In this series, we will be discussing the Convention Between the Government of the United States of America and the Government of Australia for the Avoidance of Double Taxation and Fiscal Evasion concerning Taxes on Income 1982 and the 2001 protocol (DTA).
These series aim to make sure the reader has a comprehensive understanding of the DTA and how to interpret and apply it correctly.
The only way to get a comprehensive understanding of the DTA is to make sure you understand every article on its own.
If the reader is anything like my wife, you will probably question the above statement and see it as a way of me dragging it out. Especially considering that the DTA only consists of 29 Articles in a 27-page document. How complicated can it be?
Well just to give you some perspective, the US bases all its DTAs on the US Model Tax Treaty. This model is used as a foundation and guideline on how to draft specific DTAs with various countries. The US Model Tax Treaty also has a Technical Explanation to understand how to interpret and apply a DTA. The technical explanation is 92 pages long.
Most countries in the world (excluding the US) follow the Organization of Economic Co-operation and Development’s (OECD) Model Tax Convention which consists of 32 Articles. The commentary on the OECD’s Model Tax Convention is 658 pages.
I would therefore recommend not taking international tax advice from my wife or any advisor who summarizes the DTA in one or two pages. It’s not that simple.
In this week’s blog, we will discuss Article 1 of the DTA – Personal Scope
The main reason why countries across the world implement DTAs is to avoid the imposition of comparable taxes in two or more countries on the same taxpayer in respect of the same subject matter and for identical periods. The harmful effects of double taxation on the exchange of goods and services and movements of capital, technology, and persons are so well known that it is scarcely necessary to stress the importance of removing the obstacles that double taxation presents to the development of economic relations between countries.
DTAs, therefore, help to clarify, standardize, and confirm the fiscal situation of taxpayers who are engaged in commercial, industrial, financial, or any other activities in other countries through the application by all countries of common solutions to identical cases of double taxation.
The US and Australia tax their residents on a worldwide basis and non-residents on a source basis. So, these tax systems will seek to levy taxation where there is a source of income in a state/country (state is the term used for the country, either the US or Australia) and/or a person who is a resident in a country. Both source and residence are referred to as ‘connecting factors’ in the world of public international tax. This is where the DTA comes into play, to ascertain whether the US or Australia has taxing rights on a specific type of income.
INTERPRETING ARTICLE 1 OF THE DTA – PERSONAL SCOPE
Article 1 of the DTA states the following –
Except as otherwise provided in this Convention, this Convention shall apply to persons who are residents of one or both of the Contracting States.
This Convention shall not restrict in any manner any exclusion, exemption, deduction, rebate, credit, or other allowance accorded from time to time:
by the laws of either Contracting State; or
by any other agreement between the Contracting States.
Notwithstanding any provision of this Convention, except paragraph (4) of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)) and individuals electing under its domestic law to be taxed as residents of that state, and because of citizenship may tax its citizens, as if this Convention had not entered into force. For this purpose, the term “citizen” shall, for United States source income according to United States law relating to United States tax, include a former citizen or long-term resident whose loss of such status had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.
The provisions of paragraph (3) shall not affect:
the benefits conferred by a Contracting State under paragraph (2) of Article 9 (Associated Enterprises), paragraph (2) or (6) of Article 18 (Pensions, Annuities, Alimony and Child Support), Article 22 (Relief from Double Taxation), 23 (Non-Discrimination), 24 (Mutual Agreement Procedure) or paragraph (1) of Article 27 (Miscellaneous); or
the benefits conferred by a Contracting State under Article 19 (Governmental Remuneration), 20 (Students) or 26 (Diplomatic and Consular Privileges) upon individuals who are neither citizens of, nor have immigrant status in, that State (in the case of benefits conferred by the United States), or who are not ordinarily resident in that State (in the case of benefits conferred by Australia).
This paragraph sets out the scope of DTA’s application. It applies to residents of the US and/or Australia. However, the scope is extended in certain articles of the DTA and can also apply to residents of third countries, for example, Article 10 (Dividends), Article 11 (Interest), and Article 25 (Exchange of Information). A resident is defined in Article 4 of the DTA.
