Private ruling: Shipping income
Published: July 2012
Ruling period: 1 July 2011 to 30 June 2012 | 1 July 2012 to 30 June 2013 | 1 July 2013 to 30 June 2014 | 1 July 2014 to 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the income derived by Company X from shipping services provided under freight contracts for inward and outward voyages to Australia, which are supported by the office services conducted in Australia, constitute 'profits from the operation of ships' under Article 7(1) of the Agreement between the Government of the Commonwealth of Australia and the Government of the Country Y for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (the Country Y Agreement) and exempt from income tax in Australia? | A1: Yes | Q2: Is the income derived by Company X from 'international logistics' services provided under freight contracts for inward and outward voyages to Australia, constitute 'profits from the operation of ships' under Article 7(1) of the Country Y Agreement and exempt from income tax in Australia? | A2: Yes | Q3: Is the income derived by Company X from 'domestic logistics' services provided under freight contracts for inward and outward voyages to Australia, constitute 'profits from the operation of ships' under Article 7(1) of the Country Y Agreement and exempt from income tax in Australia? | A3: Yes

Relevant facts and circumstances: Company X was incorporated in Country Y. Company X is a resident of Country Y for the purposes of Country Y's tax law and is not an Australian resident for the purposes of Australian tax law. Company X is a company that is managed and controlled in Country Y. It is incorporated in Country Y and carries on business in Country Y. The income of Company X is not subject to tax in Country Y on a remittance or receipts basis for the purposes of the Country Y Agreement. Company X is in the business of international shipping and derives its main revenue from shipping freight and transport charges ('freight contracts'). Company X has contracts to transport cargo to various parts of the world. Company X also provides freight collection services to other customers. Company X specialises in project cargoes and heavy lift shipping transport, however there is no limit on the size or type of cargo Company X will transport to Australia. Company X charters the vessels which it operates in international waters either under long term time charter, bare boat charter, trip charter or voyage charter. Currently, it owns some vessels and also operates chartered vessels. Company X provides shipping services to customers under freight contracts for inward and outward voyages to Australia, That is, cargo will be collected at a port in a foreign jurisdiction and delivered to an Australian port (inward voyage) or cargo will be collected at an Australian port and delivered to a port in a foreign jurisdiction (outward voyage). There may be instances where delivery/collection is required from more than one Australian port as part of an international voyage. Company X also conducts voyages between Australian ports. However, income arising from such activities is not the subject of this ruling request. Company X also offers inland logistics services in Australia to support its inward and outward voyage freight contracts. This is a part of its 'end-to-end delivery solution' whereby Company X offers customers complete transportation of cargo from an inland location in one country (e.g. a warehouse or factory in Country A) to an inland location in another country (E.g. warehouse/factory in Country B), comprising both the inland transportation of the cargo and the ocean transportation of the cargo. This service will apply to both inward and outward voyages to Australia. The inland logistics service may comprise both 'international logistics' and 'domestic logistics' services. International logistics refers to providing shipping customers with inland logistical support to and from an inland location to an Australian port as part of the overall international inward and outward voyage. Domestic logistics refers to providing shipping customers with inland logistics support between inland locations within Australia. For example, a customer may contract with Company X to collect project cargo in India and deliver it by ship and truck to an inland Australian destination. The inland logistics service in this instance is referred to as 'international logistics'. In addition, the customer may require goods which are supplementary to its project cargo to be picked up at another inland location in Australia and delivered to the same ultimate inland Australian destination. This part of the service is referred to as 'domestic logistics'. The inland logistics services performed in Australia may be carried out by Company X or be outsourced to a wholly owned subsidiary of Company X called Company XL, a Country Y tax resident company. Company X or Company XL then sub-contracts a third party logistics services provider in Australia to physically perform the inland logistics services. There are commercial reasons for Company X to outsource the inland logistics services to its subsidiary. Company XL derives an arm's length fee for providing this service to Company X and is subject to Country Y tax on such income. Subject to the contract negotiations with the customer, each freight contract for end-to-end delivery may specify a separate fee for the shipping transport services and a separate