For business information, annual reports, laws, ordinances, regulations and articles.

	Web Paksearch.com

(1) Profits from the operation of ships or aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

(2) Profits from the operation of boats engaged in inland waterways transport shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

(3) If the place of effective management of a shipping enterprise or of an inland waterways transport enterprise is aboard a ship or a boat then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship or boat is situated, or, if there is no such home, harbour in the Contracting State of which the operator of the ship or boat is a resident.

(4) The provisions of paragraph (1) shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

ARTICLE 8B
(ALTERNATIVE B)

(1) Profits from the operation of aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

(2) Profits from the operation of ships in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated unless the shipping activities arising from such operation in the other Contracting State are more than casual. If such activities are more than casual, such profits may be taxed in that other State. The profits to be taxed in that other State shall be determined on the basis of an appropriate allocation of the overall net profits derived by the enterprise from its shipping operations. The tax computed in accordance with such allocation shall then be reduced by- per cent. (The percentage is to be established through bilateral negotiations).

(3) Profits from the operation of boats engaged in inland waterways transport shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

(4) If the place of effective management of a shipping enterprise or of an inland waterways transport enterprise is abroad a ship or boat, then it shall be deemed to be situated in the Contracting State in which the home harbour in the Contracting State of which the operator of the ship or boat is a resident.

(5) The provisions of paragraphs (1) and (2) shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

49. Scope
The main object of this Article is to restrict the jurisdiction of one State in respect of the profits arising from operation of ships or aircraft in international traffic, that is the State where the effective management of the enterprise is situated. The profits earned by the enterprises are wholly exempt from tax, in the source country because income derived from transportation is income from services, and that income from services has its source in the place where service is rendered. Since service of transportation is rendered on high seas or the space the question of taxability of income arising from the operation of ships or the aircraft in the source country does not arise. If the domestic laws of each country were made applicable, there would have been likelihood of consequence of double taxation. Difficulty would also have arisen about the allocation of income amongst various States. The possibility of the enterprise of paying taxes in the other States could not have been ruled out irrespective of the enterprise incurring losses from the operation of ships or aircraft.

The rule of establishment of a permanent establishment (Article 5) and of the business carried through it (Article 7) do not govern the taxation on the profits from the shipping business. The rule that governs its taxation is an operative rule, which gives exclusive right to the residence country under the OECD Model. The taxation presents complex problems, if the carrying on business is treated at par with any other kind of business and its taxability is qualified by the provisions of Articles 5 and 7 relating to business profits· Taxability on the basis of the permanent establishment rules would have meant that every country would have taxed a portion of the profits of a shipping organisation, computed in accordance with its own laws, and thus the likelihood of the sum of these portions exceeding the total income of the enterprise. The possibility cannot also be ruled out when an enterprise could derive all its income without ships calling at the ports of the residence country.

The OECD Model Convention gives right to the residence State (effective management), irrespective of the contribution of the traffic operated through the other State to the income generated from such operation of aircraft or ships or of the permanent establishment. Conferment of the exclusive right to the State of existence of effective management is dictated by the consideration of difficulty in apportioning profits amongst various permanent establishments of such an enterprise.

The paramountcy of the residence rule demands sacrifice by the developing countries to forego their share of profits which could have belonged to them according to the source rule. Since the developing countries were not in a position to forgo even the limited revenue from taxing the shipping enterprise, especially those whose shipping industries have not been fully developed, the UN Model suggests how the profits from the business of shipping to be taxed. Two problems, namely, determination of shipping profits and allocation of such profits to the various countries, are resolved in the UN Model, as an alternative to the traditional approach of the OECD Model. The country of source, apart from the country of residence, in which shipping activities of more than a casual nature are conducted, might also impose a tax. The profits to be so taxed are determined on the basis of an appropriate allocation of the overall net profits derived by the enterprise from its shipping operations, and the tax computed in accordance with such allocation is to be reduced by a percentage, which is to be established through bilateral negotiations. This alternative is the method of taxing shipping profits by a country, other than a country of residence (effective management) in which shipping activities are conducted (source countries). As an alternative to this method, there is a different method, such as computing source country income as a percentage of source country receipts.

Article 8 consists of two alternatives: one (A) corresponds to the Article of the OECD Model Convention and the other (B) represents an accommodation of the views of the developing countries that income from shipping, inland waterways transport and air transport should be shared by the country of residence (effective management) of the enterprise and the country in which the activities are conducted (source country). Shipping profits under the OECD Model Convention are taxable exclusively by the country of residence or the place of effective management of the shipping enterprise.

