House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 6 Royalty withholding tax

Outline of chapter

6.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption from royalty withholding tax to non-resident lessors that lease qualifying vessels to Australian resident companies on a bareboat basis, where that vessel is used, or is available for use, in undertaking qualifying activities during the period of the lease.

Context of amendments

6.2 The income tax law defines a 'royalty' to include payments made in consideration for the use of, or the right to use, any industrial, commercial or scientific equipment. Royalties paid to non-residents are generally subject to withholding tax.

6.3 Consistently with these rules, payments made to non-residents by Australian resident companies for the lease of shipping vessels on a bareboat basis constitute royalties and are subject to royXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXalty withholding tax. However, payments for foreign vessels leased on a time charter basis do not constitute royalties and therefore attract no royalty withholding tax. Income associated with time-charter lease payments could still be taxable in accordance with domestic tax laws as well as Australia's tax treaty obligations.

6.4 Vessels leased on a 'bareboat' basis are provided without a captain or crew, whereas vessels leased on a 'time charter' basis come supplied with a captain and crew chosen by the lessor.

6.5 While the royalty withholding tax liability associated with leasing a vessel on a bareboat basis is imposed on the non-resident lessor, in practice the cost of this tax is effectively borne by the Australian shipping operator lessee through the inclusion of 'gross up' clauses in lease contracts that place this cost on the lessee.

6.6 The imposition of royalty withholding tax therefore makes it more expensive for Australian shipping operators to secure foreign vessels on a bareboat basis, especially when compared to the lease of vessels fully supplied with a captain and crew.

6.7 The new law will provide an exemption from royalty withholding tax for payments made by Australian resident companies for the lease of certain shipping vessels, on a bareboat basis, where those vessels are used commercially to transport passengers or cargo.

6.8 This change is expected to reduce the costs for Australian shipping operators of securing vessels on a bareboat basis, which in turn should increase the ability of Australian operators to crew those vessels with Australian workers.

Summary of the new law

6.9 The effect of the new law will be to exempt certain lease payments from royalty withholding tax.

6.10 The exemption from royalty withholding tax will only apply if the following criteria are fulfilled:

•

the lessee must be an Australian resident company;

•

the vessel must not be an 'excluded vessel' listed in subsection 10(4) of the Shipping Reform (Tax Incentives) Bill 2012 (SR(TI) Bill);

•

the vessel must be leased on a bareboat basis; and

•

the vessel must be used, or available for use, wholly or mainly for business or commercial activities that involve shipping cargo or passengers for consideration.

Comparison of key features of new law and current law

Detailed explanation of the new law

6.11 The new law will have the effect, from 1 July 2012, of exempting certain payments for the lease of qualifying vessels on a bareboat basis from royalty withholding tax. [ Schedule 4, item 2 ]

6.12 This will be achieved by listing those payments amongst the exclusions from withholding tax set out in subsection 128B(3) of the ITAA 1936.

6.13 To be exempted from royalty withholding tax the lease payments must meet certain criteria [ Schedule 4, item 1, paragraph 128B(3 )( m )].

•

The lessee must be an Australian resident company [ Schedule 4, item 1, subparagraph 128B(3 )( m )( i )].

-

Therefore, the liability for royalty withholding tax will remain in cases where the lessee is another type of entity or is a non-resident.

•

The lease payment must not relate to a vessel listed at subsection 10(4) of the SR(TI) Bill. The exemption will therefore apply to vessels other than [ Schedule 4, item 1, subparagraph 128B(3 )( m )( ii )]:

-

recreational vessels;

-

fishing vessels and fishing fleet support vessels;

-

offshore industry vessels;

-

inland waterways vessels;

-

salvage vessels;

-

tugboats;

-

barges;

-

vessels operating wholly or mainly from a stationary position;

-

government vessels; and

-

vessels owned or operated by the Australian Defence Force or the defence force of another country.

•

The payments must be for a vessel leased on a bareboat basis [ Schedule 4, item 1, subparagraph 128B(3 )( m )( iii )].

-

Therefore, the vessel must not come with a captain and crew.

•

The vessel must be used, or be available for use, as mentioned in paragraph 8(1)(c) of the SR(TI) Bill [ Schedule 4, item 1, subparagraph 128B(3 )( m )( iv )].

-

Therefore, the vessel must be used, or be available for use, wholly or mainly for business or commercial activities involving shipping cargo or passengers for consideration.

6.14 Lease payments that fulfil these criteria will not be subject to withholding tax. Consequentially, there will also be no obligation on the Australian payer of the royalty to withhold any royalty withholding tax on these payments.

6.15 Where Australia's domestic law treats a payment as a royalty and Australia has concluded a tax treaty that does not treat that same payment as a royalty, the payment will not be subject to royalty withholding tax in accordance with subsection 17A(5) of the International Tax Agreements Act 1953 . Some of Australia's tax treaties include a broader exemption from royalty withholding tax than is provided under this Bill. As such, certain payments that will not be excluded from royalty withholding tax under this Bill could nonetheless remain excluded from withholding tax in accordance with their treatment under relevant tax treaties.

