Royalty withholding tax: lease payments to United States tax treaty resident for hiring substantial equipment - royalty withholding tax

Are lease payments made by an Australian resident company to a United States (US) resident company for the hire of substantial equipment subject to royalty withholding tax under section 128B of the Income Tax Assessment Act 1936 (ITAA 1936)?

No, these lease payments are not subject to royalty withholding tax under the ITAA 1936.

The taxpayer is a US resident for the purposes of the tax treaty between Australia and the United States (the US Convention).

The taxpayer leases substantial equipment to a company that is resident of Australia for the purposes of the US Convention. The paramount purpose of the lease is for the hire, not the purchase, of the equipment.

The substantial equipment is equipment of an industrial nature.

The taxpayer receives lease payments from the Australian company in accordance with the lease agreement.

Under subsection 6(1) of the ITAA 1936, the definition of 'royalty' or 'royalties' includes payments for 'the use of, or right to use, any industrial, commercial or scientific equipment'. The definition of royalty in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) takes its meaning from the definition in the ITAA 1936. The payments made by the Australian company to the taxpayer pursuant to the lease agreement are royalties for the purposes of the ITAA 1936 and ITAA 1997 as they are payments made by the Australian company for the right to use industrial equipment.

With effect from 1 July 2003 for withholding taxes, the definition of 'royalties' in the Royalties Article of the US Convention (Article 12(4)) does not include 'payments for the use of or the right to use industrial, commercial or scientific equipment' Accordingly, the equipment lease payments are not 'royalties' for the purposes of Article 12(4) of the US Convention.

Subparagraph 17A(5)(b) of the International Tax Agreements Act 1953 (the Agreements Act) provides that section 128B of the ITAA 1936 (which deals with liability to withholding tax) does not apply to payments that are royalties for the purposes of the Assessment Act (that is the ITAA 1936 and the ITAA 1997) where a tax treaty does not treat the payments as royalties.

Therefore, as the equipment lease payments made by the Australian company to the taxpayer are not royalties for the purposes of Article 12(4) of the US Convention, the Convention does not treat those payments as royalties for the purposes of paragraph 17A(5)(b) of the Agreements Act. Accordingly, subsection 17A(5) of the Agreements Act applies and payments for the lease of industrial equipment made after 30 June 2003 are not subject to royalty withholding tax.