49.1. Article 8A - This Article corresponds to Article 8 of the OECD Model Convention. Under this Model, profits from the shipping business are taxable exclusively by the country of residence or the place of management of the shipping enterprise. These are not taxable at the source. Article 8 of the Model reads as follows:

"1. Profits from the operation of ships or aircraft in the international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

2. Profits from the operation of boats engaged in inland waterways transport shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

3. If the place of effective management of a shipping enterprise or an inland waterways transport enterprise is aboard a ship or boat, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship or boat is situated, or, if there is no such home harbour, in the Contracting State of which the operator of the ship or boat is resident."

49.2. Article 8B - Developing countries did not wish to adopt the OECD Model Convention and have been demanding a share in the profits of the enterprises which could be allocable to the transportation of goods, merchandise or passengers from their ports. Their insistence was on the adoption of the principle of source taxation and Of the sharing the revenue at an agreed percentage. The peculiarity of the shipping business poses two problems, if the source principle is recognised for sharing the revenue, namely, determination of shipping profits and the allocation of such profits to the various countries concerned. As an alternative to the traditional approach of the OECD Model Convention, the UN Model suggests that the country of source, apart from the country of residence, in which shipping activities of more than a casual nature are conducted may also impose a tax. The profits to be taxed in the State other than the resident State is to be determined on the basis of an appropriate allocation of the overall net profits derived by the enterprise from its shipping activities. As regards tax computation, the Model suggests that tax computed in accordance with such allocation is to be reduced by an appropriate percentage to be negotiated bilaterally. Article 8B contains an approach alternative to the method of exclusive taxation in the country of residence (effective management). It provides that the source country (apart from the country of residence) in which shipping activities of more than casual nature are conducted, might also impose a tax.

Under the UN Model profits from the operation of ships in international traffic might also be taxed in which the shipping activities that are more than casual are conducted. Only if the activities (apart from regular and frequent shipping visits) are more than casual, the taxability of profits arising therefrom is governed by the provisions of this Article, on the source principle. The question of allocation of profits arises if the shipping activities are more than casual (apart from frequent and regular); otherwise the profits from the operation of ships in international traffic is taxed on residence rule (effective place of management).

'Casual' means subject to, resulting from or accruing by chance; occurring without regularity - occasional; employed for irregular period - Webster's Dictionary. According to Shorter Oxford English Dictionary, the word 'casual' is defined to mean (i) subject to or produced by chance; accidental fortuitous; (ii) coming at uncertain times; not to be calculated on, unsettled. It means accidental or fortuitous all of which suggest absence of any previously entertained object or intention. Shipping activities being more than casual may mean the activities which are not casual or occurring without regularity, or even irregular or isolated shipping visits, provided they are planned for and not merely fortuitous in the circumstances. The phrase 'more than casual' connotes a scheduled or planned visit of a ship to a particular country to pick up freight or passenger.

The shipping activities, if are occasional or irregular, i.e., not more than casual the entire income, may be taxed only in the Contracting State in which the effective management of the enterprise is situated. But such a provision does not affect the applicability of the provisions in sub-sections (1) to (6) of section 80 of the Ordinance, to the assessment of profits derived by the residents of the other country from the occasional shipping.

Profits derived from the operation of ships in international traffic is subject to the treaty provisions; and not those derived from the coastal traffic. Coastal traffic means traffic which originates and terminates in the territorial waters of the same Contracting State. Similarly, where income from the operation of ships in international traffic is derived by an enterprise of one of the Contracting States from a State other than the Contracting States, such income is taxed only in the Contracting State of which the enterprise is a resident.

50. Determination and allocation of profits to source State
If the shipping activities are more than casual with reference to the State other than the State in which effective management is situated, the profits allocable to that State have to be determined on the basis of agreed rules. The issues involved in taxing profits from the shipping business are mainly determination and allocation of the profits between the concerned States, the levy of tax by the host country and also the credit of such tax in the home country. The allocation should be decided on a basis which permits the source country to impose its tax on profits from outgoing freight, and the amount allocated does not exceed that portion of world-wide profit of the enterprise from shipping operations which the outgoing freight attributable to the source country is of the total outgoing freight. If the allocation of profit and taxation thereon is heavy, the shipping enterprise should be free to invoke the provision relating to Mutual Agreement Procedure (Article 25). The net profits as determined by the authorities of the country of residence of the enterprise is the starting point. It furnishes a certificate stating the net profits of the enterprise from shipping and the amounts of any special items, including prior year lessees, which have been decided to be included or excluded as for example as found in the agreement between Pakistan, Hungary and Indonesia.

