ATO ID 2010/46: Section 23AH of the Income Tax Assessment Act 1936 and drilling rig deployed outside the exclusive economic zone (EEZ) of a foreign country
Date of decision: 16 February 2010
Year of income: Year ending 30 June 2010
Business line: Public Groups and International

Issue
Are the fees derived by the taxpayer, an Australian resident company, from the timecharter party of a drilling rig to a foreign resident company, 'not assessable income and not exempt income' (NANE income) under subsection 23AH(2) of the Income Tax Assessment Act 1936 (ITAA 1936) where the drilling rig is deployed outside the EEZ of a foreign country?

Decision
No. The fees derived by the taxpayer from the timecharter party of a drilling rig to a foreign resident company, is not NANE income under subsection 23AH(2) of the ITAA 1936 where the drilling rig is deployed outside the EEZ of a foreign country.

Facts
The taxpayer is a company that is a resident of Australia for income tax purposes (within the meaning of the ITAA 1936 and Income Tax Assessment Act 1997 (ITAA 1997) and Australia's various tax treaties being Schedules to the International Tax Agreements Act 1953 ). The taxpayer is the owner of oil drilling rigs and enters into timecharter party agreements as described by Taxation Ruling TR 2003/2. That is, the essence of the arrangement is one where the taxpayer renders a service to the company chartering the oil rig. The companies chartering the oil drilling rigs are non-residents for income tax purposes. In accordance with the timecharter party agreement, the taxpayer operates the drilling rig within and without the EEZ of foreign countries. Where the drilling rig is operated within the EEZ of a foreign country, the foreign country is a 'listed or unlisted country' for the purposes of Part X of the ITAA 1936. Governments of foreign countries are able to tax income derived from activities conducted within their EEZ. The drilling rigs are heavy or substantial equipment for income tax purposes. For the purposes of section 23AH of the ITAA 1936, the drilling rig is a 'permanent establishment' (PE) at or through which the taxpayer carries on business. None of the specific exceptions listed within the subsections of section 23AH of the ITAA 1936 apply in this case.

Reasons for decision
Summary: Division 6 of the ITAA 1997 provides that an Australian resident's assessable income includes ordinary and statutory income derived from all sources whether in or out of Australia. Pursuant to section 6-23 of the ITAA 1997, an amount of income will be NANE income where a provision of the Act has that effect. Section 23AH of the ITAA 1936 is one such provision which states that certain income is NANE. Subsection 23AH(2) of the ITAA 1936 provides that, subject to other parts of section 23AH of the ITAA 1936, foreign income derived by a resident company in carrying on business at or through a PE in a listed or unlisted country is NANE income. The definition of 'foreign income' in subsection 23AH(15) of the ITAA 1936 states that 'foreign income' includes an amount that: The Commissioner takes the view that the source of the income derived from timecharter party oil drilling activities is where the services are performed ( Commissioner of Taxation (NSW) v. Cam & Sons Ltd (1936) 36 SR (NSW) 544; (1936) 4 ATD 32, French v. Federal Commissioner of Taxation (1957) 98 CLR 398; (1957) 11 ATD 288; (1957) 7 AITR 76, Cliffs International Inc v. FCT (1985) 85 ATC 4374; 16 ATR 601). In Chaudhri v. Federal Commissioner of Taxation [2001] FCA 554; (2001) 24 ATC 4214; (2001) 47 ATR 126 ( Chaudhri ), the Full Federal Court of Australia in interpreting the meaning of foreign country in the context of section 23AG of the ITAA 1936 concluded as follows: In our opinion, s 23AG(3) does suggest that whatever the word "country" may mean it contemplates some unit, to use a neutral word, capable of imposing a law of income tax - or in other words, a political entity or, perhaps, part of a political entity. ... that the word "country" was intended by Parliament to encompass a political entity capable of at least taxing income derived there. Further: Ultimately, we think that we should return to the ordinary English use of the word "country" in the context of that being a place where personal service such as employment may be engaged in and where income may be derived. In that context, ordinary usage would not suggest that the high seas, or for that matter some parts of them, were in a composite sense to be regarded as a country, or for that matter a series of countries. Rather the ordinary meaning of the expression 'foreign country' in modern usage looks to a political entity, be that a tract of land, a district, or a group of islands. It does not extend to an ocean or region of the sea. The Commissioner considers that the Court's reasoning in Chaudhri would equally apply to interpreting section 23AH of the ITAA 1936. Although part of an ocean or sea would not ordinarily be a country, as the government of a foreign country is able to tax income derived from activities conducted inside its exclusive economic zone, the EEZ forms part of that foreign country. As a consequence, during the time in which the taxpayer deploys the drilling rig inside the EEZ of a foreign country, the PE is in a listed or unlisted country. Where the taxpayer is performing services from within the EEZ of a listed or unlisted country, the income derived will be 'foreign income' pursuant to subsection 23AH(15) of the ITAA 1936. As none of the exceptions in section 23AH of the ITAA 1936 apply, it follows that the income derived by the PE will be NANE income pursuant to subsection 23AH(2) of the ITAA 1936. Conversely, when the taxpayer deploys a drilling rig outside the EEZ of the foreign country or any other country, neither the foreign country nor any other country is capable of taxing the income derived there. Therefore, the resulting PE is not in a foreign country, and thus not in a listed country or unlisted country for the purposes of section 23AH of the ITAA 1936. Accordingly, the income derived by the taxpayer during the time in which a drilling rig is located outside the EEZ of any foreign country is not NANE income pursuant to subsection 23AH(2) of the ITAA 1936. Where under a single timecharter party contract, the taxpayer has more than one PE which derives income partly within and also partly without a foreign country's EEZ, the contract receipts will need to be apportioned accordingly (refer to Taxation Ruling TR 2001/11, in particular paragraph 3.64 and following) .

Legislative references: Income Tax Assessment Act 1936 section 23AG subsection 23AG(3) section 23AH subsection 23AH(2) subsection 23AH(15)
Case references: Chaudhri v Federal Commissioner of Taxation [2001] FCA 554 2001 ATC 4214 47 ATR 126
Related public rulings and determinations: Taxation Ruling TR 2001/11 | Taxation Ruling TR 2003/2
Related ATO interpretative decisions: ATOID 2003/907
Subject references: Foreign income International law International tax Listed countries Offshore petroleum industry Permanent establishment Ship chartering Substantial equipment Unlisted countries