background image
Draft ruling of taxation of ship and aircraft leasing profits — Orbitax Tax News & Alerts

The Australian Taxation Office released on 9 April 2008, for discussion a Draft Taxation Ruling TR 2008/D3 dealing with the taxation treatment of ship and aircraft leasing profits under the ships and aircraft articles of Australia's tax treaties.

The Draft Ruling clarifies the taxation implications under each of Australia tax treaties, including Airline Profit Agreements. In particular, the Draft Ruling aims to clarify in what circumstances Australia is allocated a right to tax those leasing profits and the method of assessment of such profits under the domestic rules.

The Draft Ruling does not deal with all requirements of the relevant articles. For example, the article in the Australia-Romania tax treaty requires that the operator has its place of effective management and control in Australia or Romania, which is irrelevant to the issue of which profits fall within the scope of thearticle and is therefore not considered by the Draft Ruling.

The Draft Ruling notes that Australia made a reservation to Art. 8 of the OECD Model Tax Convention in relation to the source country taxation rights on profits from carriage confined solely to places in the source state as well as profits from other coastal and continental shelf activities. With this in mind, the Draft Ruling then considers the relevant articles in Australia's tax treaties. The Draft Ruling considers in detail reciprocal exemptions, non-transport operations, etc.

ATO discusses interaction between debt/equity and transfer pricing rules

The Australian Taxation Office released, on 26 March 2008, for comment Draft Taxation Determination TD 2008/D3 in which it expressed a view that classification of an interest as debt or equity under the domestic debt/equity rules does not affect the application of the transfer pricing provisions.

Division 974 of the Income Tax Assessment Act 1997, also known as "debt/equity rules",operates to determine whether a scheme gives rise to a debt or equity interest. Such classification is important as, for example, return on a debt interest may be deductible to the issuer, whereas a return on an equity instrument may be frankable.

On the other hand, a result of the application of arm's length principle in the transfer pricing rules in Division 13 of the Income Tax Assessment Act 1936, may depend on whether a contribution of funds under consideration was equivalent to an equity or a loan. The Draft Ruling states that the application of the arm's length principle will not depend on the classification of the contribution under the debt/equity rules.

The Draft Ruling includes an example which suggests that where an Australian parent provides funding to a foreign subsidiary and the funding is classified as equity under Division 974, the transfer pricing rules may nevertheless give rise to an imputed interest income accruing to the Australian parent under the transfer pricing rules.

Administrative Appeals Tribunal of Australia held excessive transfer pricing adjustments made by Commissioner of Taxation re income tax assessments of Australian subsidiary of Swiss parent

The Administrative Appeals Tribunal of Australia (AAT) held in Roche Products Pty Limited and Commissioner of Taxation [2008] AATA 261 (2 April 2008), that transfer pricing adjustments made by the Commissioner of Taxation in respect of income tax assessments of an Australian subsidiary of Roche Holdings Ltd of Basel, Switzerland, were excessive. The Tribunal therefore confirmed that the prices which were charged to the Australian subsidiary were arm's length prices, taking into account that the subsidiary agreed to increase its assessable income for the reviewed years by AUD 58.7 million.

The decision states that establishing arm's length prices is never an easy task, which was particularly difficult in this case, as there was no substantial free market from which comparative sales could be derived. Even where such details could be obtained, the pricing level was generally related to marketing processes.

In making the decision, the Tribunal considered evidence of three expert witnesses, in which respect the Tribunal's President noted that the witnesses' approach to the issues have been "coloured by their United States experience". He said that "at times I wondered why Australian experts could not have approached this matter with just as much skill as the experts from the United States but without some of the presumptions which their work must have led to".

The decision also highlighted an interesting dichotomy between the transfer pricing provisions, dealing with "acquisitions" and "dealing at arm's length", and thetax treaty provisions, dealing with "profits" derived in acting as an "independent enterprise dealing wholly independently". The Tribunal's President noted that "the parties spent little time dealing with the words of either set of provisions and effectively accepted that the same result would obtain whichever was applied and therefore he did not rule on the question whether the double tax treaties authorize the Commissioner to make assessments of tax in accordance with their terms". He also noted that "none of the experts were either asked to, or did, directly address the provisions of either the tax treaties or the Australian Income Tax Assessment Acts", and that "had they done so my task might have been easier".

As an unusual conclusion, the Tribunal's President published the decision on a preliminary basis to invite the parties to consider whether any further submissions should be made.

Note. The AAT deals with reviews of the Commissioner's assessments based on both questions of fact and law. An unfavourable decision of the AAT may be appealed to the Federal Court, but only on a question of law.