This paragraph goes on further to state that the DTA may not increase tax above the liability that would result under either the US or Australian domestic legislation or any other agreement between the US and Australia. It also provides taxpayers with the option to rather apply domestic law instead of the DTA, if the domestic law provides the more favorable treatment. A taxpayer, however, may not make inconsistent choices between the rules of the Internal Revenue Code and the DTA rules.
This paragraph is probably one of the most important provisions of the DTA as it lays the foundation of taxing rights for the rest of the DTA. It provides the US with broader powers than what is usually provided to other countries in DTAs. This is due to the US being one of the only countries in the world (the other country is Eritrea) to continue to tax individuals who are US citizens on a worldwide basis irrespective of where they live in the world.
It contains a ‘saving clause’ which stipulates that the US and Australia reserve the right to tax its residents as if the DTA had not come into effect. The US and Australia also reserve the right to tax their citizens, individuals electing under their respective domestic laws to be taxed as residents, and in the case of the US, former citizens whose loss of citizenship had as one of its main purposes the avoidance of tax. This reservation was extended in the 2001 protocol to include not only former citizens but also former long-term residents of the US. This was to ensure that the DTA is consistent with US law, more specifically Section 877 of the Internal Revenue Code.
Section 877(c) provides certain exceptions to these presumptions of tax avoidance. The US defines ‘long-term resident’ as an individual (other than a US citizen) who is a lawful permanent resident of the United States in at least 8 of the prior 15 taxable years. An individual is not treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country and the individual does not waive the benefits of such treaty applicable to residents of the foreign country.
The major thing to note here is that even though the right to tax its citizens is reserved for Australia as well, Australia does not tax individuals based on citizenship. Whereas in the case of the US, individuals are taxed based on citizenship.
This paragraph sets out the limitations of the saving clause and where other provisions of the DTA will override the savings clause. The saving clause does not override the benefits provided under paragraph 2 of Article 9 (Associated Enterprises), relating to correlative adjustments of tax liability, or the benefits of paragraphs 2 or 6 of Article 18 (Pensions, Annuities, Alimony and Child Support), relating to social security payments, alimony and child support.
Social security payments and similar public pensions paid by Australia and alimony, child support, and similar maintenance payments arising in Australia are taxable only by Australia even though the recipient may be a resident of the US. Similarly, social security payments by Australia to a citizen of the US, wherever resident, are taxable only in Australia.
The benefits provided in Articles 22 (Relief from Double Taxation), 23 (non-Discrimination), and 24 (Mutual Agreement Procedure), and the source rules of paragraph 1 of Article 27 (Miscellaneous) are also available to residents and citizens of the Contracting States, notwithstanding the saving clause.
THE IMPORTANCE OF READING COMPREHENSION
Although most people can read, the act of reading and the act of comprehending what you read are two very different things.
Reading comprehension is the ability to process text, understand its meaning, and integrate with what the reader already knows.
Lawyers generally know the importance of reading comprehension. At law school, students are taught how to interpret legislation. So, this is not a gift or talent, lawyers are born with, but rather a skill set you can develop that will be extremely beneficial when looking at the DTA.
The reason why it is extremely important to understand the DTA and more specifically Article 1 of the DTA, is so that you understand if the DTA even applies to you. We’ve assisted numerous clients who either misinterpreted the application of the DTA or whose advisor misinterpreted the application.
The key questions you should consider to ensure the correct application of the DTA is –
- What is the scope of the DTA and do I fall within that scope to use the DTA?
- Am I a resident of Australia or the US for purposes of the DTA?
- What are the benefits available to me in the DTA?
- What is the limitation of benefits in the DTA?
- What is the interplay between US/Australia domestic legislation and the DTA?
Our team of International Tax specialists at Asena Advisor has an in-depth knowledge of how to interpret international tax treaties and how to ascertain their applicability to your specific circumstances.