The other method is the determination of profits on the basis of an appropriate allocation of the overall net profits derived by the enterprise from its shipping operation, as is followed in the agreement with Denmark.

In some of the agreements no procedure about the appropriate allocation has been prescribed, they only contain a statement that profits derived from the operation of ships in international traffic may be taxed in the Contracting State in which such operation is carried, as for example, in case of Turkey. Similar provision is found in the agreements with Denmark, FGR, Finland, France, Greece, Japan, Malaysia, Norway, Uzbekistan, Singapore, Sweden, Bangladesh and UK.

Another illustration is found in the agreement with Kenya, where a certain percentage of profits from shipping is taxable by the source country.

The amount of profit to be taxed by the source country should be that which is calculated in accordance with the law of that country, which, however, should not exceed five per cent of full amount received by the enterprise on account of the carriage of passengers or freight embarked in the source country.

The amount thus allocated is subjected to tax which is based on some proportional factor. The factor as far Pakistan is concerned has been 50: 50. Its treaties with other countries normally provide for the reduction of tax by 50 per cent. For example, in agreements with Belgium, Sri Lanka, Denmark, FGR, Finland, France, Greece, Japan, Kenya, Libya, Norway, Singapore, Malaysia and Indonesia.

Pakistan has thus adopted a unique solution to the problem relating to taxation of shipping profits; by a rule of thumb, fifty per cent of the profits arising from that business in the country of source is taxed. Exceptions are few. In case of Denmark, the agreement provides that the tax charged by a country in respect of profits arising in that country be reduced by 25 per cent in the next five years. No reduction of tax is to be made after it has been determined on the basis of income allocable to the source country, in case of an enterprise of Philippines or vice versa. The question of credit does not, therefore, arise. As regards UK, the provision is peculiar. Income of an enterprise of a Contracting State is taxable only in that State, except that income is taxable in the other Contracting State from which it is derived in any one or more of first ten fiscal years, for which the convention has effect and the tax chargeable is to be fifty per cent which would have been chargeable in the absence of this convention for the first five fiscal years and thereafter it is to be 25 per cent for the next following five years.

The reduction of taxes after they have been computed, (whether two-third, one-half, or one-fourth) on the basis of allocated profits is intended to achieve a sharing of revenues that would reflect the management and capital of the residence country devoted to the enterprise.

50.1. Shipping and air transport profits include income from incidental activities - Income from shipping and air transport is not restricted alone to income in relation to transport by a ship or aircraft operated by an enterprise but it also includes amounts which are referable to such activities. Interest of funds directly connected with the operation of ships, aircraft in international traffic is regarded as income from the operation of such aircraft and the provisions of Article 8 will have effect and not those of Article 11. Agreement with Turkey and Belgium provides similarly income from the rental on a bareboat basis of ships is taken income from the operation of ships, if such rental income is incidental to the income from such operation in international traffic. Income from the use, maintenance, rental of containers (including trailers and related equipment for the transport of containers) used for the transport of goods or merchandise is deemed to be income of the enterprise from the operation of ships, notwithstanding the provisions of Article 7 (business profits). An establishment which is exclusively engaged in providing shipping transport facilities does not cease to be an establishment exclusively carrying on the said business merely because it sets up an on-shore workshop for effecting repairs exclusively to its own ship. To carry on any activity which is essential for its business effectively, some other activity has been undertaken by an establishment that establishment cannot, be said that it has commenced to carry on another industry.

In a recent decision of the Supreme Court of Philippines, British Overseas Airways Corporation (BOAC) was required to pay tax on the income which could be said attributable to the sale of tickets in Philippines. BOAC had no landing rights and certificate of public convenience for traffic purposes in the Philippines in the years 1959 to 1971. Hence, it did not carry passengers and/or cargo to or from Philippines although it maintained a general sales agent (GSA) in the Philippines for setting BOAC tickets for passengers and cargo. A question arose whether the revenue derived from the sale of its tickets in the Philippines by its GSA constituted Philippinest source of income. BOAC had urged that income derived from transportation is income from services having its source in the place where the service is rendered - that because BOAC'S service of transportation was performed outside the Philippines, the income therefrom was from sources outside the Philippines and was, therefore, not taxable under the Philippines tax laws. The Supreme Court, in the majority decision, held that the test of taxability is the 'source' and the 'source' of income is the 'activity' that produced the income, viz., the sale of tickets in the Philippines.

