Private ruling: Deemed permanent establishment under Article 5(3)(b) of the UK Convention
Published: June 2012
Ruling period: The 2011 to 2022 income tax years
Date scheme commenced: During 2011

Ruling: Q1: Will the rulee be deemed to have a permanent establishment in Australia and to carry on business through that permanent establishment under Article 5(3)(b) of the Convention between the Government of Australia and the Government of the Country A of Country B and Country C for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 (UK Convention)?. | A1: No

Relevant facts and circumstances: The rulee is a X resident for tax purposes and is an enterprise for the purposes of the X Convention. The rulee does not have a deemed permanent establishment ("PE") in Australia by operation of Articles 5(3)(a) or 5(3)(c) of the X Convention, as it does not satisfy the requirements of those Articles. The rulee (lessor) simultaneously leased a particular number of machines to an Australian resident (lessee). The machines are identical and can be used interchangeably. The contractual arrangements between the lessor and the lessee relevant to the subject of this ruling were largely negotiated and entered into outside of Australia. None of the contractual arrangements relevant to the subject of this ruling are a hire purchase agreement for the purpose of the X Convention. In accordance with the lease agreements, the lessee has operational control over the machines. The lessee will determine where the machines are to be located and will conduct the necessary repairs and maintenance and will assume all associated risks of damage and loss. The lessor does not direct or otherwise require that the machines be used by the lessee in Australia. The terms of the lease agreements neither require that the machines be brought into Australia nor that the machines remain in Australia or in any particular jurisdiction, by the lessee. While the machines are permitted to be used or stored in any location throughout the lease period this is at the discretion of the lessee and not the lessor. The activities of the lessor are generally concerned with the leasing of machines and all related activities, including without limitation, the collection of lease payments and maintenance/use payments. Each machine is of a particular size and weight, and has a particular list price. Relevant legislative provisions Convention between the Government of Australia and the Government of the Country A of Country B and Country C for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22. Article 5(3)(b)


