This week, we will be discussing an Article in the US/AUS DTA which is generally not as relevant to individuals as other Articles in the DTA, but still important to understand. Especially regarding the interrelationship with other Articles in the DTA and how one article can override another in the DTA.
Article 8 of the DTA governs the taxation of profits of an enterprise of a contracting state from the operation of ships or aircraft in ‘international traffic’, meaning any transport by a ship or aircraft, except when such transport is solely between places in a contracting state. In simple terms, this article does not apply to an enterprise who solely renders services within the US or Australia and provides primary taxing rights to the Country of Residence.
In this week’s blog we will therefore have a look at Article 8 of the US/AUS DTA and how it interplays with Article 7 of the DTA.
INTERPRETING ARTICLE 8 OF THE DTA – SHIPPING AND AIR TRANSPORT
In our previous blog – Article 7- Business Profits , we explained that where profits include items of income dealt with separately in other articles of the DTA, then the provisions of those Articles shall not be affected by the provisions of Article 7.
Article 8 is such an article, as it deals with profits of an enterprise from the operation of ships or aircraft in international traffic. If Article 8 applies to the profits of an enterprise, it will therefore override the provisions of Article 7.
Article 8(1) stipulates that the profits derived by a resident of one of the Contracting States from the operation in international traffic of ships or aircraft are taxable only in that Contracting State. In addition, this treatment extends to certain items of rental income that are closely related to the operation of ships and aircraft in international traffic.
Article 1(3)(d) of the DTA defines international traffic as any transport by a ship or aircraft, except where such transport is solely between places within a Contacting State.
In particular, the following is subject to the above treatment:
– Profits from the rental of ships or aircraft on a full time basis (for example with crewmembers) operated in international traffic if the resident either operates ships or aircraft in international traffic or regularly leases ships or aircraft on a full basis. Such income is exempt from tax in the other Contracting State.
– Profits from the lease of ships or aircraft on a bare boat basis (meaning without crewmembers) when the income is ‘merely incidental’ to the operation of ships or aircraft in international traffic by the lessor.
Whether profits from the lease of ships or aircraft on a bare boat basis are merely incidental to operation in international traffic, the operative effect of this phrase is to restrict the application of Article 8 to those bareboat leases where:
– The primary activity of the lessor is the operation of ships or aircraft in international traffic, and
– The lessor’s bareboat leasing activity only makes a minor contribution to, and is so closely related to, this primary activity that it does not amount to a separate business or source of income for the lessor.
Article 8(2) stipulates that profits of an enterprise of a Contracting State from the use, maintenance or rental of containers (including equipment for their transport) that are used for the transport of goods in international traffic are exempt from tax in the other Contracting State. This applies regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic.
Article 8(3) stipulates that Article 8(1) and 8(2) apply to profits derived though participation in a pool service or other profit sharing arrangement entered into by carriers in shipping and air transport in the interest of international cooperation. As an example, airlines from the US and Australia may agree to share profits relating to the transport of passengers between the two countries. They each will fly the same number of flights per week and share the revenues from that route equally, regardless of the number of passengers that each airline transports. Article 8(3) further makes it clear that all of the income arising from the pool service or other profit sharing arrangement and not just the income derived directly by that carrier is taxable in the Contracting State of residence.
Article 8(4) states that the carriage of passengers, livestock, mail, merchandise or goods taken on board in a Contracting State for discharge in that State is not from an operation in international traffic of ships or aircraft and may therefore be taxed in that State (source state). This relates to profits from the transport of goods or passengers picked up and discharged within the same Contracting State and therefore does not fall within the definition of international traffic and may be taxed by that State at source. However, for the Contracting State to impose such tax at source it is considered that the requirements of Article 7 would need to be satisfied.
This can be simplified with the following two examples:
Example 1 – Company A, a US shipping company contracts to carry goods from Australia to a city in the US. Part of the contract includes the transport of the goods by road from its point of origin in Australia to another point in Australia. The income earned by the US shipping company from the overland leg of the journey would still be taxable only in the US.
Example 2 – Company B is a US airline company which carries passengers from New York to Hobart, with an intervening stop in Perth. The Perth to Hobart leg of the trip would be treated as international transport of passengers with respect to those passengers and would still only be taxable in the US.
INTERRELATIONSHIP WITH ARTICLE 7 (BUSINESS PROFITS)
Profits from the lease of ships or aircraft that are not covered by the Shipping and Air Transport Article will fall within the scope of Article 7.
Examples of profits that would fall within Article 7 include the following:
– Full basis leases of ships or aircraft that are not operated in international traffic by the lessee or where the lessor only operates ships or aircraft between places in the source country and does not regularly lease ships or aircraft on a full-time basis; and
– Bare boat leases not incidental to the lessor’s international transport operations.
More importantly the source country’s taxation is only permitted under the Business Profits Article to the extent the profits are effectively connected with a permanent establishment in that country.
This is a great example of how a specific article in the DTA can override the provisions of Article 7.