Assessability of foreign branch income derived from New Zealand

Are lease premiums received by the taxpayer, an Australian resident company, under an operating lease of substantial equipment with a New Zealand resident company, not assessable income and not exempt income under subsection 23AH(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The lease premiums received by the taxpayer, an Australian resident company, under an operating lease of substantial equipment with a New Zealand resident company are not assessable income and not exempt income under subsection 23AH(2) of the ITAA 1936.

The taxpayer is a company that is a resident of Australia for income tax purposes.

The taxpayer carries on a business, a part of which includes the leasing of 'equipment'.

The leased equipment is 'substantial equipment' for the purposes of Article 5.4(c) of the tax treaty between Australia and New Zealand (New Zealand Agreement) contained under Schedule 4 and Schedule 4A to the International Tax Agreements Act 1953 (Agreements Act).

The taxpayer leases the substantial equipment to a New Zealand resident company (the lessee) under an operating lease agreement entered into in New Zealand.

The lessee operates the substantial equipment in New Zealand, as part of carrying on a business in New Zealand.

The lessee makes regular premium payments to the taxpayer from New Zealand in accordance with the terms of the operating lease agreement. The leasing of the substantial equipment is a part of the taxpayer's broader business.

Subsection 23AH(2) of the ITAA 1936 provides that, subject to other parts of section 23AH, foreign income derived by a resident company in carrying on a business at or through a permanent establishment in a listed or unlisted country is not assessable income and is not exempt income.

The definition of 'foreign income' in subsection 23AH(15) of the ITAA 1936 states that 'foreign income' includes an amount that: • apart from section 23AH, would be assessable income under a provision of the ITAA 1936 or the Income Tax Assessment Act 1997 (ITAA 1997), and • is derived from sources in a listed or unlisted country.

The term 'listed country' in subsections 23AH(2) and 23AH(15) of the ITAA 1936 has the same meaning as in Part X of the ITAA 1936, which means for present purposes, a foreign country declared by the regulations to be a listed country for Part X purposes (see the definition of the term in subsection 320(1) of the ITAA 1936). New Zealand is included in Part 1 of Schedule 10 to the Income Tax Regulations 1936 and, as a result, is declared to be a listed country under regulation 152C of the Income Tax Regulations 1936.

The lease premiums paid to the taxpayer under the lease agreement satisfy the definition of 'foreign income' under subsection 23AH(15) of the ITAA 1936: • apart from section 23AH of the ITAA 1936 it would be included in assessable income under subsection 6-5(2) of the ITAA 1997 as the lease premiums the taxpayer receives under the lease agreement are ordinary income; and • based on the facts stated above concerning the place of contract, payment and use of the equipment, the lease premiums are derived from 'sources in a listed country' for the purposes of paragraph (b) of the definition of 'foreign income' in subsection 23AH(15) of the ITAA 1936.

The lease premiums are 'derived by a resident company at a time when the company is a resident' for the purposes of subsection 23AH(2) of the ITAA 1936 because they are paid to the taxpayer under the lease agreement and the taxpayer is an Australian resident company at the time the lease premiums were received and, as a result, derived by the taxpayer.

The definition of the term 'permanent establishment' or 'PE' in subsection 23AH(15) of the ITAA 1936 provides for present purposes that, in section 23AH of the ITAA 1936, the term has the same meaning as in the New Zealand Agreement because Australia has a tax treaty with New Zealand. Accordingly, in this instance, the term 'PE' in section 23AH takes its meaning from the Permanent Establishment Article (Article 5) of the New Zealand Agreement.

Article 5.4(c) of the New Zealand Agreement provides that an enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if substantial equipment is being used in that State by, for or under contract with the enterprise.

When referring to Article 4(3)(b) of the tax treaty between Australia and Singapore (the provision in that tax treaty equivalent to Article 5(4)(c) of the New Zealand Agreement) in McDermott Industries (Aust) Pty Ltd v. Commissioner of Taxation (2005) 142 FCR 134; 2005 ATC 4398; (2005) 59 ATR 358 (McDermott's Case), the Full Federal Court stated : That deeming goes beyond there being a deeming of a permanent establishment. It operates as well to deem the enterprise to be carrying on trade or business through the deemed permanent establishment.

Having regard to the similarity of wording of the relevant provisions in both tax treaties in all material respects, the Commissioner considers that the Full Federal Court's conclusion above also applies to Article 5.4(c) of the New Zealand Agreement.

In the present case and consistent with the conclusions reached by the Full Federal Court in McDermott's Case, substantial equipment is being used by the 'enterprise' of the taxpayer and 'under contract with the enterprise' by the lessee in New Zealand for the purposes of Article 5.4(c) of the New Zealand Agreement. Therefore, the taxpayer is deemed to have a permanent establishment in New Zealand and to 'carry on business through that permanent establishment' for the purposes of Article 5.4(c) of the New Zealand Agreement. Hence, the taxpayer derives the foreign income 'in carrying on a business at or through a PE of the company in a listed country' for the purposes of subsection 23AH(2) of the ITAA 1936.

In relation to the words 'subject to this section' in subsection 23AH(2) of the ITAA 1936, subsection 23AH(5) of the ITAA 1936 provides that subsection 23AH(2) does not apply to the foreign income derived by the company if, amongst other things, the foreign income is eligible designated concession income in relation to a listed country.

In the present case, the foreign income does not satisfy subparagraph 23AH(5)(c)(ii) of the ITAA 1936 because the lease premiums in this case are not 'eligible designated concession income in relation to a listed country' for the purposes of that subparagraph. The lease premiums are not 'designated concession income' for the purposes of the definition of the term in subsection 317(1) of the ITAA 1936 as they are not the kind of income specified in the part of the regulations relevant to the present case (that is, subregulation 152B(1) and column 4 of Item 209 of Part 2 of Schedule 9 to the Income Tax Regulations 1936).

Also in relation to the words 'subject to this section' in subsection 23AH(2) of the ITAA 1936, subsection 23AH(7) of the ITAA 1936 provides that subsection 23AH(2) does not apply to the foreign income derived by a company if, amongst other things, the PE is in an unlisted country. However, subsection 23AH(7) does not apply in the present case as the taxpayer's permanent establishment is in a listed country.

As the lease premiums are income that satisfy all the elements of subsection 23AH(2) of the ITAA 1936 and any of the other parts of section 23AH of the ITAA 1936 do not apply in the present case to deny the operation of subsection 23AH(2), the premiums derived by the taxpayer from the leasing of substantial equipment under an operating lease agreement with the lessee, a New Zealand resident company, are not assessable and not exempt income under subsection 23AH(2).