Reasons for decision: Summary: Article 5(3)(b) of the Convention between the Government of Australia and the Government of the Country A of Country B and Country C for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 (UK Convention) deems a X enterprise to have a PE in Australia if the X enterprise maintains substantial equipment for rental or other purposes within Australia (excluding equipment let under a hire-purchase agreement) for a period of more than 12 months. | Detailed Reasoning - Substantial equipment: The term 'substantial equipment' is not defined in the UK Convention. Paragraphs 104 to 106 of Taxation Ruling TR 2007/10 Income tax: the treatment of shipping and aircraft leasing profits of United States and United Kingdom enterprises under the deemed substantial equipment permanent establishment provision of the respective Taxation Conventions , however, explain the meaning of 'equipment' and in particular that the term will include items of machinery. On that basis, the machines are items of equipment. Paragraph 107 of TR 2007/10 states that the relevant meanings of 'substantial' in the Macquarie Dictionary , 2001, 5 th edn, The Macquarie Library Pty Ltd, NSW are: · of ample or considerable amount, quantity or size · of real worth or value · of or relating to the essence of a thing; essential, material, or important. Paragraph 110 of TR 2007/10 states that whether equipment is 'substantial' is a question of fact and degree to be determined: · on balance, according to the facts and circumstances of each particular case; and · in an absolute sense, that is, when viewed independently; not in comparison with something else; or · in a relative sense; that is, by comparing it to something else. Accordingly, based on the ordinary meaning of the term, the relevant case law ( McDermott Industries (Aust) Pty Ltd v. Commissioner of Taxation (2005) 142 FCR 134; 2005 ATC 4398; (2005) 59 ATR 358 ( McDermott ); Tillmanns Butcheries Pty Ltd v. Australian Meat Industry Employees' Union (1979) 42 FLR 331; Case H106 (1957) 8 TBRD 484; (1957) 7 CTBR (NS) Case 98 ( Case H106 )), and the guidance at paragraphs 1.61 to 1.64 of the Explanatory Memorandum to the International Tax Agreements Amendment Bill 2003 incorporating the 2003 Convention between Australia and the Country A of Country B and Country C ("the EM to the 2003 X Convention"), the Commissioner considers that the following factors are relevant in determining whether equipment is 'substantial': · size · quantity - where part of a unified process · value · importance - in the sense of whether the equipment plays a core role in the income producing activity. The common characteristic of the examples of substantial equipment in McDermott and at paragraph 1.63 of the EM to the 2003 X Convention is the size of the equipment. The Commissioner therefore considers that size is the key factor and has greater weight in determining whether equipment is 'substantial'. If an item of equipment is sufficiently large in size, it will be 'substantial' in an absolute sense. In such instances, this factor alone will be decisive. As the nature of the 'substantial equipment' test is one of fact and degree, determined on balance according to individual facts and circumstances, the Commissioner considers that the factors listed above, other than size, are not of themselves determinative. Each of these factors needs to be considered with the others, having regard to all the facts and circumstances of the particular case. This is consistent with the analysis in Case H106 , where the Board of Review used more than one of the factors stated above to find that the equipment in question in that case was substantial. Where there are a number of items of equipment that are not large enough individually to be substantial in an absolute sense, the Commissioner considers that the size of the items collectively and the quantity can only be considered if the items of equipment are part of a unified process. This arises from the context in which the term 'substantial' appears in the provision; that is, it is part of the expression 'substantial equipment' as opposed to 'a substantial amount of equipment'. Value is a relevant factor in determining if equipment is substantial on two levels; firstly, in the sense of its cost (as per the ordinary meaning of the term) and, secondly, in the sense of its value creating potential. In relation to the latter, paragraph 1.62 of the EM to the 2003 X Convention refers to high value activities involved in the development of natural resources. Equipment may be so valuable that it may be considered substantial in an absolute sense. For example, in Number 630 v. Minister of National Revenue (1959) 59 DTC 300, tunnelling equipment costing $600,000 was considered to be substantial equipment purely on the basis of its cost alone. However, it is not possible to set a precise monetary threshold in relation to cost that will be appropriate for all cases. Importance as a relevant factor is reflected in Case H106 where Mr Fletcher, the Chairman of the Board: The meaning of 'substantial' is relative and in the case where the machinery required is not extensive, and the whole is involved, it is 'substantial'. The statement above from Case H106 , the ordinary meaning of the term 'substantial', and the context in which the term is used, indicate that the sense in which importance is relevant is where the equipment is core to the enterprise conducting its income producing or value creating activity, or to it creating its product in a particular country. | Detailed Reasoning - Application to the machines: The dimensions of the machines are not large enough in size to be considered substantial in an absolute sense. This is consistent with the view in ATO Interpretative Decision 2007/20 Income Tax - United States Convention: whether packing machines are 'substantial equipment'. That decision considered a packing machine of particular approximate dimensions. As the packing machine and the attachment operated as part of one unified process, the packing machine and attachment were considered collectively to determine if they were substantial. It was decided that the combined size was not substantial in an absolute sense. Each of the machines being considered in this ruling is a standalone piece of equipment which operates and is used independently, and not as part of a unified process. Accordingly, the individual machines cannot be considered collectively to determine if they are substantial. In considering the value of the machines, the list price of each machine is indicative that the equipment is substantial purely on the basis of its value. The business activities of the lessor are generally concerned with the leasing of these machines and all related activities and as such the machines play a core role in its income producing activities. On balance, the value of each machine is sufficient to conclude that it is 'substantial' equipment for the purposes of the X Convention. | Detailed Reasoning - Maintains substantial equipment for rental or other purposes within Australia: Article 5(3)(b) of the UK Convention only deems a X enterprise to have a PE in Australia if the X enterprise maintains substantial equipment for rental or other purposes within Australia for a period of more than 12 months. The meaning of 'maintains…for rental or other purposes …within Australia' is discussed in TR 2007/10 . The ruling explains, at paragraph 114, that the relevant meaning of the term 'maintain' in the Macquarie Dictionary is: · · to keep in existence or continuance, preserve; retain; and · · to keep in a specified state, position etc. This indicates that in the context of Article 5(3)(b) of the X Convention, to maintain something requires a positive element of keeping it in a particular state or position. The broader reference to 'maintains substantial equipment .... in Australia' in Article 5(3)(b) indicates that the focus of the provision is on keeping substantial equipment in the physical location of Australia. The requirement that an 'enterprise' maintains substantial equipment indicates that, taken as a whole, the actions of the enterprise are to be directed towards keeping the substantial equipment in Australia. The reference to 'for rental or other purposes' indicates that the actions of the enterprise are to be directed towards keeping the substantial equipment in Australia for its own use or for use by others such as lessees. Accordingly, the lessor would maintain the machines as substantial equipment in Australia if its actions are directed towards keeping the machines in Australia. If the lessor's actions are not so directed, this indicates that it is not maintaining substantial equipment in Australia. TR 2007/10 states, at paragraph 117, that where substantial equipment is located outside Australia before being leased in Australia, the actions of a lessor enterprise have to be directed towards an outcome that the equipment is relocated to Australia for its use in Australia. This does not necessarily mean that the lessor enterprise must itself relocate the equipment to Australia in order for its actions to be so directed. A condition of the lease that the equipment be physically located only within Australia for the term of the lease would be sufficient for these purposes. Paragraph 118 of TR 2007/10 discusses situations where the actions of the lessor are not directed towards keeping the substantial equipment within Australia (for example where it is of a general nature such that it can be used in most locations and the lessor has no requirement as to where the lessee ultimately uses the equipment), and it simply eventuates that the lessee brings the equipment to Australia and uses it in Australia. In such situations, the lessor would be considered to be indifferent as to where the substantial equipment is to be used under a lease. If however the substantial equipment is already located in Australia, is made available for lease in Australia and is actually used in Australia, the Commissioner considers that these facts demonstrate that the actions of the lessor enterprise are directed towards keeping the equipment in Australia. This will be the case regardless of whether the lessor enterprise brought the equipment to Australia to make it available for leasing, or simply allowed it to remain in Australia for the purpose of leasing following the expiry of a previous contract. Thus, a non-resident lessor enterprise will be considered to maintain substantial equipment within Australia where that lessor: (a) directs or otherwise requires that the substantial equipment be used by the lessee within Australia; or (b) already has the substantial equipment located within Australia which is available for lease in Australia, and equipment is used within Australia. | Detailed Reasoning - Application to the lessor: In accordance with the lease agreements, the lessee has operational control over the machines. The lessee will determine where the machines are to be located. The lessor did not have the machines located in Australia to be made available for their use or lease in Australia. None of the machines were located in Australia at the commencement of the leases. The actions of the lessor are not considered to be directed towards keeping the substantial equipment in Australia. Accordingly the lessor will not be deemed to have a PE in Australia as it does not maintain substantial equipment for rental or other purposes within Australia for a period of more than 12 months.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.