Words and Phrases - "effectively connected"

The Indian-resident taxpayer performed services for its Australian customers from its offices in India and through an Australian permanent establishment. Art. 12(4) of the Royalty Article of the Australia-India Treaty provided:

The provisions of paragraphs (1) and (2) [of Art 12] shall not apply if the person beneficially entitled to the royalties, being a resident of one of the Contracting States, carries on business in the other Contracting State, in which the royalties arise, through a permanent establishment situated therein…and the property, right or services in respect of which the royalties are paid or credited are effectively connected with such permanent establishment…. In such a case, the provisions of Article 7 … shall apply.

The Indian taxpayer argued that the royalties received by it in India (which were accepted by Australia as not being attributed under Art. 7 to the Australian PE) nonetheless were “effectively connected” to that PE in the sense that the work in India advanced the common goal with the Australian PE of servicing the Australian customers. The taxpayer then argued that the quoted statement - that Art. 12(2) “shall not apply” - meant that Australia was precluded from imposing withholding tax on these royalties.

In rejecting this submission, and finding that the royalties were subject to Australian withholding tax, the Court stated (at paras 31, 43):

Article 12(4) is to be construed in the context that Art 7(7) gives priority to Art 12 over Art 7. Without Article 12(4), royalties forming part of the business profits of an enterprise attributable to a permanent establishment in the source State would be taxable by the source State but subject to a limit on the amount of tax that may be charged. No evident object or purpose is indicated, and none was suggested by the Appellant, for construing Art 12(4) in a way that would disentitle the source State from the right at all to tax a payment otherwise within the scope of Art 12(2) but outside the scope of Art 7. To the contrary, the evident purpose of Art 12(4) is to relieve the source State from the limitation on taxing rights imposed under Art 12 by taxing such royalties under Art 7, not to disentitle the source State from any taxing rights where otherwise Art 7 would not give such taxing rights. Such a construction gives effect to the language of Art 12(4) and is consistent with the extrinsic materials. …

Used as an adverb in conjunction with “connected”, “effectively connected with” should be understood to mean having a real or actual connection with the activities carried on through the permanent establishment. Whether or not such a connection exists is not answered merely on the basis that the property, rights or services provided “serve to effect the purposes of the permanent establishment”.