fee for inland logistics services, or there may be only one lump sum fee charged to the customer. The fee for the inland logistics service is computed by reference to the cost of Company X outsourcing the services plus an arm's length mark-up added for Company X arranging the service. All contracts entered into by Company X will be negotiated and concluded by Company X in Country Y. This includes all arrangements to take care of insurance, freight costs, tariffs and duties, and contracts with service providers (including the inland logistics services providers sub-contracted by Company XL). Although Company X does not intend to regularly offer inland logistics services to non-shipping customers, it is possible that in certain circumstances an inland logistics contract may be entered into with a new customer who does not have a primary shipping contract with Company X. Company X does not consider that this circumstance would arise frequently, and would only be considered on an exceptions basis in order to secure a new shipping customer. Such activities are not the subject of this ruling request. Inland logistics is a very small component of the total business of Company X. Company X has an office in Australia to undertake certain activities in Australia to support Company X's freight contracts which have an Australian connection. The Australian office is currently staffed by a couple of employees of Company X. The Australian office does not receive or handle any payments from customers or to service providers on behalf of Company X. All costs relating to the office are directly incurred and paid by Company X in Country Y.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 Australian Treaty Series

Reasons for decision: Summary: The income derived by Company X in respect of its freight contracts, including the 'international logistics' and 'domestic logistics' services provided under those contracts constitutes 'profits from the operation of ships' under the ships and aircraft article of the Country Y Agreement and will not be taxable in Australia. | Detailed Reasoning - Detailed reasoning: The Country Y Agreement operates to avoid double taxation of income received by Australian and Country Y residents. Article 7 of the Country Y Agreement deals with the taxation treatment of profits derived from shipping and air transport. The effect of this Article is that the right to tax profits from the operation of ships or aircraft is generally reserved to the country of residence of the operator. In this case the country of residence of the operator is Country Y. Where Article 7 applies to the company, Australia will not have taxing rights over profits covered by this Article. That means that Australia will not require the Country Y company to include an amount in assessable income under subsection 6-5(3) of the ITAA 1997. Of particular relevance is Article 7(1) which states that" Profits from the operation of ships ... derived by a resident of one of the Contracting States shall be taxable only in that State. However, the profits will be taxable in Australia if they are profits from the operation of ships confined solely to Australia (Article 7(2)). Therefore, to determine if Article 7(1) applies, it is necessary to determine whether the income, the subject of this ruling, derived by Company X constitutes 'profits from the operation of ships'. Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements says that regard may be had to the OECD Model Tax Convention and the OECD Commentary on the Model Tax Convention (and subsequent revisions to that Commentary) to assist in the interpretation of double tax agreements. Paragraphs 4 to 4.2 of the OECD Commentary (OECD Model Tax Convention on Income and on Capital: Condensed Version 2010) on Article 8 of the Model Tax Convention state that: 4. However, as international transport has evolved, shipping and air transport enterprises invariably carry on large variety of activities to permit, facilitate or support their international traffic operations. The paragraph also covers profits from activities directly connected with such operations as well as profits from activities which are not directly connected with the operation of the enterprise's ships or aircraft in international traffic as long as they are ancillary to such operation. 4.1 Any activity carried on primarily in connection with the transportation, by the enterprise, of passengers or cargo by ships of aircraft that it operates in international traffic should be considered to be directly connected with such transportation. 4.2 Activities that the enterprise does not need to carry on for the purposes of its own operation of ships or aircraft in international traffic but which make a minor contribution relative to such operation and are so closely related to such operation that they should not be regarded as a separate business or source of income of the enterprise should be considered to be ancillary to the operation of ships and aircraft in international traffic. The OECD Commentary also includes specific examples of ancillary activities, such as arranging inland transport, ticket sales and container leasing. Australia has withdrawn its observation to the OECD Commentary which previously indicated that Australia adopted a different interpretation in relation to some aspects of the shipping profits article. In line with the OECD Commentary, Taxation Ruling TR 2008/8 Income tax: