By Miles Hurst, Partner and Amrit MacIntyre, Partner, Baker McKenzie
Space is becoming crowded, with an ever increasing number of satellites orbiting the Earth. They belong to many countries, as well as private owners. The increasing economic activity carried on through satellite networks, both in orbit and in geostationary positions, has for some time raised questions as to the reach of the jurisdiction of States to tax that economic activity. These issues arise both in the context of goods and services tax (GST) or value added tax (VAT) and income tax as both governments and the courts attempt to deal with the questions at hand.
GST and VAT
In the context of GST and VAT, the question arises as to how far these systems of tax can go to tax economic activity occurring in space. This is a question that recently fell for consideration before the Court of Appeal of Nigeria in the case of Vodacom Business Nigeria Limited v Federal Inland Revenue Service (CA/L/556/2018). The particular question was whether a supply of satellite bandwidth capacities to a business in the jurisdiction from a non-resident foreign company was subject to VAT in Nigeria. The specific question was whether the service was under the relevant legislation “supplied in Nigeria”. The Court’s view was that VAT could and did apply on the basis that a service was supplied in Nigeria. It noted that the relevant satellite was located in orbit and the transmission of bandwidth capacities to and from the satellite was done by a transponder located in Nigeria. For this reason, even though the satellite was in orbit, the service it provided to the taxpayer was supplied in Nigeria.
The Court rejected a contention that to qualify as a service supplied in Nigeria, the service had to be physically rendered in Nigeria. The Court’s view was that insofar as bandwidth capacities were supplied into Nigeria, the foreign company carried on business in Nigeria within the meaning of the relevant VAT legislation since its services supplied in Nigeria were being utilised there.
The Vodacom case may break new ground in adopting a wide view of what constitutes a service in the jurisdiction and has as a result raised considerable interest globally. The Court addressed the tensions in GST between the “origin” principle which focuses on the place of origin of a service as determining the taxing nexus and the “destination” principle which focuses on where the service is consumed. The Court took a position in favour of the destination principle. This is in contrast to a 2016 case determined by the Income Tax Appellate Tribunal of India, Intelsat Global Sales and Marketing Ltd v ITO (ITA Nos 1070 to 1074 and 1621/Mds/2010), which took the view that if a taxpayer maintained a satellite in orbit and local companies were uploading signals and data transmitted by the satellite, the taxpayer might not have been rendering a service in the jurisdiction. The views expressed in the Intelsat case, it is submitted, represent the accepted view, at least until now.
The matters considered in the Vodacom case raise matters of interest in Australia because the GST Act looks for a territorial nexus similar to that considered in the Vodacom case to determine whether taxation should apply. The relevant test in Nigeria looks to whether “services are supplied in Nigeria”. The GST Act employs the concept of when a “thing is done in the indirect tax zone” (for relevant purposes, Australia). Specifically, a supply of anything other than goods or real property is relevantly connected with the jurisdiction if “the thing is done in the indirect tax zone” (s 9-25(5)(a)). Despite the differences in how the two tests are expressed, the findings of the Court in the Vodacom case as to where a service is supplied, it is submitted, may have relevance in determining where a thing is done for Australian GST purposes, although whether an Australian court is likely to favour an approach similar to that taken in the Vodacom case, over the more conventional approach, is less clear.
The issues raised by the Vodacom case may create particular questions for governments in the case of services provided into the jurisdiction by foreigners for consumption by non-business consumers in the country as it potentially opens the possibility of taxation of such services. However, in Australia, this was a matter dealt with by legislation in 2016 operating with effect from 1 July 2017 (Tax and Superannuation Laws Amendment (2016 Measures No 1) Act 2016, Act No 52 of 2016). These changes meant that a service supplied to an Australian consumer with no other connection to Australia could be brought to taxation within the GST system regardless of where the service provider was located and regardless of the means of delivery of the service. The issues arising in the Vodacom case will be less relevant in this situation.
Similar questions have been arising as to the extent to which States can impose income taxes or withholding taxes on income related to the economic activity of satellites.
The starting point for any income tax analysis is whether States can be entitled to tax profits attributable to foreign entities operating satellites fixed in a geostationary orbit above their territory. In most double tax treaties, a State can tax such profits if the activity creates a permanent establishment which, in simple terms, will generally be created if an entity has a fixed place of business in that State through which the business of an enterprise is wholly or partly carried on.
As a matter of international law, the accepted view is that States have complete and exclusive sovereignty over the airspace above their territory (Art 1, Chicago Convention on International Civil Aviation 1944). What is less clear is where “airspace” ends and “space” begins, with different views expressed as to where the exact vertical boundary of States should lie (see DN Reinhardt, “The Vertical Limit of State Sovereignty”, 72 J. Air L. & Com (2007), p 65)). For satellites clearly located in “space”, the generally accepted position, as reflected in the OECD’s commentary on the OECD Model Tax Convention on Income and on Capital (OECD Model Tax Convention), is that the satellite itself should not be considered a fixed place of business in a State even if it is geostationary. This may be tested as new products operating at the edge of space come to market.
