Article 8 deals concern the taxation of profits from operations of ships and aircraft in international traffic.
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In this topic, we will cover the following:
What is International Traffic?
To begin with the Article, we need to understand what international traffic is. The term ‘international traffic’ is defined under subparagraph e of Paragraph 1 of Article 3 as
“any transport by a ship or aircraft except when the ship or aircraft is operated solely between places in a Contracting State and the enterprise that operates the ship or aircraft is not an enterprise of that State.”
For more information on it, refer the post on Article 3.
Who has the taxing rights in case of international shipping and air transport?
Erstwhile OECD model convention stated that the taxing powers would be left to the Contracting State in which the place of effective management of the enterprise was situated. But the review of the treaty practices of many countries revealed that they prefer to assign the taxing rights to the Contracting States where the enterprise exists. Hence the Article was changed in 2017.
Profits of international shipping and air transport can be bifurcated into three parts:
Profits obtained by the enterprise from the transportation of passengers or cargo by ships or aircraft (includes ownership, and lease).
Profits from activities directly connected with the operation of the enterprise’s ships or aircraft in international traffic. The activities directly related can be identified as any activity carried on primarily in connection with transportation.
Profits from the activities which are ancillary to the operation of the enterprise’s ships or aircraft in international traffic. The ancillary activities are the activities that the enterprise does not need to carry on for its operations of ships or aircraft in international traffic but which makes a minor contribution relative to such operation.
Note: Paragraph 1 of Article 8 does not apply to a shipbuilding yard operated in one country by a shipping enterprise having its place of effective management in another country.
How to tax the investment income of shipping or air transport enterprise?
Investment income made from the treasury activities will be covered under the specific Article provided for the same. Income derived from the investments made as an integral part of carrying on the business of operating ships or aircraft in international traffic in the Contracting State so that the investment may be considered to be directly connected with such operation. For example, the income received from the security deposit maintained by the carrier with some international airport for providing the parking space will be treated as the income under Paragraph 1 of Article 8.
Note: Paragraph 1 of Article 8 applies to income derived by enterprises operating the ships or aircraft in international traffic concerning emission permits and credits where such income is an integral part of carrying on the business of operating ships or aircraft in international transport.
How to tax the operations undertaken through the pool, joint operations, or a global operating agency?
The business of international traffic through shipping an aircraft is extensive, and various international cooperation and arrangements exist. To clarify the taxation position of the participant in a pool, joint business or in an international operating agency and to cope with any difficulties which may arise, paragraph 2 of Article 8 of the OECD Model Tax Convention states that the profits derived from such activities are attributable to the participant in proportion to its share in the joint operation. And is covered under Paragraph 1 of Article 8.
Take the quick quiz for revision
#1. AirLance is an aircraft service for the passengers, which has flights from Munich-Berlin-London. The passengers board the separate plane from Berlin to London, and they have separate tickets for Munich – Berlin flight and from Berlin – London. Assuming AirLance is a UK based aircraft services and UK – Germany has adopted OECD Model Tax Convention, will Munich to Berlin flight be covered under International traffic?
The enterprise transports the passengers from one Contracting state to another, and to do so, it might include the inland transport of the passengers to arrive at the originating pickup place. Hence, Munich to Berlin flight of AirLance aircraft is covered under International Traffic
#2. AirLance, the UK based aircraft provider, is an aircraft service for the passengers from London – Berlin-Munich- Cape Town. AirLance sells the tickets for the Berlin-Munich, which is undertaken by AirGerman aircraft, a domestic German air carrier. Assuming UK-Germany has adopted the OECD Model Tax Convention, will the profit made by AirLance from the sales of the ticket of AirGerman be covered by Article 8?
The services of sales of tickets of Berlin to Munich were ancillary service undertaken by AirLance and hence covered by Paragraph 1 of Article 8.
#3. AirLance, international air carrier services between France and Germany, provides magazine for the passengers in its aircraft. It has advertisements for various products. Assuming France and Germany have adopted the OECD Model Tax Convention, the income received from such publications are taxable under which Article?
Ad based income earned by enterprises from magazines offered aboard operated ships or aircraft is ancillary activity. And profits generated by such advertising fall within paragraph 1 of Article 8.