the taxation treatment of ship and aircraft leasing profits under the ships and aircraft articles of Australia's tax treaties supports the view that activities which are so minor and so closely related to the 'operation of ships' that they should not be treated as a separate business or as a separate source of income should be treated as being ancillary to the 'operation of ships'. | Detailed Reasoning - Shipping services: Company X provides shipping services to customers under freight contracts for inward and outward voyages to Australia. Company X's Australian office supports the development and execution of Company X's freight contracts with an Australian connection. The Australian office does not generate any income in its own right and all costs relating to the office are directly incurred and paid by Company X in Country Y. Therefore, the activities of the Australian office are accepted as being part and parcel of the activities which would be expected to be undertaken by Company X in order to ensure the orderly transport of goods. Accordingly, the income from the freight contracts for inward and outward voyages to Australia undertaken by Company X is income from the 'operation of ships' for the purposes of Article 7(1) of the Country Y Agreement. Company X is a Country Y resident company, therefore, under Article 7(1) of the Country Y Agreement this income will not be taxable in Australia. | Detailed Reasoning - Inland logistics services: As already discussed, the operation of ships' also includes activities which are ancillary to the overall operation of a ship for income producing purposes. Insofar as other transport services are concerned, paragraph 7 of the OECD Commentary states that: 7. A further example [of an ancillary activity] would be that of an enterprise that transports passengers or cargo by ships or aircraft operated in international traffic which undertakes to have those passengers or cargo picked up in the country where the transport originates or transported or delivered in the country of destination by any mode of inland transportation operated by other enterprises. In such case, any profits derived by the first enterprise from arranging such transportation by other enterprises are covered by the paragraph even though the profits derived by the other enterprise that provide such inland transportation would not be. Therefore, the 'operation of ships' can include inland logistics services provided under end-to-end freight contracts. In the case of Company X, the inland logistic services, the subject of this ruling, are offered as a supplementary service to customers under a freight contract. They are an integral part of the overall transport service which is offered to the shipping customer and they are provided under a single freight contract with the customer which comprises both the shipping services and the inland logistics services. These inland logistic services are offered only as a supplementary service to customers under a freight contract. From a commercial perspective, it is advantageous for the customer to enter into one single contract with Company X to provide the end-to-end delivery, rather than contracting separately with a local logistics provider to transport cargo from a port to an inland location (and vice versa). The margin of income derived by Company X on its inland logistics services, taking into account the arm's length fee paid to Company XL to sub-contract the logistics services, is relatively minimal and the profits derived by Company X from this aspect reflects the fact that it is merely the arranger of the inland logistics services. It is a natural extension of the service of shipping goods to provide door-to-door delivery as part of that overall transportation service. The income derived by Company X from providing inland logistics services is so minor and so closely related to the shipping operations that those services should be regarded as being ancillary to the shipping operations. Accordingly, Company X's income from its inland logistics services is considered to be 'profits from the operation of ships' for the purposes of Article 7(1) of the Country Y Agreement and will not be taxable in Australia. | Detailed Reasoning - Article 7(2): Under Article 7(2) of the Country Y Agreement, Australia may tax the profits from the 'operations of ships' if it is confined solely to places within Australia. TR 2008/8 confirms that in interpreting Article 7(2) of the Country Y Agreement it is the physical operation of the ship that is at issue (TR 2008/8 paragraphs 114 and 115). The income, the subject of this ruling, is the income derived by Company X from the transportation of freight to and from Australia. Income from the transportation of freight between Australian ports is not the subject of this ruling. Accordingly Article 7(2) of the Country Y Agreement will not have any application to the income from the transportation of freight to and from Australia. | Detailed Reasoning - Conclusion: The income derived by Company X in respect of its freight contracts, including the 'international logistics' and 'domestic logistics' services provided under those contracts (but not including income derived solely from transportation between Australian ports) constitutes 'profits from the operation of ships' under Article 7(1) of the Country Y Agreement and will not be taxable in Australia.

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