A separate but related consideration is whether a satellite’s “footprint”, this being the area in which its signals are received, can be identified as a fixed place of business. The OECD takes the stance that a satellite’s footprint cannot be treated as a fixed place of business because the area cannot be said to be at the satellite operator’s disposal. India has adopted a different view, arguing that as the satellite’s footprint is fixed and has commercial value, it can be identified as a fixed place of business through which the entity is carrying on business in that State (India has a reservation to the OECD commentary on Art 5 of the OECD Model Tax Convention to this effect).
More recently, there has been some discussion as to whether States might be entitled to apply royalty withholding taxes to certain amounts payable to foreign satellite operators. In particular, satellite operators often enter into “transponder leasing” agreements with customers paying fees for the use of the satellite’s transponder transmitting capacity. Under most tax treaties, royalties are defined to include at the very least payments received as consideration for the use of, or the right to use, property, or for information. Under this definition, it is generally accepted that the better view is that payments made under a transponder leasing agreement should not generally be characterised as a royalty. The reasoning for this is that the payment is being made to use the transponder transmitting capacity of the satellite, rather than being made in consideration of the use of, or the right to use, the satellite. However, this reasoning is dependent on the drafting of both the particular transponder leasing agreement and the tax treaty in question, both of which vary.
A recent case in which this issue arose was Director Of Income Tax vs New Skies Satellite Bv  382 ITR 114, in which the High Court of Delhi was asked to decide whether the Indian Revenue Service (IRS) could tax income derived by a satellite operator under transponder leasing agreements. In this case, the IRS was seeking to tax the payments received by the satellite operators from their customers by arguing that these payments came under the meaning of royalties under both India’s domestic law and the relevant double tax treaties. Like many of Australia’s double tax treaties, the relevant treaty contained a wide definition of royalty which extended to payments as consideration for the use of, or the right to use, a “process”. In an unusual development, prior to this case reaching the High Court, the Indian legislature retrospectively inserted certain “clarificatory” explanations to the domestic law that sought to broaden the meaning of “royalty” and in particular, to provide that the “expression ‘process’ includes and shall be deemed to have always included transmission by satellite”. The IRS argued that because the signal underwent various processes in the satellite before being broadcasted in India, the income received by the satellite operators was payment for use of a process and therefore a royalty under this definition. The IRS further asserted that the meaning of “royalty” in the relevant double tax treaties had always been interpreted consistently with the retrospective clarificatory explanations.
The Court rejected the IRS’ argument, holding that these payments were not royalties because although there was some processing, the customer’s payments under the transponder leasing agreement should not be considered to have been for the use of, or right to use, that process in the context of the treaty because no satellite technology was transferred to the customer. It also held that the clarificatory explanations inserted into the domestic law could not extend in operation to influence the interpretation of the relevant tax treaty, in the absence of any agreement between India and the other party to the treaty and that India’s reservation to the OECD commentary in and of itself did not influence the interpretation of the treaty in question. Whilst the IRS was unsuccessful in New Skies, the case nonetheless highlights that there are questions here to consider.
The taxation questions arising out of the delivery of services in and from space will continue to remain relevant with increasing levels of economic activity in space and, increasingly, on the edge of space in the upper layers of the earth’s atmosphere. As matters presently stand, the ability to tax that activity may generally require finding some kind of taxing nexus with the jurisdiction, leaving open questions as to how governments will in the future deal with cases where no such connection can easily be found.
There are strong views in many end-market economies and developing economies that the current rules are not fairly allocating taxing rights where profits are being derived from business activities in their market. This group of countries is increasingly exerting their influence to address these concerns, most recently through the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). As pressure increases internationally to have more weight given to market factors rather than traditional geographical concepts when allocating taxing rights between States, the application of arguably outdated treaty concepts to economic activity in space will no doubt continue to be tested.
These questions may acquire a new relevance in Australia in light of the federal government’s recently announced initiative to fund local businesses operating in the space sector to the order of $150m as part of a partnership between the Australian Space Agency and NASA.
However, taxpayers facing ATO audit hypotheses that involve the proposed reconstruction of a transaction under Div 13 of ITAA 1936 or Subdiv 815-A of ITAA 1997 should carefully consider the findings in the Glencore case in light of their own facts and having regard to expert evidence as required. If the audit hypotheses involve the application of s 815-130 of ITAA 1997, taxpayers should carefully consider whether those provisions permit the ATO to disregard the actual commercial or financial relations in connection with which actual conditions operate in light of relevant evidence, including expert evidence.
[This article was originally published in CCH Tax Week on 11 October 2019. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]