TAX NEWS - 2010

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New Zealand Tax: New treaty with Australia eases PE definition relating to substantial equipment

The new tax treaty between New Zealand and Australia, which is generally effective as from 1 May 2010, is likely to ease conditions under which a permanent establishment (PE) will arise where a person operates substantial equipment in the other country.

Article 5(4)(c) of the previous treaty provided that an enterprise was deemed to have a PE in a country if substantial equipment was being used in that country by, for or under contract with the enterprise. The wording of this provision would deem a nonresident lessor under a cross-border "dry" lease of substantial equipment (i.e. a lease of equipment without providing for staff or other facilities in the other country) to have a PE in the country in which the equipment was used. This is demonstrated in the case of McDermott Industries (Aust.) Pty. Ltd. v. Commissioner of Taxation (McDermott), where the issue was whether a Singapore company that had no office, staff or other facilities in Australia had a PE in Australia by virtue of leasing a vessel to an Australian resident company (note that article 4(3)(b) of the Australia-Singapore treaty has the same wording as article 5(4)(c) of the old Australia-New Zealand treaty). A PE was deemed to arise in Australia because (i) the barges were "substantial equipment" and (ii) the nature of the leasing arrangements was such that the barges were either being used by the Singaporean entity in Australia itself or by the Australian entity "by, for or under contract" with the Singaporean entity.

The new treaty between New Zealand and Australia introduces a "183 days in any 12-month period" test and provides that a deemed PE will arise where a person "operates substantial equipment in the other country." Under this new provision a lessor with a dry cross-border leasing arrangement of substantial equipment likely will not be deemed to have a PE in the country in which the equipment is used. In other words, no PE will be created where the contract is for the lease of substantial equipment without the provision of staff or other facilities in the country in which the equipment is to be used, and where the lessor has no control over the use of the substantial equipment in the other country. In addition, the OECD Commentary to the Model Treaty provides that, where industrial, commercial or scientific equipment are leased to another country, as long as such letting is not being maintained through a fixed place of business in the other country, the leasing will not constitute a PE of the lessor.

For example, if a New Zealand enterprise leases a mobile crane to another person and that person operates the crane at an Australian port for its own purposes, the New Zealand enterprise would not be deemed to have a PE in Australia. However, if the other person operates the substantial equipment for or on behalf of the enterprise, the enterprise would be considered to operate the equipment in the country. The introduction of a 183-days test also means that a New Zealand company can operate substantial equipment in Australia without creating a PE within that time period, and vice versa.

The Australian Taxation Office (ATO) has considered its substantial equipment provisions in considerable depth, such as in the Explanatory Memorandum (EM) to the new treaty released by the ATO. The EM explains that the words "operation" and "operates" have been included to clarify that only active use of substantial equipment assets will be captured by the new article. The EM further clarifies that this means that an enterprise that merely leases substantial equipment to another person for that other person's use in a country, would not be deemed to have a PE in that country under these provisions.

The New Zealand Inland Revenue Department (IRD) has not issued any guidance or interpretative statements on the application of the new provision. However, any interpretations taken by the IRD are likely to be consistent with the ATO's view.

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