The definition of a royalty in the Australian domestic tax legislation is likely to capture the majority of equipment leases entered into by Australian businesses and prima facie the Australian lessee would be required to deduct 30 percent withholding tax (WHT) from the lease payments. This can represent a significant cost as typically the WHT is borne by the lessee under the contract.
However, where the payment is made to an entity which is tax resident in a country with which Australia has a Double Taxation Agreement (DTA), the rate of WHT may be reduced to 10 percent or nil depending upon the particular DTA and in the case that the payment is made to an Australian Permanent Establishment (PE) of the overseas lessor, WHT is unlikely to apply at all.
Again, the PE question is not as straightforward as it seems. Even where an overseas lessor has no physical presence in Australia, the presence of its equipment in Australia could in itself result in the company being deemed to have an Australian PE where the equipment is considered ‘substantial’.
The term ‘substantial’ is unfortunately not defined but the ATO has indicated that size, value, quantity (when used in a unified process) and importance to the income producing activity should be taken into account when considering whether an item is ‘substantial’.
An extra complication is that there are a number of different PE definitions adopted in Australia’s DTAs. For example some DTAs require the ‘substantial equipment’ to be in Australia for a set period of time or used for a specific purpose such as the exploration or exploitation of natural resources, so again the position differs depending upon the lessor’s country of residence.
Given these complications, it is important for lessees to establish the WHT position before entering into any contracts.
The above considerations would apply equally to the overseas lessors, who need to consider whether they have a taxable presence in Australia as a result of their leasing activities.