This decision is illustrative of how the application of domestic laws could result in demanding tax which otherwise should not have been payable had there been an agreement for avoidance of double taxation. Such double taxation may hamper the flow of international traffic.

Operational activity in order to become fully functional requires some supportive and auxiliary activities, such as transportation of goods by truck connecting a depot with a port or airport, containers frequently are used in inland transport, the operation of bus service connecting town with its airport, the sale of passenger tickets, advertisements, delivery of goods to the consignee, maintenance of guest houses or rooms in hotels for the stay of passengers or crew during transit are some of the auxiliary activities which have necessarily to be undertaken for the efficient operation of ship or aircraft. The cost of each such activity is included in the ticket.

The nature of the ticket issued by enterprise operating ship or aircraft has wholly in the right acquired by the 'purchaser' - the passenger - to demand a prestation from the enterprise, and such a prestation consists of the carriage of passengers or goods from one destination to another. The ticket is really the evidence of the contract of carriage by the ship or airline between the enterprise and the passenger. The purchase price of a ticket is quite different from the purchase price of physical goods or commodity. It is really a compensation paid for the undertaking of the enterprise to transport the passenger or the cargo.

50.2. Special provisions in sections 80A and 80AA of the Ordinance - Income is deemed to have a source in Pakistan if it is derived from the carriage by sea or air of passengers, livestock, mail or goods. However, sections 80 and 80A are the special provisions for the computation of profits and gains of the business respectively of shipping or aircraft operation, in case of non-resident assessees. In the case of shipping business profits and gains chargeable to tax is calculated at the rate 8 per cent, and in case of business of aircraft operation 3 per cent of the aggregate of the following amounts:

- The amount paid or payable to the assessee, whether in or out of Pakistan, for such carriage from any port (place) in Pakistan
- The amount received or deemed to be received in Pakistan from such carriage from any port (place) outside Pakistan

No deduction for expenditure is allowed. If the destination of the carriage is in Pakistan, the entire amount irrespective of whether payment is made in or out of Pakistan, and if such destination is not in Pakistan only that payment which is received or deemed to be received in Pakistan, is the basis with reference to which chargeable profits at the rate of 8 per cent has to be computed. As aforesaid, no further deduction as provided in section 23 of the Ordinance is permissible for arriving at the taxable income. But the double taxation agreements provide further relief. They either provide complete exemption in case of non-resident assessees, except for transport exclusively within Pakistan; or provide that in case of aircraft operations the profits from the international traffic be only taxed in the country in which the enterprise is situated and in case of shipping operations the profits of that enterprise may be taxed in Pakistan but some percentage of such tax has to be reduced for gross amount of tax.

51. Agreements limited to international maritime and air traffic
Agreements with Greece, India, Iran, Jordan, Kenya, Lebanon, Saudi Arabia and USA cover only international maritime and/or air traffic. These agreements are based on the principles of sovereign equality, national interest and mutual advantage and assistance.' Broadly, they reflect the principle of equality in the distribution of cargo its transportation, and freight earnings and avoidance of competition in trade with the third countries. They provide for adoption of all appropriate measures within the limits of the laws and regulations of each country to facilitate and expedite maritime traffic, to prevent delays to vessels and to expedite the completion of customs and other formalities at ports. From the tax angle, the agreements provide for exemption from income-tax on freight earnings on cargoes carried by vessels from the ports of one country to those of the other.

Profits of non-residents from the shipping business is chargeable in Pakistan in the manner as laid down in section 80. This section, however, gives way to the treaty provisions. Section 80 is only a special provision which provides for the assessment and recovery of tax at the point where a foreign vessel leaves the Pakistani shores and the provision is merely intended to ensure that there may not be any evasion of tax due on the freight and passenger fare earned which would be income accruing or arising in Pakistan.

Freight earnings are normally agreed not to be subject to income-tax by the Contracting State. Freight earnings mean the reward payable to the carrier for the carriage of the goods. The payment which the charterer agrees to make to the owners of the ship should be in consideration of the carriage of the goods, i.e., the amount is payable on account of the carriage of the goods. It has, therefore, to be shown that one is the consideration for the other. The exemption from tax on an income on freight earnings applies only to cargo carried from the port of one Contracting State to the port of another Contracting State. If destination is the third State, the provisions of the treaty are not applicable.

	Web Paksearch.com

Home | About Us | Contact | Information Resources