a ship fully crewed and supplied, is one of 'ship operations'.
Alternatively, even if the taxpayer is not deriving profits directly from ship operations, such leasing profits that are indirectly derived from ship operations also fall within the scope of Article 8.1 by virtue of paragraph 5 of the OECD Model Commentary on Article 8.1, which clarifies that: Profits obtained by leasing a ship ... on charter fully equipped, crewed and supplied must be treated like the profits from the carriage of passengers or cargo.
Therefore, the taxpayer's leasing profits fall within the scope of Article 8.1 of the New Zealand Agreement. Under this paragraph, New Zealand is allocated the sole taxing right over such profits. Australia is prevented from taxing the leasing profits, unless they fall within the exception provided for in Article 8.2 of the New Zealand Agreement.
Article 8.2 of the New Zealand Agreement allocates a taxing right to Australia over the taxpayer's leasing profits that would otherwise be solely taxable in New Zealand under Article 8.1, where the profits are from 'ship or aircraft operations confined solely to places in [Australia]'.
For the same reasons as for Article 8.1, the reference to 'profits from ship operations' in Article 8.2 include the leasing profits derived by the taxpayer from chartering out its ship to the Australian resident.
There is no guidance in the Explanatory Memorandum to the New Zealand Agreement to assist in the interpretation of what would constitute 'operations confined solely to places in Australia' in a non-transport situation. Article 8.4 of the New Zealand Agreement is not applicable because it only clarifies the meaning of the expression for transport activities (that is, where the profits are derived from the carriage by ships of passengers etc). The expression is therefore given its ordinary meaning.
Although the ship's operations are in Australia for certain parts of the charter period, the operations are not confined solely to places in Australia. The ship operations from which the taxpayer derives its profits, that is the charter of a ship fully crewed and supplied, are also in New Zealand for some of the charter period because the charter commences and returns from a port in New Zealand. Accordingly, the leasing profits derived by the taxpayer, as distinct from the fishing profits derived by the charterer, from the ship's operations are not confined solely to places within Australia.
Therefore, the requirements of Article 8.2 are not met and Australia does not have a taxing right over the taxpayer's leasing profits under Article 8 of the NZ Agreement.
Paragraph 106 of TR 2002/9 explains that income will be exempt income under section 6-20(2) of the ITAA 1997 where it is not taxable by virtue of the provision of one of Australia's tax treaties. The leasing profits derived by the New Zealand resident are therefore exempt income because Australia is prevented from taxing the income under the New Zealand Agreement. As a result, the income is not assessable income under subsection 6-5(3) of the ITAA 1997 because exempt income is not assessable income under subsection 6-15(2).