6.16 Lease payments that are exempted from royalty withholding tax under this Bill may, nonetheless, result in an Australian tax liability. For example, an Australian tax liability may arise if income associated with exempted lease payments has an Australian source or is attributable to an Australian permanent establishment of the non-resident lessor.

Example 6.22 : Payments exempt from royalty withholding tax (under this Bill)

Blackbothom Co, an Australian resident company, is the lessee of a ship used for the transport of goods, from Captain Potts's Ship Trading Co, a Panamanian resident company that has no permanent establishment in Australia. The ship is leased on a bareboat basis and is used in commercial operations to transport goods.

Australia has no tax treaty with Panama, so there are no treaty limitations on Australia's right to tax royalties.

The payments for the lease of this ship would be considered a royalty under subsection 6(1) of the ITAA 1936. However, the payments for the lease of this ship would fulfil the requirements for an exemption from royalty withholding tax as:

•

the payer and lessee is an Australian resident company;

•

the lease is for a vessel on a bareboat basis;

•

the vessel is not an excluded vessel under subsection 10(4) of the SR(TI) Bill; and

•

during the period of the lease the vessel is being used commercially to ship cargo for consideration.

Example 6.23 : Payments not exempt from royalty withholding tax (under this Bill or under a tax treaty)

Blackbothom Co, an Australian resident company, is the lessee of a tugboat from Captain Potts's Ship Trading Co, a Panamanian resident company that has no permanent establishment in Australia. The tugboat is leased on a bareboat basis and is used in commercial tugboat operations.

Australia has no tax treaty with Panama, so there are no treaty limitations on Australia's right to tax royalties.

The payments for the lease of this tugboat would be considered a royalty under subsection 6(1) of the ITAA 1936 and would be subject to royalty withholding tax under section 128B of the ITAA 1936. Payments for the lease of this tugboat are not exempt from royalty withholding tax, because the vessel is an 'excluded vessel'. They would also not be exempt because during the period of the lease the vessel is not undertaking qualifying activities, nor is it available for use in undertaking qualifying activities.

Lease payments for this tugboat would be taxable in accordance with Australia's domestic law at the rate of 30 per cent.

Example 6.24 : Payments exempt from royalty withholding tax (under this Bill and under a tax treaty)

Blackbothom Co, an Australian resident company, is the lessee of a ship from Shirkleton Shore Seaworthy Co, a New Zealand resident company that has no permanent establishment in Australia. The ship is leased on a bareboat basis and is used in commercial operations to transport goods.

Under this Bill, payments for the lease of this ship would fulfil the requirements for an exemption from royalty withholding tax as:

•

the payer and lessee is an Australian resident company;

•

the lease is for a vessel on a bareboat basis;

•

the vessel is not an excluded vessel under subsection 10(4) of the SR(TI) Bill; and

•

during the period of the lease the vessel is being used commercially to ship cargo for consideration.

In this case, Australia's tax treaty with New Zealand would also operate to 'exempt' the payment from royalty withholding tax as the payment, being made for the use of commercial or industrial equipment, would not be considered a royalty under Article 12(3) of that treaty. The amount would therefore not be subject to withholding tax under Australia's domestic law in accordance with subsection 17A(5) of the International Tax Agreements Act 1953 .

Example 6.25 : Payments not exempt from royalty withholding tax (under this Bill) but payments are exempt under a tax treaty

Blackbothom Co, an Australian resident company, is the lessee of a vessel being a tugboat from Shirkleton Shore Seaworthy Co, a New Zealand resident company that has no permanent establishment in Australia. The tugboat is leased on a bareboat basis and is used in commercial tugboat operations.

The payments for this tugboat would be considered a royalty under subsection 6(1) of the ITAA 1936 and would be subject to royalty withholding tax under section 128B of the ITAA 1936. Under this Bill, payments for the lease of this tugboat are not exempt from royalty withholding tax, because the vessel is an 'excluded vessel'. They would also not be exempt because during the period of the lease the vessel is not undertaking qualifying activities, nor is it available for use in undertaking qualifying activities.

However, payments for the lease of a tugboat would not be considered a royalty under Article 12(3) of Australia's tax treaty with New Zealand. Consequently, the amount would not be subject to withholding tax under Australia's domestic law provisions in accordance with subsection 17A(5) of the International Tax Agreements Act 1953 .

6.17 Provision is made to enable the Australian Taxation Office to share taxpayer information with the relevant Department in certain circumstances - refer to paragraphs 2.53 to 2.55 in Chapter 2 of this explanatory memorandum.

Application provisions

6.18 The exemption from royalty withholding tax for qualifying lease payments will apply to payments made on or after 1 July 2012. [ Schedule 4, item 2 ]